Good morning defiers! I interviewed Andrew Keys, ConsenSys Capital co-founder and managing partner at DARMA Capital yesterday. When we spoke, his $100 million fund was about to sell ether as it approached $230, and would wait until the cryptocurrency fell to between $226 and $219 to buy back. They ended up selling 3 percent of the fund at $234 and started buying back $227.

He explains why his team of quant traders came to that conclusion, talks about the sliding ETH/BTC ratio, why he invests in base protocols and not dapps, and of course, why he’s a raging ether bull.

I edited the interview for length and clarity and bolded what I think are the best quotes.

Andrew Keys: DARMA Capital is based off of the notion of fat protocols. So if you agree that in the legacy Internet today the value accrued at Facebook, Amazon, Netflix, Google and a handful of others. And really TCP/IP didn't make much money. Tomorrow, my position is that if blockchain actually works properly, the application layer should really be peer-to-peer and commoditized. So you're not going to get too much value at the application layer. The value, in my opinion, will accrue to the protocol layer. There’s smart contracts, decentralized file storage, computation, messaging, mesh networks. I believe that we're in the equivalent of 1994. Dial up started in 1996. I don't even think we had dial-up.

Ethereum is a core tenant of Web3, it's my personal largest holding and it's our belief that Ethereum is the best candidate for the smart contract layer. We are 10 years bullish on Ethereum. If you are a believer in that, then the next logical thing is you want to acquire more ether. And so we have a single asset fund, the DARMA Optimized Long Ether fund, and our goal is to generate alpha or outperformance of the benchmark of holding the asset. So simply put, if an investor gives me a hundred ether or in-kind cash of that hundred ether, my goal is to preserve that a hundred ether and make 12 to 15 more ether for him or for a year later.

Camila Russo: So you’re goal it to outperform ether by 12 to 15 percent?

AK: Yeah. 12 to 15 percent alpha.

CR: How are you able to generate alpha just holding the base assets?

AK: So we're not, we'll sell it. We track what are called risk regimes. So basically, our chief investment officer John Slazas built quantitative analytics called JS Services, and sold this type of technology to the likes of Goldman Sachs and Morgan Stanley for over 30 years. And now we take the same software and we apply it to ether.

We've dug very deep into Ethereum and started to track all of the metrics. So things like developer downloads, wallets that are created per day, the amount of gas that's being used. We track all of these metrics on Ethereum. The next thing is then what we do is we hand it over to our quants in Chicago, Puerto Rico, Frankfurt and Tokyo. It's a 24 hour desk.

To the DeFi nature of this fund I would say that we're relatively traditional in so much as that we're a fund that's registered CFTC, that has a net asset value that struck on a monthly basis. It's audited by KPMG. But what we do use is blockchain-based analytics from Alethio, where they track things like flows from the wallets. That's one of the metrics that we have to understand when the best time to trade is. If there are many people selling that could be a catalyst for us to sell.

CR: Okay. And so what do you do to generate Alpha is basically, sell all or a portion of your ETH to hedge for whenever the price is moving against you, and so in that period of time you would hold cash instead of ETH?

AK: Yeah, so we were less long, exactly. So for example, the market, post the Facebook news, when the market ripped up and ether was at like 350, that got to our risk regime, which was an extremely high level, meaning that the market was overbought relative to what's been going on for the year the market was overbought and then, and then basically we sold 20% at 350 and then we bought it back at 225. It's by the minute we use these risk regimes.

CR: Based on your metrics, what’s going on right now?

AK: So, we're getting into overbought territory here. We're sellers at 230 to 233.

CR: How much would you sell and when would you buy back?

AK: We would sell, you know, maybe 10 percent of the fund and then we would look to enter back anywhere between 226 and 219. Like this morning we sold 10 percent of the fund and then we bought it back at about 2 percent lower.

(In a follow-up email this morning, Andrew said they ended up selling 3 percent of the fund with ether $234 and started buying back $227. “It’s retraced to its daily target today... I wouldn’t call it oversold today,” he wrote.)

CR: And that’s all based on technical analysis and the other proprietary metrics you track?



AK: Yeah. What you're seeing here is like, in my opinion, the institutionalization of ether. We are not building the next cool DeFi app, but what we are doing is we are bringing 30 years of capital markets, quantitative trading experience, and we are using analytical tools like Alethio to track the market and, and basically applying these types of strategies to do quantitative, systematic alpha generation of Web3 protocols and our flagship, ether.

Image: DARMA’s risk stages. The red section indicates ether is overbought (time to sell).

CR: I wanted to ask you about the ETH/BTC ratio. What's going on there? It just seems like it keeps dropping.

AK: So it does seem like it keeps dropping. I think there a few considerations at play. First off, unfortunately since last year we haven't had a definitive date for the upgrade to proof of stake, which also reduces the block validation reward. So we're still printing a lot of ether all things considered versus bitcoin today. There's a lot of supply out there. Second, there is a tentative proposal for the POS upgrade on January 3rd, 2020, that's not been nailed down. But I think until we get that hardened up, you're still going to see bitcoin outperform ether.

Third, Ethereum is a bit more complicated than Bitcoin for the media to understand. And you've got the Pomplianos of the world, the Brian Kelly's of the world, screaming at the top of their lungs, “Bitcoin, Bitcoin, Bitcoin,” and I think they don't understand that, storage of value can be $7 trillion in digital gold. But digitizing the global economy is an $80 trillion opportunity. What ether is, is the fuel necessary to run the next generation of the Internet. I just think that really right now people are entering in to the crypto space, the first thing that they do is they buy Bitcoin because that's kind of the household name.

CR: One argument I've heard for the bear case of ether is that maybe Ethereum can become the leader in smart contracts platforms, but ether doesn't necessarily have to appreciate for that to happen. Ether can be the fuel, but it doesn't necessarily have to gain value.

AK: I disagree. The value of the platform underlying the tokens has to be larger. So there's one consideration and then there’s just basic supply and demand. You're going to need this scarce asset to run the actual, applications. You're going to have that inert demand, which is why ether is our flagship fund. I was early, early Ethereum, so I bought a bunch with that in mind and our goal with the fund is to outperform just holding the assets.

CR: What DeFi platforms do you like?

AK: I like Compound. I like Maker. I like them all in theory. But like, Maker, all of it is amazing, but it's not ready for prime time. The interest rates are egregious. If you sell, you'll lose 2, 3 percent on it. It's an a liquid market. If you go to Eth2Dai.com And you de-lever out of your position and you sell some ether to pay back your Dai for your CDP. If the spot market for ether right now is 230, you probably get a bid to buy it at 225 on Maker.

DARMA isn't a venture fund even though we have the capabilities to do it, first off, because the market is still super nascent. You're right that we're seeing in the DeFi space the first killer apps, if you will. But you still are taking essentially, protocol risk, team risk, product market fit risk. And there's not enough market cap for institutions to invest in the application layer. So really, there's only two assets that have regulatory clarity and liquidity. Hester Pierce said bitcoins is not as security. And Jay Clayton said Ethereum is not as security. So you've got those two, and the only two assets that you can really trade with any volume is bitcoin and ether.

CR: Who are your investors?

AK: ConsenSys is a client, a lot of the early engineers in the Ethereum ecosystem are our clients. They're limited partners and the fund has about $100 million dollars in it.



CR: When exactly did it launch?



AK: The fund was a multi-family office strategy, a multifamily office strategy of James Slazas, who was the head of capital markets for ConsenSys and myself in May of 2017 and we externalized it in January of 2019. So we have track record all the way back from May of ‘17 to January ‘19 to present.



CR: How was it performed since then? Since January, 2019.



AK: It's outperform holding ether by about 4.5 percent.

Image source: DARMA presentation.

CR: Can you tell me a little bit more about the second fund you’re planning? The bitcoin fund?



AK: So we're going to figure out other systemic protocols to Web3. Ethereum is our flagship. It's our biggest belief. But you could also argue that Bitcoin is a systemic protocol. I am, like, a Bitcoin minimalist. That being said, if you are an institutional investor, you should probably have a little bit of your allocation to bitcoin if you want to invest in blockchain. So we'll create a Bitcoin Optimized Long fund. And then in that notion of Web3, there's file storage, there's mesh networking, there's computation. So basically we’re figuring out what are the best in breed of those and doing the same exact thing. Because these are super volatile markets, the good quants can outperform.

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