'We're Not Carnival Barkers': Who Wins the CFTC's Prediction Market Brawl?

Transcript

If you're an executive at um you know poly market or call sheet call me up we can talk about it parametric insurance right why aren't these guys building in this space because that is a highly illquid opaque and I would say un you know unsubstantial marketplace that doesn't live on chain doesn't have smart financial quants trying to solve the problem through DeFi and is more or less trafficked by a bunch of parasitic brokers and large balance sheet players. Hey everyone, welcome to Bits and Bips where we explore how crypto and macro collide one basis point at a time or I guess today tens of basis points at a time. We're here to discuss the latest stories in the worlds of crypto and macro. As a reminder before we dive in, Bits and Bips has its own channels. Now,

if you're listening on the Unchained feed, come subscribe to Bits and Bips directly so you don't miss an episode. And before we begin, a word from one of our sponsors. This episode is brought to you by 1- in Aqua, the shared liquidity layer from 1 in. Back multiple liquidity positions with one wallet balance and keep your tokens in your wallet until a swap fills. See how it works at 1in.com/aqua. Not listening to Bits and Bips yet? It's our weekly crypto and macro market show with Rahm Alawalia, Austin Campbell, and Chris Perkins. Search Bits and Bips and subscribe.

All right, everybody. Quick market snapshot because we're going to be talking markets today. Uh, Bitcoin touched 80K, currently is hovering in the high 7,800s as I'm looking at my screen here. Uh, extending last week's run. Um, spot Bitcoin ETFs flipped hardened inflows. We've seen billions of dollars in across the entire week. Over 500 million Wednesday and Thursday and over 300 mil on Friday from the numbers I have in front of me. The 30-year Treasury yield remains elevated in the 5.2s. Uh highest basically since 2007.

10 years not much lower at 4.65. So where we are with all of that is Bitcoin is now only 37% below its all-time high. Um for today as always I'm your host Austin Campbell high scholar of zero knowledge group. I'm here with my two usual co-hosts Ram Alawalia maester of wealth the leader of Lumida and Chris Perkins the golden hand of Franklin Crypto. But today I am particularly excited because we have Gordon Grant with us portfolio manager head of derivatives at Bitwise. So to lay everything out before we start talking markets, everybody remember we've got Bitwise on here, we've got

Franklin on here and I used to run stable coins at Paxos. So all of us have views. Um let's start with some framing and then I want to talk markets, guys. So the tape last week turned pretty hard. Bitcoin topped 75K and kept running over the weekend and into today. As we said, the ETF flows flipped. Uh, and the catalyst appears to have been the Treasury. They started doing long-end buybacks, talking 30-year sector with maybe some in the 10 to 20 year. They were looking at 2 billion up to 4 billion, maybe more as of today, and 30-year yields ran up.

4 billion is limited relief in a 32 trillion market. But there are some people who are saying this is positive. So Arthur Hayes uh on Laura's Unchained interview said I think this is the beginning of a major move on Treasury buyback change. Wars and Bessant are quote running the Powell and Yellen playbook. Keep the short end cheap so the Treasury can issue short and buy back long. A sort of operation twist. quote, "They are going to start printing money and the buyback is meant to scare the market into believing 5% on the long bond is the level we'll defend it at."

Um, ETH cleared 3,000 on that, but other analysts have stressed the buyback is not QE. The Fed did not turn on the printer, and that the bond market moved first, and it was a short squeeze that did the rest. So I want to start before we get into some of the other commentary since we have a few people here who know a little bit about these markets and Gordon I'll go to you first. When you're looking at what Vessant is doing and what it's doing to perceptions and volatility in the market, what are you seeing here? I feel like Bitcoin was kind of the last of large cap liquid assets X crypto to pick up on the volatility bug that's

been percolating, permeating, pervading uh the macro space for the last several months. We had chips and GPUs and data center players and large cap fintech and then the energy markets earlier in the year uh and rates themselves. And I think what Bessant has done from my perspective, right, sitting here and trying to run a number of significantly sized uh Bitcoin and crypto volatility books is make a connection between tradi rates volatility and now crypto volatility in a way that is meaningful to institutional participants and that a narrative can be built around. uh and I I think the market reaction is really

saying not much more than that which is to say as you pointed out Austin volumes are not so significant from this perhaps redux of operation twist and the context of the size of the market but signals can be as effective as sizes uh I think we we saw this a little bit with the way uh micro strategies own policy articulation played out earlier in the year when signaling wasn't effective it took some size to finally get things moving here it's a bit of the opposite u and the expectations around what it could mean if there's a steep yield curve and exactly the type of behavior that you you meant people hear think see and project in terms of price and their participation burr even if the liquidity is not yet hitting the system and

probably from a delta or second order perspective it matters more because most folks who are watching might have started to sense palpably that the tide was going out on liquidity And this matters, right, in in some substantive way. >> Rahm, I want to flip over to you as somebody who's been following markets for a while here. What are you making of the price action over the last week? >> Well, it's extraordinary. There's a lot happening. Number one is after Bessant had the uh intervention into the end market that set commodities racing again. And if you look at the spy versus gold chart for example, you know, commodities just out running. So that's

called the debasement trade. Uh and then you had Trump's comments around crypto which has sparked an incredible short squeeze in Bitcoin. Uh and you have the Treasury Secretary talking about hyperlquid. It's like we're in a parallel universe. I mean it's as strategic apparently as like Taiwan semiconductor. still continue to think like that is the asset of this cycle. It's got all sorts of interesting you know properties around it. We talked about this a few months ago the you know the the circle and Coinbase uh deal with them. Um you know bit Bitcoin is a momentum asset. It it does have momentum now and uh unlike other assets momentum assets just kind

of tend to keep going. So when they have momentum, you don't you you don't want to like fade that. It is at a very interesting juncture uh right now and you really have to manage this like daytoday. Um is how I would look at it. You know there seems to be a bit of waning momentum around there but you don't have any you don't have any red bars yet. So you know I think there's like a tactical view and then strategic view. I can't even think that Hyperl is like the better asset in the category. U you know Trump also has midterm elections coming up. He doesn't want investigations from the house. Uh and who got him elected?

Fair shake pack. So the timing around this intervention plays to the political cycle as well. Uh clarity act has been challenging. This is a way to deliver a win and potentially uh juice up those coffers to set up for the next midterm fight. >> Yeah, I was going to say, do you guys see the Bitcoin gold chart? >> It's been pretty much vertical. Uh which is which is really I think it's a good story for Bitcoin. And you know, just to unpack some of the stuff you guys said, we've been talking on this show for a long time about the new uh Treasury Fed accord, right? And um I think you're going to see more of this in action this week as um Worse ends up in Jackson

Hole. Probably not going to say a ton because he said told people he's not going to say a ton, but what are you seeing? You're seeing these two guys working in very close coordination. And what have we known since the beginning? Um it's that Bitcoin, it's that crypto. It's very very responsive to liquidity. It's very very responsive to rates. Um, I think people are starting to see that Wars will may say some things, maybe he'll be hawkish, but I know we just don't see him moving rates anytime soon. He was not put in the seat if the president thought he was going to raise rates in any way, shape, or form. And you're seeing a lot of um a lot of the yield yield curve, I guess I don't want

to say control, but action being a function of Bessant. Um and um you know, is this the beginning of a new regime? Well, it's pretty clear to us that Besson himself uh is very focused on keeping rates in check. He talks often about the 10-year. Uh maybe this time he went out a little further on the curve. Um this also plays very nicely into the stable coin story. If we can get stable coins going because if we can move um debt to the front end of the curve, short-term treasury bills, we can issue more stable coins, we can have people consume those stable coins, yields will stay nice and tight. Uh and that's good if you're running a government and you want to keep your interest rates in check. You don't want to pay all that interest, you know. So, I think that's

generally positive. So I think an interesting dynamic that's emerging there Chris to piggyback on your comments is if we look at the setup have Bessant talking about buying back the long end and issuing at the short end. We still have above target inflation for the Federal Reserve but we also have significant amounts of outstanding current Treasury debt. It puts us, if you really zoom out and think about government finances in the simplistic way possible, which is to say dollars in, dollars out, a very funny situation where I might say fiscal dominance, that is to say, the spending of Congress and the outstanding debt load means raising rates also strangely

shoots more money out of the fire hose. If you are quickly reinvesting all of this in short-term debt, there's more money going from the government into the private sector. So, one of the things that I've been keeping an eye on here, and Gordon, I actually want to flip this back over to you for your opinion, is the increasingly divergent behavior between the front end and the long end of the curve, right? Like we see this behavior in EM historically where the government starts doing things and kind of regardless of what they do, people lose confidence and the long end just starts going up and up and up. We're seeing a little bit of that in the United States and that also tends to be v. So what are you making of this whole situation through that lens?

>> Yeah, bingo. In a in a classical economics course, you you talk a lot about liquidity preference. I I liken this to excess variance causing a buyer strike. And that's really the problem here. There's actually nothing in common between 30-year rates in the front end, just as there's very little in common between one month implied V and one-year implied V. Sometimes they're the same level, and sometimes they're different by many factors or even orders of magnitude depending on the asset class. Uh that excess variance has now caused liquidity to worsen, right? It's not the same as it was when rates were a lot lower. I think it's it's also therefore um caused a knock-on effect in disparities based on what I read. Again,

I'm not in the Treasury market all day every day like I was when I was at a macro shop for a long time. Uh, but the on the run, off the run stuff appears to be rearing its head again. It's also showing up uh as it seems a little bit in some of the swap spreads and all of that is kind of a signs of bad cholesterol as my former mentor and boss and NWI used to call it. And I and I think, you know, an operation twist, a jawbon policy articulation out of the Fed might be uh, you know, kind of intended to bring down some of that LDL or at least change people's perceptions and say, "Is this really LDL?" Or maybe, you know, there's something going on here. There's a little bit more HDL in that mix than you think, and you

shouldn't be as scared of it. Now, are they gonna get and you know this is going to open Pandora's box for our calls, so forgive me if if I'm doing that, but I think are they ever going to be able to get the international community, not ever. Ever's a long time, but in the near future, are they going to be able to convince the international community to get back into the long end in a big way, right? What would it take to convince some of the most significant international participants in the Treasury market to say, "Hey, take that bet on US policy orthodoxy, uh, US rhetoric consistency, um, you know, US decisionmaking hierarchy in a way that would inspire, you know, people to come back into the long end in in a big big way." Not sure that's the case, but I I

think um it it's kind of a a low um you know, it's it's like a low credit quality perception that that we're going to have to deal with here. Of course, there is no credit quality because they can always pay back and in their own currency, but I think you know the the credit quality for them is the variance, right? And it is something that you you tend to see in in sort of junk issuers and and high yield where even at higher levels of yield, there's higher levels of yield and price variance and that's kind of making the treasury market seasick. Uh and there are some markets that thrive on V, right? Bitcoin people tend to like when the V picks up, right?

When the V is low, it's not good for Bitcoin, right? That takes us to deck 22, Jan 23 when frontend Bitcoin va is in the teens and 20s when price at that time was in the teens and 20s. Takes us to where we were until August 19th at about 9:30 in the morning, right? Where Bitcoin is hanging around its bottom decile of price and bottom decile of all high volume Bitcoin gets people excited about it because it starts to inflate the right tail of distribution. And rates it kind of works the other way. Rates are bounded at zero. They're unbounded to the top side. And so this kind of ball starts pricing in not just greater gyrations around some mean reverting tendency but the skewess of the distribution. You go hey the log

normal adjusted probability of 30-year rates going back to four is now going to be more equivalent to like 30-year rates or let's say 20 year rates 10 years forward hitting six 78 and that starts to scare people. Um, so you've got that skew moving the wrong way and you've got that cretic premium in the tales of the distribution moving the wrong way. And it's interesting to see how that's being detrimental for treasury market stability, but it's actually creating momentum behind behind Bitcoin. And for those of you that play in longerdated volatility in Bitcoin, you know, we've been of the view for a little bit of time that the long end was just inappropriately priced where you had stuff like one year almost sub 10 delta strikes at you know take your pick um

you know 40 uh 42 43 V uh and that started to move the other way. So at the money vault is now higher and the out of the money options vault is higher and that's exactly what's happening in treasuries just in the opposite way. >> Hey Gordon the other thing I would add is in our space the crypto space when that volatility results in basis where you have the future price is higher than the spot price all the big boys want to come in um because when that gets attractive um crypto has been proven to be a very lucrative place to play the basis trade.

basis trade is very very good for spot assets because what you do is you buy the spot you sell the future when you have more buyers and sellers what happens price goes up so that's another thing to really watch is watch basis and that is very very healthy for our markets >> big time and been a long time coming right for us to get back >> been a long time it's been it's been awful right and there no basis trade like no reason to buy spot sell future >> and and like this was this was a big trade during the last cycle and I think it was one of the things that drove of assets pretty high. >> So to pile in here on what's going on in treasury markets, there's a weird little corner pocket of the treasury market most people don't think about too often

called tips, which is the inflation protected treasury market. We're starting to see some weird and chunky things moving around in the tips market, which is also usually a good sign something is like getting creaky in there, right? Like you're seeing very bizarre stuff like a one-year, two-year, threeyear butterfly action, which means the twos are much shallower than the ones and threes. You're seeing like bizarre steepeners. Real yields has been hitting some highs since the crisis. Like all of these are basically signs to me that people are starting to think the endg game of some of the US fiscal imbalances may be closer than people think. Because if you look at the timing framework, we're probably now five to

sixish years off to having to do something about social security, right? Like either just straight up cut benefits or start modifying programs or change behavior or just straight up print money. And when you're already going into that with a debt to GDP of 100 plus, you typically end up in one of two places historically. One of those is inflation, where what happens is they'll hold rates down below what essentially real inflation is to work your way out of this over a, you know, however long period, call it a decade or two. And for those who think that haven't happened before in the United States, look at the post-war aftermath in the 40s, 50s, and then look at the 70s. Like we've done

this repeatedly. The other one is default. But again, the US is denominated in dollars, controls all its debt and dollars. The dollar is used globally. Here, I think inflation is the much easier political choice. So, I don't really see people going with default in this case. And that leads, I think, Rahm, all the way back to you, which is to say you're talking about Bitcoin as a momentum trade here. And by the way, I do agree there's definitely momentum in crypto markets because while the fundamentals have definitely improved for something like Bitcoin here, it's hard to look at like Cardano rallying and sympathy a significant amount and be like Cardano has tens of users. I'm not seeing people piling in

and like more builders there. This is just a momentum trade. And so there's going to be some breaks and mean reversion within the category. But where I wanted to get to is is this momentum or put differently when everything is rallying like this, is it just inflation? >> Well, let me pull back to your point on treasuries. You're actually channeling Ray Dalio there. Um, it's interesting analysis. Uh, I don't think you're going to see the end bond vigilantes breaking the US Treasury market. It's the most liquid market in the world. It's the least dirty shirt in the laundry basket.

The productivity growth is here. The earnings growth is here. Nominal GDP growth of of the United States resembles like China a few years ago. Meaning like we're the we're the Asian tiger now. So I wouldn't get overly concerned about rates. I've noticed that in the equity markets rates instead of names aren't going down anymore. In fact, I I don't think Bessant even needed to intervene. Markets were settling of their own accord. his intervention might have actually spooked investors. So, uh, I wouldn't, you know, how I see this playing out is if rates go to five% on the 10-year, that's the top in rates and you buy whatever you can, that might be the time to buy bonds or somebody out

there, not me, but somebody I could I could get behind that logic. But if that happened, risk assets would be very cheap. Uh, and I wouldn't be surprised if in 6 to 9 12 months the 10 years lower than 4.79 because you are seeing disinflation, you are seeing productivity growth. So uh yeah I I think this is much to do about nothing. Uh you also have this August. It seems like policy makers always like to scare markets. August dump all the bad news here. They do the interventions here. Moody's does something around now also. So you know that's that's some of this on uh yeah on Bitcoin momentum. You know it's funny the the four-ear cycle is in a way starting a little bit too early.

So, I I don't think this a lot of people are off sides on this as well. And uh you know, Bitcoin didn't deliver what it should have this past cycle. That's just a fact, right? You're you know, versus where you were four years ago versus the prior cycle high. So, I think the dynamics that play out in crypto are going to be very different. Again, it does have significant competing narratives against it, including physical AI. Everywhere you look, you got a robot outr running Usain Bolt. Now you got Travis Kalinet uh building physical robots to do mining to do cloud kitchens to do autonomous vehicles. So I still think a lot of attention and capital

will be more focused in those areas. >> Gordon, what do you make of the Dailyo parallel there? I knew uh I knew Rahm might drop that one. I'm curious as to your thoughts. I'm I'm going to, you know, kind of pull out the EM playbook to which you alluded and I I think is apppropo here. Um, and I'll be the devil's advocate. How likely could it be that US inflation index product could start to get looked at such as something like Brazil's NTNB market? For those of you that have played in that space, I remember it being 2011 12 era going into the taper tantrum. I was at NWI. We had one of the world's

biggest asset managers come to us and go, "What's wrong with the inflation link product in Brazil, Mexico, South Africa, you name it. Is there an opportunity here for Alpha?" We debated it and they created a hundred million dollar SMA to go out and do currency light hedged uh investments into inflation index product and all of those jurisdictions. It took a minute for that to to kind of come right round. You know, NTNBs have crazy duration. You can get it even longer than the flavors in North America and G10 markets. But eventually it did because they went through a period of significant belt tightening, monetary tightening, other

forms of austerity, and they left behind some of the vicissitudes of policy heterodoxy, fiscal heterodoxy. That's not unlike what we're seeing here, right? where although productivity a big driver although rates up at this level in the long end starting to impose some degree of tightening of financial conditions along with energy markets and by energy markets what we really talk about are the product markets total CEO out there today talking about the bifurcated physical crude and physical products markets not unlike the front end and the long end of the bond curve right these don't appear to exist in the same zip code maybe not even the same continent anymore. But I I do I do see uh Ram's,

you know, POV there, which is to say, you know, 5% tens, it's either this thing comes back down or we're all going to hell in a hand basket, right? Because it just can't absorb that. And that should be the top of real yields, the top of nominal yields minus, you know, plus or minus some some variance buffer. >> Yeah. And I I look at this through the lens of if we're at 5% in the 10-year, either, as you said, rates are going way up to start handling this or they're coming back down and we're going to financially repress people in some way and you'd want to be owning the inflation products or you want to be owning gold and Bitcoin in those cases because you are either, what's the right

way to say this? playing the game as aggressively as possible or you don't want to be playing that game at all. And those are kind of the two vectors. It's not staying at five. Like if something else just be long at that point around that point in sort of the surface. But I think what was most interesting to me watching Bessant and then the market reaction is right now I'm not sure we could tell from the market signals which way people are predicting things will go because this is probably a net improvement in either of those like outcomes right now. But where are we going to be three months from now, six months from now, a year from now? Like there's some iterativeness to this game and I wonder how much people understand

that. path dependency uh you know in in full force and you raised a great point about optionality probably worthwhile to dust off your Bloomberg I need to do it myself and check out where the forward curve is right where's the 10-year 10year 20 or 20 year um you know the old playbook the macro playbook comes out at the money spot at the money forward uh receiver spreads things of that nature could be interesting not a recommendation to make an investment or withhold from taking action but I'm curious to what are the payoff uh you know ratios for for those types of of strategies at this level of rates especially in forward space.

>> Yeah. And I think we've seen some movement recently like front end backend in breaks in the inflation market for instance. It's all those little granular bond things are coming back and mattering now that the whole curve is not laying flat close to zero. So, all right. Before we get any further into the bond market, because we're going to lose everybody if Gordon and I keep talking about that, we are going to go ahead and take a quick commercial break. >> $540 million. That's how much concentrated liquidity sat idle in a given week in the first half of this year. About 30% of the DeFi TVL if you're wondering. That's according to Dune Research commissioned by 1 in. But

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podcast, go there and subscribe now. For the next few weeks, we'll play segments of the full interviews on Unchained as a reminder. But for now, you'll only hear those short segments of Bits and Bips on Unchained. No more full episodes. You can get links to all of the dedicated channels with the full episodes at unchangedcrypto.com/bits andbbits spelled vips. Thanks again. >> All right, everybody. Welcome back. Now, we're here to talk about people fighting. Uh, and specifically, we're going to talk about the CFTC. So, at the CFTC's inaugural innovation advisory committee meeting in DC on August 21st, uh CME chairman Terry Duffy and Kali's

co-founder Luana Lopez Lara traded, shall we say, insults over prediction market oversight. Duffy was saying, quote, "We're not a bunch of carnival barkers at a circus." And warned, "Some event contracts are open to manipulation." He said again, quote, "I have more people in my regulatory department than you have in your entire company." To which Khi's CEO responded, "Maybe you should learn a little bit about efficiency then." And Duffy said, "Maybe you should learn about cred credible markets." Now, before we get into the brawl between them, let's also talk about uh Mike Celig and his comments here, chair of the CFTC.

Congress gave the CFTC exclusive authority to regulate prediction markets, he said, and that the agency will defend its jurisdiction against states seeking to nullify federal law. He said, "We've crossed the Rubicon and are standing at a new frontier in finance and framed the prior era as quote anti-crypto armies, doomers, and decelerationists." So, this is a hell of a brawl. Chris, I want to start with this one for you since I know you're like a derivatives markets guy as well. What do you make of the sparring between the CFTC and KHI? Do you think each argument has validity? Is somebody solely talking their book? Like how how are you internalizing that one?

I mean I'm actually thrilled to see this dialogue happening because like I mean I was in this market for so many years and like after the global financial crisis any kind of creativity like any type of innovation kind of died like in derivatives markets there was nothing like the the biggest innovation was like the regulated businesses that we built which is like not really you know that innovative you know we do stuff around the edges you finally finally finally after years we finally have these two new innovations coming out at the same time. They've been around for a little while, but now you're finally seeing product market fit. Um, and guess what?

This is another, you know, we always talk about convergence. We're seeing more and more the crypto market is exporting stuff into traditional markets, whether it's 247 markets, whether it's perpetuals, and notice I didn't say futures or swaps, kind of think they're futures. Um, and also prediction markets. Like these are things that have really been a part and parcel to to crypto markets where they had product market fit. I am thrilled. I am thrilled that we're seeing this innovation. I'm thrilled that we're starting to see this innovation happening onshore. Uh which again, sadly, all our innovation, all this innovation happened offshore because people were scared. I mean, I had portfolio companies that were literally put out of business when they tried to build on shore because again, the technology didn't reconcile with like

with what we have. And so, we talked about market moves uh earlier. We said macro caused a lot of it. We also saw the president uh say, "Hey, chairman Celig and I are going to work to get hyperlquid on shore." And I think you have to say that a lot of the hyperlquid move was idiosyncratic, you know, related to that subject. Now, as these perp dexes are coming on shore, what can they do? Um number one, they can follow the old way, which is get what I like to call the cocktail of derivatives licenses, DCO, FCM, DCM. Or maybe the CFTC is going to be bold enough and if anyone can do it, it's chairman Celig on finding ways to align with the principles of the regulation, disclosures, controls, etc. um with the technology as it works and like you know

I testified in Congress a bunch of years back saying you know what we don't really need intermediaries with this technology. You may want them but you don't need them. Um anyway, so regarding this hearing, so you have Lana uh from Koshi, you got Duffy from CME, and the first thing that I love about it is the visual. You can't get two more opposite people, right? Just look at them. And um and you know, te Terry is the CME has been a dominant factor. They're an incredible business. Um and lately, their stock price has been taking a hit because of some of this disruption. And when when you're an incumbent, you have to make a decision, and it's a tough decision. Do you try to fight? Do you try to fight? Do you try

to put up um regulatory gaps? Do you do you do you try to to do whatever it is to keep the status quo where you're doing quite well, or do you swim with it? And when, you know, have partnerships? It looks like Chairman Duffy is is looking to fight right now. Uh he was very uh Terry was very critical of prediction markets, saying that they're prone to manipulation. Well, I've got news for you. It's illegal to manipulate derivatives markets. And to the extent somebody manipulates a derivatives market, the CFTC is going to hold them accountable.

So guess what guys, don't do it. And you know, the other thing is like they'll immediately go and say, you know, FTX this or FTX that. Let's just look at history. FTX blew up over, you know, overseas. Uh when we have a thoughtfully regulated market, which you want to see here, um that's a good thing. And so, um, and then Lana's right, you know, if she's able to accomplish these things with more automation, probably pretty awesome than rather have a lot of people manually going around checking things. So, like look, at the end of the day, what am I a fan of? I'm a fan of innovation. I'm a fan of markets that are not subject to manipulation. And to the extent there is fraud, manipulation, or abuse, let's get after him, Chairman Celig, and that's exactly what he's doing. Um, and like I'm a fan of

automation. Automation is the way that we can scale. So, let's accelerate these derivatives markets. You know, ICE has been very thoughtful as well in their embraces the technology. They did the deal with Poly Market. Um, I think I think you're my personal sense is that Terry Duffy is probably um, you know, he he's probably not consensus right now. I'm seeing a lot of the other exchanges actually move very moving very fast to embrace prediction markets. Oh, last thing guys, let's just remind each other, derivatives rule the rule the world. Um, spot markets don't really matter that much. It's derivatives that rule everything. All right, I've said my piece.

>> I like to call this the pugilist and the ballerina. That's that's what I think yesterday's name was all about really. And it's it's it's all all there in it, you know, and you've got >> youth, elegance, right? And and then you've got, you know, the kind of swaggering uh prize fighter looking to take back the title belt. And that dynamic is totally understandable. Um, but I I think it's it's going to be, you know, kind of grace and elegance, intelligence, uh, suave panache poise that ultimately wins here. But you said it right, Chris, about derivatives markets ruling the world. And speaking of fighting, not just CFTC fighting, if you want to see an instance for how these markets sometimes have um, you know, we we'll call them uh,

inappropriate activity such as the betting that happened around a conflict and kinetic outcomes in the Persian Gulf. those are actually quickly spotted, right? And and people were slapped on the wrist and I think you're going to face significant penalties for uh for placing wages on things for which they had, you know, kind of asymmetric and material non-public information. So, um while I'm not going to say that I see no point in the points that uh you know, Duffy has made, I'm going for the ballerina uh you know, to to take the uh the belt home in this discussion. >> I think was a classic she was a classically trained ballerina by the way.

>> Oh, 100%. That's that's absolutely right. >> I was gonna say it's not like there hasn't been manipulation in traditional derivatives markets. So >> war did not happen. Everybody memoryhole that thing. It's not real. >> It's totally not the case that hedge funds have taken position in derivatives and then hammered thinly traded spot on people in the CDS market. Like none of those things have ever happened. It's fine. It's fine. But like all nonsense aside there, I was watching this and it's interesting to me to see the fight being between Kalshi and the CME because I want to take the opposite side. The dominant voice here who should probably

be determining this is actually the customers, right? Because if we're thinking about what makes markets valuable, it's can people use them for purposes that actually have utility. Are we hedging? Are we speculating? Are we raising funds? Like are we engaging in things that ultimately lead to productivity? Because you know I have an old economics professor who used to say if you're not doing those things that actually is gambling right but if those activities are at sort of the core of what your markets are doing at least in some amount then you have real capital markets. And I'm curious as to where this debate goes based on how people vote with their money and vote with their feet because the reality is the

CEOs of like Kali and CME can say whatever they want, but you still got to win the game to get the trading volumes and deliver the best product to people. And isn't that ultimately what we should be following? Like Rom, for you as an investor, when you see this fight breaking out, how are you thinking about this on a forward basis? like who's winning and who's losing. >> Well, on the one hand, having these prediction markets to price events, including election outcomes is truly extraordinary. It's it's great to see that. On the other hand, like of course those markets are manipulated. Of course, it's negative expected value for the consumer. Uh and I don't think it's a healthy product for the vast majority

of consumers. You know, from an investor standpoint, the question is, can Kalshi translate in a boarding event like the World Cup and make that customer sticky and then adopt new categories? We'll see. That's hard to do. Uh I'm not terribly excited about those businesses given where their valuations are. You know, I think one of these businesses just doubled their valuation after the World Cup and raising money. Uh I look at that as if you're an insider you should be selling. I think that's you know what some of these folks are doing.

So on the one hand said about the innovation I just don't they're great products for for consumers uh or investors. >> How long Rob do you think you use prediction markets as part of like hedging strategies? And Gordon you guys doing that already? >> It's great for getting information and insight from that's how I would look at it. But you know the best hedge for a a risky asset is to sell the asset. That's the first thing you do. >> Yeah. So, I agree with Rahm about using the information that you get from the markets today. That's what they're useful for because we've got liquid, transparent functional scalable um linear and nonlinear derivatives markets. That's the space I play in. And that's where I think I find um, you

know, positive expected value, consistent alpha, let's say, across a volatility surface. And unless I'm thinking about running an ARB strategy, let's say between binary outcomes in prediction um space and a vanilla options outcomes, which is not yet within my mandate, but um you know, if I were back at Genesis running a regulated derivatives business, we probably would have had a healthy slice of that in the prop book. Um but looking forward, right, what are the products that could be healthy for the customer base? Uh I got one for you. Um and if you're an executive at U, you know, Poly Market or Call Sheet, call me up. We can talk about it parametric insurance right why aren't these guys building in this space because that is a highly illquid opaque and I would say un you know

unsubstantial marketplace that doesn't live on chain doesn't have smart financial quants trying to solve the problem through DeFi and is more or less trafficked by a bunch of parasitic brokers and large balance sheet players the primitives that have been discovered through polyarket and call sheet tell us one thing liquidity will aggregate around outcome come um projections whether those are fairly priced or not is a separate discussion but when you look at the world today and Chris you and I and our little ted had this discussion you know you are all about making entropy great again uh and I'm right there with you and I think the way that we make mega happen is by creating mechanisms for decentralized financial risk mitigation that disintermediates a

lot of the interstatial tissue sclerotic interstatial tissue I should mention that has held back uh you know financial innovation and a derivatives market where you could let's say get parametric coverage for I don't know a Bolivian dam operator that's facing a perhaps existential drought and he's not going to be able to get his favorite XYZ broker or underwriter to to approach that is a great thing right um and other types of knatcats and other types of hard to to categorize binary outcomes around which we can build oracles that are robust to manipulation that's really interesting stuff. Um I do think also that you know working with financial parameters as a start uh and not just event parameters rwees um is helpful because it starts to drive convergence

right there can be manipulation let's say in things like you know the 15minute epochs on Bitcoin outcomes on a predictive marketplace but guess what once they get liquid enough the vanilla options and linear derivative guys are going to come in and try to orbit it and that's going to drive convergence in a cubrious way and I think ultimately what I've kind of in tone about insurance potentially in a parametric fashion living on chain or living on these types of markets may may also ultimately be able to be cured in the same way. So it's it's neither all bad nor good but uh for now it's a great source of um incremental useful information. It's a good conditional prior, right? And I think all of us on this call in some way, shape or form, we live in a basian

um you know uh intellectual and investing framework. And if you can give us another high alpha um conditional prior, we'll take it. So thanks Paul and Mark. So, I think >> I'll pile in though to say I think the parametric stuff is a severe dead end. As somebody who's probably traded maybe more ILS than almost anybody in the world over the past two decades, which is to say you have two very severe problems in parametric markets as you think about building out that market that has caused them not to take off. Number one is your basis to what your actual exposure as an insurer is. On the front end of the contract, I owe people economic losses for things that have happened. On the back end of the contract, I have a parametric trigger

and all too often they move in the same direction, which puts me towards bankruptcy, not away from it. Like I will have missed on the parametric trigger and lost a shitload of money or the storm will miss some location, but it'll have hit some parametric gate. So I kind of made money for no reason. It starts being a very weird thing. And this leads to a regulatory overhang where they don't give you full reinsurance credit for the parametric cover which is why they don't want to buy it. Right? If you look at the balance sheet of like an Allstate or credential if we want to think about life markets they're trying to get as close to risk distribution as possible.

That is to say we do a bunch of business on the front end. We have to have some level of legal risk retention but we want to offload as much of the rest out the back as cheaply as possible as we can. And if you look at Pru's balance sheet, by the way, they are offloading vastly more risk than they hold on to nowadays. And when you don't get full reserve credit for offloading through parametric markets, it's just incredibly inefficient. So the prices that you're willing to pay are nowhere near a market clearing price. So you just don't use it. Where I think parametrics are useful is more going to be, and Gordon, you may have alluded to this, like local disruption type events. I don't think it's going to be useful in insurance markets because this whole framing of like economic losses and exclusions and

principal agent problems and fraud are really what drives all of that and the parameter is like maybe number eight on my list of things that I'm worried about there. >> Yeah, it's a it's a stop gap. I I think you're right and I think it actually speaks to the Terry Duffy and Lana problem. Right. You've got um you know pugilistic dinosaurs and very lith nimble ballerinas and they each have their own view of the world. I think Terry Duffy would say that the regulatory framework to to which he must uphold himself is the same as the one that the insurers would say hey look parametric's a great idea I can't use it because I don't get full offset and the prediction market people would go that's because your regs suck and you know I I can't work with those we're here to

solve the future problems of finance and that may be part of the the gap that um you know that that those folks are trying to solve both in the insurance space but also trying to think of how you reconcile and as you say both cases it's going to be the insureds who are seeking coverage right and in this case of course it's going to be the client right the the um you know directional uh position um person who wants to come in and get that and they're going to say okay maybe I like uh the products that appear on um you know Terry Duffy's CME in various shapes or form or maybe I really like poly market call sheets or maybe I pick and choose and some are good for some risk mitigation situations and some are are not and and I think as a portfolio manager Chris, you probably

could relate to that as well as anyone. >> As you think of the utility of prediction markets, there's a few things to consider. Number one, the information can be invaluable if there's sufficient liquidity and liquidity helps you with that. Well, the the the paradox of prediction markets is that they're they're these like micro mini markets, right? And oftent times these micro mini markets, which is where the value is, there's just not enough liquidity. So, it's hard to find truth. Um, I do think you're going to eventually see pretty amazing markets form where you're betting on parts of the company. So then rather than just like reading an earnings statement and coming up with a recommendation, buy or sell, if you're an analyst, you'll be able and these markets are already forming, guys, like you'll be able to look at certain parts

of like sales in the southwest or number of phones units sold. You'll be able to bet on them and you'll get much closer to truth. Again, the values deriving from the data. Then of course any good derotives markets you have hedggers and you have speculators and those are like define terms. We're starting to see the emergence of some hedging. Uh you know there's classic story of the bar who's betting you know for against the Knicks so that they can hedge the uh the drinks that they're going to give everyone for free. You know that will that will start um spreading uh provided there's enough liquidity in the market that you can actually put on a hedge. And then the last thing is speculation. Speculation is a very important part of markets for for those of us who study them. It creates liquidity and there's plenty of

speculation to go around. Uh and my my daughter who thinks that she's smarter than any market uh will tell you that. >> I want to get to a last item so that Rahm has his chance to take the once per show mandated shot at Sam Alman. >> Oh, here we go. >> Yep. >> Nothing burger. Nothing burger, >> which is the 20 cent Frontier model. So there was a mystery model released called oxal or zeroax alpha depending on how you want to look at it uh which appeared on open router quote a frontier model built for efficient coding sustained agentic work in real world production use a lot of people have been speculating it's from ZI and the GLM family of models. There are a couple of

things that led to that potential conclusion within the architecture of the model. Some of the other models evaluating it were guessing that that was the case. But rather than talking just about the hunt, let's talk about something important here. This is the top openweight coding model. Um, it scored a 28.3 on terminal bench 30. Uh, and by the way, Fable is 33.7, GPT 5.6, Soul is 34.6. So, we're talking a pretty goddamn powerful model. And then it's going to be priced apparently at a tenth of the frontier per token rates. Uh, Coin Bureau said a mysterious new AI

model reportedly beating Claude Fable 5 and GPT 5.6 Soul at coding and nobody knows who built it. They said the model designers we have the capacity for a 100red trillion tokens per day. Decent amount of compute. Um and Bloomberg is saying the US China AI gap chart is getting obliterated. Noting that Kimmy K3 is also close to fable and 70% cheaper per task. So Rahm, I want to lob this ball over to you first because I know you've been thinking about AI economics for a while. What do you make of the speed at which openweight models are coming and the economics of them

when they're getting this close to or better than the frontier models? >> Yeah, capitalism and competition is wonderful. Consumers are mean small business adoption on ramps customers are now at 42% and growing. This is all wonderful news. I have a theory on who this could be. this model. Uh, Nvidia, it was announced today, is investing $6 billion into a company which is Americabased. It's called Poolside. They're investing at a $12 billion valuation. Sorry, they're investing a billion dollars at a pre- money of a 12 billion valuation.

Uh, so this could American open wave model. Maybe this article was timed with the release of that model on open router. That's my hypothesis. I was at an headquarters last week as a friend who I called a member of technical staff. Uh, you know, it's impressive what they're doing. They I think their margins will come in better than most people think. When they drop their S1, I expect it'll be a market defining event.

People are going to look at are they subsidizing users? Um or are their gross margins attractive without the need for subsidy. I think it'll be more of the latter. Um and uh yeah, this is not a bubble. It's a real story. You're going to see continued investment. The question is in the midterms, will politicians continue to press utility companies and press data center firms or will that drive up data center cancellation rates which would be very counterproductive for you know American progress.

>> Yeah, I think one your point about the ultimate winner here being consumers is almost certainly correct. It's interesting to see with the AI buildout how much of a parallel there has been so far to the original internet buildout which is to say we've gone through things like where is the value going to acrewue what companies are going to have these problems who is developing these frontier solutions and then rapidly destroying everything and trying again and destroying everything and trying again as we get better and better very quickly. I will remind everybody almost nobody is still using Netscape or AOL, right? And yet at the time those were paragonss of the market in some ways.

And so I think you're right that the ultimate value goes to consumers. What is very interesting to me here is that whether you're a call it open weights or closed weights like model person and how you think about the economics there. the bottleneck is going to be compute and power and those are structural areas right and we're seeing% >> a lot of push back against that like Gordon and Chris I'm curious what either the two of you are making of this sort of like schizophrenia in the market of the market being very excited about the model companies while everybody is trying to kill every data center known to man >> yeah well I I was just going to say look

I I I think poolside is a great um you know speculative of projection. Clearly, um, you know, Yensen Wong was out in his first expost not long ago talking about the merits of open source. Um, and people have trumpeted this. You know, open source has a great track record. Um, but not always, um, you know, the the king of the hill, Linux, many people site surely. uh and um you know as as someone who for my own econometric research um and and sort of quantitative uh insights do sometimes uh use o you know open um you know open source openweight models the stuff is great I mean what what can you say um and you know monopolies oftent times have a shelf life um and monopolies on LLM um

you know like we see out there they look like monopoly type pricing um and so it stands to reason that at least In some use cases, the king of the hill may be dethroned. But the big picture, as you say, is consumer wins on token pricing most likely uh at least in the short term, but the big picture long-term um is power, right? I mean, it's really kind of the binding constraint of human productivity expansion. Uh and I I often ask this question tongue and cheek, which is to say, is the compute industry uh and data center industry going to look like the Bitcoin mining industry?

Because when I was at Genesis making markets and trying to convince miners in 2021 and 2022 to collar their production and they're telling me that they had three or four cent power from now until the end of time, I usually just laugh. Um and I think um you know the the question now is how viable is the massive buildup of North American compute going to really be? Or if you are a frontiersman, should you be calling up Sirar Berdi Muhammadof in the independent free unaligned Republic of Turk Menistan who will sell you power at 1 cent from now until as long as he shall live? Um you may he live 100 years from now and and is that a place that you should really be thinking about diversifying compute? I don't know because I'm not in that business. But I

do look at the paradigm of guys who swore up and down that North America was an economically viable place for Bitcoin mining. And then it became it was economically viable as long as you add an NRCOT contract. And then it was well it's economically viable because it can fund data center business that runs at much higher and more distributionally stable um you know irr. Um I I I think that these are questions that are going to need to be asked just where do you source the power for your compute and is the political establishment going to permit that? Um, and therefore the question I always like to ask is how do you hedge that? Uh, and that's probably a subject for another podcast.

>> Uh, prediction markets. Um, look, it's really really um it's very rare that Republicans and Democrats agree on things and when you're starting to see them starting beginning to agree on that data centers are going to be a major issue um as we go into the elections and it seems to be that they're starting to align a little bit. Um, that's not good news for the AI industry. And uh, the good news is I think they started to wake up and they realized that they're going to have to really work on their narrative. They're going to really have to work on explaining the value that they're here to bring through these data centers. The whole NIMBI discussion is very much in effect. Um, but believe you me, this is going to be a defining

election for the AI industry. And I really really hope that they are able to tell a better story about the utility that they're bringing. And to the extent where they've gone, you know, too far and the data centers are maybe not built in a way that are that you want them in your backyard. Um maybe they need to adjust their approach. But like I think that the entire industry is going to be under increased political pressure. Um but as crypto people, we know what that's like, guys. Uh so maybe we can give them a couple of couple of ideas. I mean to some extent if you look at sort of the grabag of reasons people have for opposing AI most of them are factually incorrect about data centers like the

water usage arguments are just wrong. Uh some of the job arguments are just wrong. I think what we really have here is just a factual like narrative structure problem for the data centers because let's be totally honest, nobody trusts big tech, right? Especially when the pitch of a lot of the AI companies has been we're going to destroy all your jobs and then as a side effect our machine god is going to rule over your society but totally trust us this is fine. It's not surprising to me that a lot of people are like we don't want these things around you.

>> I'll I'll challenge you. Tell me >> people don't like social media. People like Amazon. They like usage of their Google services which they get for free. >> They consume Netflix. They enjoy their Tesla. So Americans do like technology. The issue is the leadership of these frontier lab models are scaremongering Americans about mass employment. The perception of AI in China has an 85% favorable rating. In the US, it's 35%. Now we've only seen the criticism of the AI data center. So these are just utilities. You know utility, sewage systems utility. No one complains about nimi. Someone is upgrading the sewage in the backyard. They're utility.

Intelligence on demand is utility. All these utilities confer benefits. It's not going to be hard for people to combat these once you're in the election debate. talk about uh his daughter who is cured of a disease or or cancer see these innovations and again small business using this so they're going to see through this I don't think it's a winning argument I think it's actually a very weak argument uh and to the earlier point you've got firms like Andrew spending $200 million in packs pro AAI packs that riots fair shake by the way in the last election a lot of this criticism against AI and the wealth tax is actually a political

move because they've seen Silicon Valley lean right and so they're trying to attack that at the knees. Let's do a wealth tax. Let's control AI because we want to preserve political power. >> So I will say I think like having been in a meeting or two just to see what these are like I agree with you people hate social media they hate AI. I think some of them just don't have trust with the big tech companies because I'll counter you on Google. I've had a lot of people criticize them for surveillance.

Rom like I do think it's a trust issue on all these things. I also think it's to some extent like a revenge of revenge of the nerds kind of thing. By which I mean you've hollered out rural communities. You've been unrepentant about it. You don't understand the human cost. And you've just acted like everything's a number in a spreadsheet. It's not surprising to me people are pissed with you and just kind of want to poke you in the eye with the stick. But I think we need to figure it out because to channel Chris here before we have to go, there are national security implications to this as well. And I think it's important that the US has these capabilities. So since we're out of time, I'll say thanks again for joining us for this episode of Bits and Bips. We'll be back in one week to

discuss more about how the worlds of crypto and macro are colliding. Until then everyone, thank you you for watching and hope you enjoyed this episode of Bits and Bips. Just remember, nothing we say here is investment advice and please check unchainedcrypto.com/bitsandbbits for more disclosures. Hey hey hey.