Custody Solutions and Infrastructure, Family Offices, and How Funds Can Educate Their Analysts on Crypto QuantLayer Follow Sep 26, 2018 · 36 min read

Here’s a transcript of QuantLayer Crypto Podcast #9.

In this episode, we talk about our experience at the Crypto Hedge Fund Summit in New York, and what we learned about custody solutions and infrastructure being built for institutional investors. We go over what a family office is and how they differ from institutional investors. We discuss how important custody is and why. We also break out a multi-point thesis for how funds should think about educating their managers and analysts on the crypto space.

The episode in its entirety can be listened to here:

QuantLayer is a software consultancy based in Brooklyn, New York. All opinions expressed by podcast guests are solely their own opinions and do not reflect the opinions of QuantLayer. The information presented should not be construed as investment advice. Guests may maintain positions and assets mentioned in the podcast.

Vikram: So yeah. It’s been a busy week for us in the platform. I want to thank everyone who has been signing up for the platform and getting our weekly updates. We’ll put a link in the show notes if you want to take a look at the prior issues, but the goal of the update is basically that we want to let you guys know how our product is getting updated and what features we’re adding to the platform, so thanks.

Faizaan: And I guess I didn’t mention on my end. The big milestone was we did actually get our production-like environment up and running so we’ll have the platform ready, just going to share soon. That was one of the last big things ready before we launch our alpha.

Vikram: Yeah. And that’s really cool because of the way the application has been architected. Faizaan, you can probably talk to a lot of the stuff better than I can. You know, it’s very easy for us to be able to add new sources the way it’s all been set up.

Faizaan: Yeah. So what’s really nice is we’re essentially working off one code base, so it’s not like we have a lot of code bases that we have to maintain. When it comes to architecture and deployment, we’re able to run different chunks of it on separate nodes. We may have a hundred sources, but we can run 70 on one node and 3 on another or whatever makes sense in terms of resourcing and DevOps, so having that up and running is nice.

Vikram: Yeah. I thought it would be fun too to take a look at, you know, we’re eight podcasts in now, so I’m just curious. I wanted to see which ones have been most listened to.

The first one was our deep dive into the Bitcoin ETF filing and our comparison of Nvidia and Bitmain, so that was kind of interesting. That stood ahead to the rest of the pack.

Number two was our first episode which makes sense. I imagine if, you know, new people coming to listen to podcasts and wanted to hear the QuantLayer Genesis story. So if you haven’t listened to that one, that one is a lot of fun. You should definitely listen to that one. It basically covers how we got into this crypto rabbit hole.

And the third one which is actually right on the heels of number two is our episode, I think the last one, short selling explained. That was a fun one to record to. You should check that one out. It tries to give a really clear and concise explanation of how short selling works, so that one is a lot of fun too.

Faizaan: You had some big news about non-crypto markets today.

Vikram: Yeah. So Apple officially hit a trillion dollar market cap which is pretty crazy when you think about how far it’s come. I remember after Steve Jobs passed away in 2011 or so, and people were saying that it was done, like it was cooked; it wasn’t going to go anywhere and it hit the height of its capabilities and whatnot, that they were not going to have any new good products come out; they won’t really differentiate themselves, etc. I think it goes to show that it wasn’t just Steve Jobs. It was the entire team he had, their whole design method and infrastructure they had in place. There is a pretty big milestone as far as stocks go. The next closest ones are probably, I think, Microsoft and not Facebook anymore. They lost a big chunk. There was some chatter I remember earlier in the year about… was it Bitcoin or Apple going to hit that trillion dollar market cap first. It makes more sense that Apple hits it, but it also goes to show like how small the crypto market is.

Yes, there was some other stuff that happened the last week, we were at the Crypto Hedge Fund Summit here in New York City, and that was a great conference. Our friends at Trade Terminal invited us to this event that they were hosting. It was an all-day event with really interesting talks that covered institutional asset management for crypto, so there was a great deal of talk around crypto custody and the different kind of infrastructure being built. Just as a heads up, Trade Terminal, we’ll link then in our show notes. This is not an Ad at all. I just really like what they’re doing. So they’re an algorithm and crypto trading firm with 50 different strategies in place. Their founder basically had been mining Bitcoin back in the day, and then he realized he can make more money building miners and then selling them; and then, they use all that capital to build where Trade Terminal is now.

So they came out to New York and I thought that it would just be fun to talk through some of the stuff we learned there. Attendance were pretty robust like there were a few hundred people and they were standing remotely at the back. There were a lot of people who flown in from Asia. I met a fund manager based in Hong Kong, a few in Taiwan, and a few in Singapore. The type of US funds were a lot of these family office type of funds which is probably the simplest way to manage funds given there’s no real custody solutions right now, so they’re all probably like self custody at this point.

Faizaan: So what is a family office?

Vikram: Very broadly, they have an investing ability that’s different from other investment advisers. So back in 2010/2011, the SEC made a rule about this. We have a summary of the rule. “The securities and exchange commission, the commission is adopting a rule to define family offices that will be excluded from the definition of an investment adviser under the Investment Advisers Act of 1940, and thus will not be subject to regulation under the Advisers Act.” And then it goes on to define what the family offices are and what the members of the family are. “As proposed, Rule 202(a)(11)(G)-1 contains three general conditions: First, the exclusion is limited to family offices that provide advice about securities only to certain family clients. Second, it requires that family clients wholly own the family office and family members and/or family entities control the family office. Third, it precludes a family office from holding itself out to the public as an investment adviser.” and then it goes into like what a family member is, so it is what it sounds like, someone who is a member of a family or as SEC speak “a family member includes all lineal descendants of a common ancestor who may be living or deceased as well as current and former spouses or spousal equivalents of those descendants, provided that the common ancestor is no more than 10 generations removed from the youngest generation of family members. All children by adoption and current and former stepchildren are also considered family members.” It’s just basically a member of your family.

The interesting thing about this document, this isn’t crypto specific, but it’s related to one of our prior podcasts about the Bitcoin ETF, so the say that they received 90 comments on this document, mostly from legal representation of different family offices, and those comments help guide their decision making.

A lot of people out there like to think that the SEC is this unit that is dictated by the government. They’ll listen to whatever the government wants them to do, but they really actually do listen and particularly like a field like crypto, they want to learn from people that are involved in the field. So, for everyone listening, if there is a rule or decision that you care about that the SEC is reviewing, you can comment on it. We saw that with the Bitcoin ETF that is being proposed, we will end up seeing like how they take those comments but at least they do take them, and they’re definitely reading them. But seriously, stay away from moonboy comments. Don’t say one lambo when you’re writing to the SEC. Be thoughtful and measured and explain why some aspect of the rule that you care about is important to you, and then someone at the SEC will read it. I mean, the family office one had 90 comments, the Bitcoin ETF one had less than 200, that’s not a lot. I mean, you could spend the night just reading through them, so someone is going to read them.

Faizaan: Just going back to the family offices at this conference, what were they interested in specifically?

Vikram: So they care about bitcoin and other crypto in terms of what other institutions are going to do. They’re interested a little bit in ICOs but more so on the security token side, less so on the Tilde side. So, last year where they might have been participating in ICOs, definitely not this year because the craze is over basically, but they are interested where security tokens are headed. So yeah, family offices, they can take “more risky” investments like bitcoin. They can self custody and do a whole bunch of other stuff. These funds that fall under that Advisers Act of 1940 that we mentioned earlier are the kinds of funds that take custody very seriously; not that family offices don’t but some of them have legal requirements that they have to follow.

A few other things that we heard at the conference that are pretty interesting, family offices come to the OTC desks. So typically in other markets, not crypto, if you go to an OTC desk, you can probably get a big discount to the asset you’re purchasing. By big, I mean like a few percent, not like 25%. They would go and asking for 6% discounts because that’s what they’re used to, like I want to buy a big stock of Microsoft. I don’t think they would get a 6% discount on that, but they will get some percent of discount. No one was giving them that so they realized they had to pay like 20% premium if they wanted to buy a large block of bitcoin stock, basically because there are no sellers.

Faizaan: Oh, because there’s no one selling that much?

Vikram: Yeah. And there’s so much slippage. Slippage is like when there’s a big difference between your bid and your ask, if someone wants to sell like 100 million dollar block of bitcoin, if they want to sell it to a family office, they’re going to sell it at a premium because if they go to the open market, there might be too much slippage. It just doesn’t make sense. They would lose money on that, just the sale.

That came up. We also heard chatter from developers but using state channels to trade and settle big blocks of bitcoin. I’m keeping an eye on that. That will be interesting. We’ll see where that goes.

Faizaan: Does that add any value over just people matching up and doing the transaction like two parties just executing a transaction, and do they really need a technical solution? Like this is a case of developers getting excited about doing something technically that can just be done now or is there some value added?

Vikram: I’m not sure. It definitely felt like there are two views of thought in this, on each coasts, like New York School of Thought is like, “we have to have custody and we need to have insurance and reinsurers and all that;” and then we had the west coast crowd saying, “we’re just two state channels and we have to worry about custody or insurance or anything like that.” I don’t know the answer to your question, possibly.

Family offices, they’re doing a ton of OTC trading already and when people are saying they are waiting for institutions, they’re not talking about family offices, they’re just talking about those investment advisers we’re talking about earlier. Of course, there are theories that institutions are “holding down” the market until they get involved. I understand this theory, it’s that somehow the crypto market is so manipulated, bitcoin in particular is easy to manipulate and so the price can be held down. There’s a same theory about gold that when gold futures came out, gold became more easy to manipulate because when they came out we’re cash settling instead of not. They weren’t physically settled. I don’t have a whole ton of insight into this but if the market can be manipulated on the way up with tether and wash trading on exchanges, then it probably can get manipulated on the way down, too. I don’t have any clear evidence about this but it’s definitely impossible.

So yeah, back to the conference, we did learn a ton about where custody in general infrasture stands now. The keynote speaker, Nolan Bauerle, was from CoinDesk and CoinDesk has put out the state of blockchain Q2 report. It’s pretty interesting how they laced stuff out. We’ll link to it in the show notes. A few of the report’s highlights, there’s 5 of them, and I’ll read through them very quickly and offer my interpretation of what they mean:

The first one, bitcoin miner revenues fall by 22% along with average fees by 19%. I think this is just directly related to price declines.

Second one, bitcoin hashrate grew by 26% which fell short of the prior quarter at 47%. This is also probably related to the price. The prior quarter, the price was probably going up more and less so in Q2. But in any event, my interpretation is that network hashrate continues to grow which is great for security of the network, but then maybe it didn’t hit prior growth rates, so it will be interesting to see like if this is a good metric over time. Will the re-market expectations around what hashrates should be and whatnot? I’m not sure.

Third, observation, SEC declared Ether not a security. ETH price showing 9% jump shortly after.

Faizaan: What were the ramifications if it had been declared as a security?

Vikram: If it had been declared a security, there would been a bunch of funds that had illegally participated in a security offering. Worst case, the government can come after you with a disgorgement penalty.

Faizaan: That sounds very violent.

Vikram: It’s terrible. Yeah, it sounds very violent like a sword going through the belly. It’s basically the government demands that you pay back all your profits. If you buy Ether like a dollar and it goes to $500 and you made $500 million profit and now they’re asking you to repay that, like that’s what they can do. In non-crypto, I mean, it happens all the time. So if they had done that, that would have been pretty dramatic for the space because funds would have been forced to sell their crypto holdings in order to pay this disgorgement penalties. It doesn’t mean like we’re out of the woods or anything. These penalties could still happen. I wouldn’t be surprised if the SEC comes after some funds with these penalties and maybe some ICOs are specifically more like securities than others, like in their case maybe we see these disgorgement penalties pop-up again, but it’s defined risk. Again, to your question, if it had been declared a security, there would be a massive hangover like for a while.

So, number four, total ICO funding reaches about 19 billion with the average ICO of 39 million. The 39 million seems kind of high and maybe a more useful metric here is the median since the Telegram ICO and other [inaudible 0:14:29.9] ICO are securing things there. I always thought that there are a ton of like smaller offerings and then a couple that are huge.

Faizaan: Even the smaller offerings seem more like what you’d see in a [inaudible 0:14:40.7] but are raising 10x than they would in traditional.

Vikram: Right.

Faizaan: But even the median is a pretty high number.

Vikram: Number five, the majority of survey respondents think price declines were caused by shorts and rebounds from over speculation. People love to say when an asset goes down, it’s because the shorts are doing it. In our last podcasts, we actually talked a lot about shorting, what’s involved, and how expensive it is especially in crypto so I’m skeptical that shorting is reason for the price declines, but again this is just a survey so I don’t know who they were surveying but I guess it makes sense there.

Faizaan: Nolan walked through a few of those highlights and then a couple other areas that are really relevant for investors, and actually pretty relevant to our platform itself, like the kind of alerts that we’re offering.

Vikram: So he broke out traditional investing versus crypto investing into the kind of buckets people should care about. So he categorized this term as early investing methodology which is like trade volume, market cap, things like that, things you can only see on exchanges and that was like the traditional Wall Street view, I guess this is what he was calling it, which is only one part of the equation. But there’s this new mix of stuff, and I buy a few of these more than others. I’ll go through them. The highlight buckets of interest:

The first one, price interest. Actually what the price of the asset is, like what bitcoin is and then what Ether is relative to bitcoin, what ZenCash is relative to bitcoin, and so forth.

Exchange interest meaning like how much the asset trades on exchange whether there are trading pairs in an asset. Most trading pairs now are with bitcoin, but some are popping up with Ethereum trading pairs. The idea is like the more trading pairs you have against a new currency, that new currency has more value because you need to buy that currency in order to buy the trading pair.

Network interest. I’m definitely very interested in this one. This is on-chain transaction volume, hashrate, number of transactions, number of nodes, transaction fees, and things like that.

Social interest. I’m less interested in this but these are things like Reddit subscribers, online subscribers, Twitter follows, Google search trends, news sentiment, and things like that. I guess Google search is probably I’m more interested than necessarily the others, but we’ll talk about this in general in a bit.

And then also developer interest. How many people are watching a GitHub, repo, contributors, stats, forks, merge, PRs, open issues, closed issues, new commit, and stuff like that.

So one general concern I have about this approach is that it’s possibly attributing too much quantitative analysis to things that are (a) very gamable, and (b) not as concrete as something like revenue or earnings in traditional markets.

Faizaan: Yeah, like the big one that we saw in the ICO market was Telegram followers. All these ICOs would like pop-up with like thousands of telegram followers and it was bots or just garbage.

Vikram: Yeah, exactly. Also GitHub commits, both are actually very easy to gain.

Faizaan: Yeah. Just update the ReadMe, change punctuation, etc.

Vikram: Exactly. I mean we’ve seen that too. We’re like, looks like something has had 100 commits over a few days. Most after projects has a pretty decent number of commits and you go look at them and there’s just ReadMe updates.

Faizaan: Yeah, same thing with, you know, mentioning Telegram and the fake GitHub, even Twitter. I guess Twitter has recently had the bot purge but before that, you could buy it.

Vikram: Yeah.

Faizaan: Funny story there. We won’t name any names but we had a former co-worker that likes the game, these sort of things, for personal or who knows for what. They went from around 50,000 to like 300 followers post bot purge which I thought was hilarious.

Vikram: Just overnight. Yes, you can buy Twitter followers and have a high paid marketing team to respond to Reddit post and whatnot. All that stuff are so gameable these days, so definitely don’t view that as a… I don’t think it’s great. It shouldn’t be a cornerstone of any investment thesis.

Faizaan: I think with stuff like GitHub, there’s definitely more qualitative stuff you can look for. You can see who is on the actual development team. If you are familiar with the programming language they are working in, even just glancing through some of the work, you can get an idea of the quality of work without doing something quantitative, and there are static analysis tools you can run as well. But I guess that’s a little more difficult to do technically than just quantitative stuff.

Vikram: If you’re non-technical and you just want like quantitative stuff, maybe that’s why you look at that watchers because it’s like a specific number, but I know from experience like I might watch a Repo and then just not care anymore. I’ll be like, Oh look that’s interested Repo. Just watch it and maybe I’ll check it some other time, and then actually you don’t, right? And I think that’s kind of common.

Faizaan: This is a point for me of a lot of interest on stuff I want to work on to add to the platform, because right now we track all of these GitHub current messages and like if you search for the word bug, it will basically surface all of the commits that had bug in the commit message. You can quickly scan through, and a lot of them are UI or small things but every now and then, you’ll see like a bug and the smart contract code which is definitely something to investigate further.

Vikram: You saw one in Tron today, right?

Faizaan: In the smart contract generation code, there was a bug that was fixed. The problem was that, it didn’t have any more detail. At that point, you’d have to do a pretty deep dive or maybe reach out to the developer team to see what was actually fixed. I think what’s interesting for us to work on is some way of surfacing the second layer of information here beyond just “here was a commit” and maybe surfacing “here’s a commit that’s more likely to have something interesting,” so that’s going to be something I think that’ll be fun to work on in the coming weeks.

Vikram: Yeah, definitely. That’s far as like gameability and what’s useful within GitHub and what’s not. As far as the second one was about revenue and earnings, so people always compare these crypto networks with companies and the comparison is just flawed. With companies, you have things like revenue and earnings and metrics associated with cash or the cash like quality of the firm and you can project its value, right? Like last 3 years, it has done this much. This is how much the market’s growing. This is the thing that they’re going to do to like get a hockey stick or whatever, and then in bull case, you can come up with the value. You cannot do that in crypto. There’s no earnings. There’s no revenue. There’s nothing like that.

Faizaan: So that’s a big reason that you can’t compare these crypto teams with companies, and it just messes up the discussion a little bit.

Vikram: With keeping all these stuff in mind, like I think the following is a pretty solid way to… sale running up, a crypto fund, and had a team of analysts. This is what I would do, and I think this would cover a lot of what is important. We can call this like the QuantLayer plan of Crypto Hedge Fund.

So, the first thing I think that they should do is look into and have a solid understanding of the history of the internet, the history of internet protocols and how they fit with one another. So like TCP/IP, FTP, SMTP, HTTP, HPS, what does all these things mean, right? If you go to Wikipedia’s entry on internet protocol suite, we’ll link that in the show notes. You’ll see how wide this is. There’s like an application layer, transport layer, internet layer, link layer. So, understanding this stuff is important. People don’t need to know about the technical details, like how it was implemented, what program, language, why they picked one language over another and all that; but understanding what they do, what problem they solve, I think that would help a lot. And we’re seeing that now particularly at protocol-level discussion in crypto and I think that will help aid a lot of that conversation.

Second thing, so understanding application-level protocols. Like say, go for FTP, so what problem did they solve that the root-level protocol didn’t. People always talk about second layer solutions for crypto. There’s a lot of hate against it, and I think hate is like it’s uneducated hate because you have certain limitations that a particular protocol has and if you want to do anything on top of the protocol, you just have to build something else. I think we have talked about this a little bit before.

Number three, then I’ll have them study the Cypherpunk Movement and understand what the Cypherpunk Movement wanted with respect to decentralization, because they basically helped launch the original internet and things have become so centralized today, it’s veered away from its original intent and none of this isn’t necessarily philosophical. I meant it is of course by nature, but also it helps us understand given how centralized things are today, where could they possibly head? Because that will give you a view into the future of these protocols if they’re head in the direction that they’re intended to. So those are the thematic things that I think are important.

Next of course is understanding cryptographic technology and cryptocurrency technology and but not having to be necessarily a developer. You’d want to get to the point where you can look at a commit and if you don’t understand the code, that’s fine. But from the commit title and the file name, maybe you can come up with some intelligent questions to ask developers about what’s going on. I think like the handful of things that we’ve provided in the past, we’re talking a couple of podcasts ago about the Golem network, Mainnet bug where funds are missing. Even if I wasn’t a developer, I could look at that and just read it and say, “Okay. This seems a little awesome or seems weird.” I think everyone can get to that point. You don’t have to be a developer to just look at a commit.

Number fine, I guess along these lines, get involved with the developer community and then find out where they’re making particular decisions and ask them what can be done on-chain and what has to be taken off-chain given whatever their vision is. Understanding this will help understand future network growth and develop.

You know, we have some thematic stuff and then some code for non-technical user type of stuff and then for the financial analyst in the crowd, there is one area that they can get really deep in and that’s number six which is just understand on-chain matrix and why they’re important. This is probably most related to financial analyst or research analyst type of role, but it’s a great way to understand cryptocurrency network health right now; so these are things like on-chain transaction volume, hashrate, number of nodes, how decentralized the network is, transaction fees, and stuff like that.

I think like if you get those six things nailed down, and of course it takes time. I think that getting the thematic things is important and it takes a little bit of time to like come to the same place that the Cypherpunk Movement kind of wanted.

Faizaan: I would add a seventh point to that. It ties back to point number one where you focus a lot on the history of internet protocols, but I would say also the history of bitcoin because in the development of bitcoin, leading up to it, and then even after the white paper came out and the subsequent development. A lot of the scaling problems, security issues, like things that underline most cryptocurrencies if not directly, then thematically, a lot of that stuff is very thoroughly discussed at a high level by the bitcoin team and its supporters. And so, I think that can give you a really good grounding in this sort of topics around technology, scaling, and the game theory / economic incentives as participants or different attack factors that have worked and why they work when you’re assessing any other up and coming currency. I think some of the stuff that’s very crypto-specific is really there in the last 10 years of bitcoin history, maybe to an extent, Ethereum.

Vikram: I think that’s a very good point because not understanding bitcoin’s history can end up clouding someone’s judgement so if you took like… could you see so many comments around some of these other cryptocurrencies saying like, “Oh, bitcoin’s block size is too small.”

Faizaan: You see, these currency is getting attacked or doing stupid stuff and they’ll make a decision and then it goes south and it turns out that, in 2013 the bitcoin team like actually discussed this and like, this was a known issue but this new coin team overlooked it. Obviously, bitcoin is a very specific type of cryptocurrency but a lot of the underlying issues that affect all but the very esoteric cryptocurrencies. You should at least understand those first and then you can obviously keep going and learning about the more esoteric stuff, but having a good grounding and just the basics, bitcoin is a great place to start.

Vikram: Yeah, I know, we went on a little tangent there, so coming back to the conference we were at. Some of the other things that we learned about custody and infrastructure, I think it really hit home about how important custody is, so we all have heard a thousand times that custody is really, really important for institutions and it is. In the US, if you’re $150 million fund or bigger, you’re legally required to have a custodian. So, if you’re that big of a fund, you literally cannot hold bitcoin without a custodian.

There are very few good custody solutions right now and this is a big problem. If you manage money on behalf of someone, you have to take on a lot of legal risk. In crypto, it’s heightened because if you lose your client’s private keys, you’re done. There is no recourse, absolutely none. So as a result, firms are looking for reinsurance companies because someone has to take that risk on, like we can only pump that risk so far. I am the fund, I’m going to pump the risk to the custodian and custodian needs to pump the risk to somebody, and it’s going to keep going that way until the insurer is going to get involved. That was pretty interesting.

There has been a little bit of movement in the space. We heard that there is someone insured, a 125 million block of bitcoin, so someone is willing to take that risk on which is pretty interesting. There is also some chatter about decentralized custody solutions and I think these were a little too like high level. I didn’t hear many specifics about it.

Faizaan: I think it’s going to be probably harder to get those to meet the legal requirements on the short term, right?

Vikram: So there’s a law panel at the end of the conference and it was just all lawyers. One thing that they mentioned was that in order for the crypto community to get rid of custody rules for crypto funds, blockchain tech will have to prove itself, and that’s what they said. We will see what that means. But that’s a kind of thing that seems like it’s pretty far out. Decentralized custody solution. That seems like a thing that’s pretty far away from adoption.

Faizaan: How much cash does Berkshire Hathaway have? Can they just reinsure all of the crypto right now?

Vikram: Yeah, they should. That will be hilarious if they just dive if that’s how they decide to take the risk on. We won’t buy bitcoin but we will ensure it. So, what else do we learn? Some of the firms that are more trading or market-making oriented, they leave assets on exchanges and of course that brings a ton of risk into the equation. You leave an asset on an exchange, like you go into our platform type and hack or exchange hack, there’s literally tons and tons of articles that pop up.

Faizaan: Yeah, I think like close to a billion dollars already this year, or something like that.

Vikram: They managed this risk and I think calling it manage is a stretch. They manage it by having assets across multiple exchanges. They just put a small percentage of total assets on a single exchange like they won’t put 30% of their crypto assets on a single exchange because if they lose that, it’s a 30% less.

So, all that stuff is pretty interesting on the custody side and then on the infrastructure side, we heard some interesting stuff. Funds currently spend a lot of capital on back office expenses particularly around regulatory expenses. For current estimate, it’s 80% of back office fund expenses are regulatory related. So, in 10–20 years, this will become 5%, presumably due to the work that’s going on right now. One of the panelist made this kind of controversial statement especially with all the asset managers. Asset managers will be like Uber drivers. I guess what he meant there was as Uber transferred wealth from the Medallion taxi market of yesterday to individual drivers, there’s this budding view now that yesterday’s asset managers will begin to lose share to a platform of decentralized crypto asset and new asset managers, and we’ll see how that plays out. There are a few crypto projects that have embrace this view like what they’re doing is they have a platform that you can trade on and they also keep track of all your returns, so there’s no way to fake it. So, that’s one side of the market place, the other side of the marketplace is if you wanted to invest in one of these managers, you can go look at all the managers they have in their system and see what their returns are and then decide, “Oh, this manager consistently makes 3% every month, that’s my kind of manager.” and you just can go send them some ether, and “here, go manage my bitcoin. Go manage my ether.”

Just because it’s easy to set your funds, like you just need a wallet and you just send it, if it was not crypto, you’d have to do a wire transfer. I don’t think they actually do like KYC/AML so that adds some risk. In the US, you have to be an accredited investor to invest in particular types of funds. Here, say someone made like a few thousand on a crypto and they just want to see it grow and they trust that someone in the fund historically has done really well, they can just send it to them. They don’t need to be accredited or anything.

Faizaan: I guess I don’t follow why that is legal, like doing that with crypto but not with… I get why it’s not legal with regular money like you have to be accredited. Why can’t I just send my $5,000 worth of bitcoin to someone that have them. You’re trading it on my behalf without me being accredited. Why is that okay?

Vikram: I don’t know if it’s okay or not. There’s just no roles in place that have said it’s not allowed. Some of these managers are not even in the US like I remember looking at one of these platforms and one of the managers was like in Poland who has been doing really well.

Faizaan: If I’m the one that’s sending the money, am I at risk of getting disgorged?

Vikram: I don’t know like my limit of legal knowledge is the use of term disgorgement.

Faizaan: I think we have so many of these questions that have filed up that I think we probably need to have a lawyer on to just run through all of these scenarios.

Vikram: We’ll just ask them the most ridiculous questions and they’ll give us serious answers about it too. This whole like decentralized manager thing, I think is very interesting, because if somebody in Poland can trade crypto successfully and put up good returns on a regular basis, why are you buying SMP futures, index, or why are you giving money to your mutual funds that’s charging a few percentage just to match the market. I mean, this is the idea behind why hedge funds became popular, because in down markets they were supposed to protect their investors and produce much better returns. So we will see how this plays out. I actually do think there’s merit to this. I think it is controversial of course as I mentioned it’s going to be like Uber drivers, but it doesn’t mean it won’t happen.

Faizaan: Yeah. To me, the big change here is still not technological because I feel like with software and online bank transfer, I don’t see how this is that different with me sending $5,000 to some guy in Poland, assuming the legal issues aside, versus me sending $5,000 equivalent of bitcoin. It seems to me the main issue is really just the legal one. Yeah, I guess I just need to learn more about this.

Vikram: Yeah. Some of the other things that these platforms are trying to do, they’re trying to like you can invest in a strategy like spread out my 5,000 worth of bitcoin across like a manager that’s this risky and put 10% in a really risky manager with like really volatile returns and put the other 90% in like a safer ones. Things like that. It’s going to get pretty crazy like I’m really curious how this is going to look in 5 years.

Another thing we heard which strategy makes sense. So 2000 was the year of crypto-only funds popping up, and 2018 the panelist they’ve been saying they see a lot more traditional asset managers open up crypto desk, so this is like BlackRock doing research in crypto or Morgan Stanley. Just the other day, I think yesterday, they announced they hired a former credit Swiss banker to head their digital asset strategy. These are pretty conservative businesses that are hiring because there’s so much demand from their clients to find out. It’s really embarrassing like if you manage a high net worth individuals assets and you tell them for years, like they’re hearing from their friends that bitcoin is really interesting and then you tell them that, “Oh no. Bitcoin is not interesting, just don’t get involved. It’s fraud. It’s just drug money.”

Faizaan: And then their friends go and make like 100x, 200x.

Vikram: It’s embarrassing, so they got to cover their ass and do something in this space.

Overall, it was a really interesting conference. It had us pretty excited about where things are heading especially on the infrastructure side since you know that’s where we’re building.

Faizaan: Speaking of what we’re building, we had some interesting alerts come through again that I took some notes of: One thing, I know that you care about a lot is, we’re seeing a lot of high usage ETH contracts. We’re not going to link to them because a lot of them are shady business, and we don’t want to give them additional traffic. What do you think of this?

Vikram: So like there are a couple legitimate Ponzi-like schemes that had the highest DeApp usage in the ethereum network in the last couple of weeks. I think I mentioned them to you and I remember you had this… I have never heard of these things before so I’m just curious to hear your views on that, but they reminded you of this real-time auctions. So, basically they are like, okay you have the next hour and whoever is the last person to submit ETH to this address is the one who’s going to win the pot. Just imagine what the consequences of that are. I guess they reminded you of this real-time auctions, right?

Faizaan: Oh, like penny ones that I was showing you?

Vikram: Like, how do those real-time auctions work?

Faizaan: I think this came out when I was like in high school or college. I just remember. It was really fascinating because at that time, I didn’t have any money so the thought of getting some of the stuff really cheap was cool and then I investigated it and I was like, “whoa! This is a crazy scam designed to take advantage of people.” But they’re still around, a few of them. There was a time when they were like huge like they were advertising on national television, but basically it’s an auction. Unlike eBay or whatever where the highest bidder wins and then either the seller or the buyer pays the small auction fee, what you do is you essentially buy bids and each bid increments the price by a penny. Let’s say you want one of the shiny new Macbook Pros for like all loaded up $3,500 and you go on this auction site and you’ll see the bid is at $200. That sounds like a great deal. Essentially what you can do is let’s say, I take my 8 cents, I buy 100 bids so for $8, I can now bid a hundred times to increment this thing by a penny. Essentially, whoever the last bidder is obviously gets to keep the thing. Generally they go for a lot, lot lower. If it’s worth 3,500 bucks, it will go for quite a bit less than you’d find it anywhere. But on this auction site, they’re essentially making money in one of these cases, 7 or 8 cents per 1 cent increment. It’s the summation of all those 1 cent bids. Something that’s $200 has actually had 2,000 to 20,000 bids placed at 7–8 cents a piece. So, even though the buyer might get to purchase this thing for $1,500 plus what they spent on bids, the auction site might have made $20,000 on this thing by just collecting bids since they’re charging everyone for their bids. So, I think we’re seeing some form of these things that have existed but now are able to exist again because it’s crypto and noone looks at history. We’re seeing that in the ETH space.

Vikram: Not to give people business ideas but this is a kind of thing that auction sites seems like perfect for crypto.

Faizaan: Because it’s all these little low fee micro-transactions. With the traditional auction sites, just because of their credit card proxies they still have to sell you bids and chunks for the economics to make sense, like you have to buy 150 bids or something. With this, they can go pretty small or just take the transaction when you make the bids. It’s a great platform for somebody with really shady businesses to sort of have a second life.

Vikram: Great platform.

Faizaan: Maybe I’m just a bidder because I never won anything on these sites. I was like 19.

Another topic that we’ve mentioned loosely before is when evaluating the credibility of some of these ICOs or coin team. A lot of times the coin team is legitimate that they have good intentions. Other times, they’re legitimate and have good intentions but this structure of the ICO may be that they really cash out very early. Ideally, you want something where they incentivize to keep working in their payout as if the platform is successful like down the road. And then there’s just outright fraud. There was this thing called MobileGo. It’s part of this GNation. It’s basically eSports wagering mobile MMO game platform and basically the CEO and his brother, it looks like they may have committed some fraud.

Vikram: Whenever you hear CEO and his brother, it’s probably not good.

Faizaan: Yeah. Money was withheld from company employees. One of those guys in charge was unpaid for his work since shortly after the ICO. Basically once all this came to light, the price is down 85% against the dollar and 96% against bitcoin since the ICO, so it’s pretty much and probably unlikely to recover.

Vikram: Not necessarily crypto related but it seems like it’s a great application of crypto but like eSports are on fire. I was an article recently about parents just trying to hire coaches for their kids who play Fortnite. Fortnite has hit some ridiculous number on sales. I think it’s hit like a billion dollars in sales. Stadiums are getting rented out to watch like FIFA video games, soccer video games being played, and then like World of Warcraft and stuff like that. It’s just interesting to see how that’s progressing but it seems like a pretty good to use case. Isn’t gambling on eSports seems like a pretty good to use case for crypto?

Faizaan: Interestingly, I remember one like $50,000 is a really big purse for an eSports competition. Now these guys are like millionaires. They’re at the top of their game. Also, I know like even the NBA struck a partnership with I think the MGM or one of those gaming groups to be like their official partner which I thought was crazy, because traditional sports and gambling always had a really negative connotation and now we’re essentially seeing like sports betting and eSports betting all going very mainstream. I think adding crypto to the mix is fuel to the fire. So we’ll see how the industry plays out.

Vikram: I think Mark Cuban invested or promoted some eGaming ICO. I forgot the name. We have to look into it but pretty interesting space.

Faizaan: You just bought an Xbox, right? You just started playing.

Vikram: I did. I just got an Xbox. I haven’t like console game for a really long time. When I was at the fund, during earning season, once earnings calls were over like most calls are probably over around 6 o’clock, our PM had an Xbox with Halo 2 and all of us would just go in there and play for like 2–3 hours. It was ridiculous. Like all of us would go home at like 9 or 10, playing for hours and hours of Halo.

I got that Call of Duty: World War II, it was phenomenal. The graphics are so good for the campaign. Multiplayer is like their good but not much has changed in the last 10 years. I got like a Halo Master chief, like Halo 1 through 4, there is slight improvement as far as graphics go for Halo 4 versus 1; but the gameplay and stuff, it doesn’t feel like super different. Regardless, they’re still a lot of fun to play.

Faizaan: I wasn’t actually allowed to have an Xbox or any video game of some sort. I got my first Xbox when I was 19. Pretty much whenever Grand Theft Auto comes out, I’ll play that game and then I’ll play FIFA and that’s it.

Vikram: It’s that what you have right now? Those two?

Faizaan: Yeah. I also have Forza, like I had the whole wheel and simulator setup that I’d use to learn racetracks before I’d go drive on them, but now that the classic car club has its own full simulator, I put that on the way in storage because I’m not going to use my own.

Going back to alerts we found, in the previous episode, I had mentioned that this Alexander Vinnik guy is accused of some fraud. There was a supposed assassination attempt. Basically Russia has also been trying to extradite him. He’s been held up in Greece and it looks like they’ve finally got legal approval to have him extradited so we’ll see how that goes because according to the article, he’s responsible for up to $4 billion in fraud which is a pretty hefty sum.

Vikram: Do these numbers mean anything anymore? Like does a billion mean anything?

Faizaan: Well my problem is like there’s been so much price volatility. I was like, was the $4 billion in December. Let’s say bitcoin does go to like 500K or whatever, what’s going to be interesting is seeing articles written about value of some of these frauds in $20 or $25. I think there was a $30 million bitcoin auction after they recovered the stuff from Silk Road. That was a lot of bitcoin in 2013 dollars? So it’ll be interesting to see what these numbers inflate to if bitcoin does go to huge valuations.

We always discuss the scale of fraud in bitcoin. I think both of us are pretty pro-crypto but also want to keep a close eye on all the shady stuff that’s goes on. Someone put an article together basically adding up all of the fines that banks have paid since 2008, it’s actually an investment banking firm, Keefe, Bruyette, and Woods. So the top 11 biggest banks in the US have paid an amazing $243 billion in fines since 2008. Then it goes as a very opinionated piece and it goes to say like those are just a fraction of the actual illegal fund activity that the banks participated in and they put an estimate of like 20 trillion. I don’t know if I’ll buy all that, but the number that is legitimate is the fines actually paid. It’s just to say that there’s a lot of shadiness that goes on in crypto but it’s always good to get a perspective of what that compares to against some other financial instrument. One of the examples they gave, New York Department of Financial Services fined the British bank Standard Chartered $340 million for allegedly laundering $250 billion of Iranian money. Their claim is like banks are paying these huge fines but it’s actually less than 1% of ill-gotten gains. I think that’s a bit of a stretch because I think that’s just money that pass through. It’s not like the banks made that money but regardless. It’s a lot of fines.

Another one that I found which was interesting because we’ve talked about GitHub and how we basically listened to most of these GitHub repos, but this exchange Altex basically had a lot of money stolen because of a bug in their wallet. What’s neat about that is like the article actually referenced like PR #3985 fixed to wallet balance display bug which seems innocuous enough but this bug also extends to exchanges, and it goes on to explain the bug in details. What’s neat is like we thought that there was value in tracking all of these commits with their messages, and we’re seeing that a lot of these articles that are referencing fraud related to bugs in the code are actually referencing these same PR so there’s definitely something there.

Vikram: Yeah. That is very interesting. I just imagined like a future Bloomberg for example. Remember like during earning season, you’re just staring at your screen. Like if you’re a short-term trader waiting for earnings to hit, for like Facebook, you’re just waiting and it always hit Bloomberg first. It would hit and then we had stream of like headlines. It’s like either journalist or maybe they have like a really rudimentary form of pragmatic analysis in place, but it would spit out like important lines from the press release, very quickly. So, I just imagine a future where like you see XMR PR #8024 merged. Everyone knows what that is.

Faizaan: I got another scam that we found. This eosGAS Alpha Wallet v1.1 that was released, it was basically if you put your private keys in this wallet, you have your own stake tokens stolen instantly. They disabled comments in Telegram, and they were basically trying to get people to use their wallet and it happened via scam. Luckily it showed up in our platform shortly after the wallet release, but just be careful where you put your private keys as always.

Once again, we’re hitting our one-hour limit. I have this whole diatribe about IOTA that I think has been pushed two weeks now. I think next week we’ll maybe aim to squeeze that at the beginning.

Show Notes:

Topics:

QuantLayer’s top three most popular podcast episodes

AAPL hit a trillion dollar market cap

Recap of Crypto Hedge Fund Summit

Definition of a family offices into family member

Family offices doing OTC trading of Bitcoin

Crypto custody and infrastructure

State of Blockchain Q2 report

Traditional investing versus crypto

Kinds of buckets people should care about

Things you should do when running a crypto fund

Real time auction versus high usage ETH contracts

MobileGo in freefall after team member fraud

Alexander Vinnik extradition request to Russia from Greece approved

Top US banks have paid $243 billion in fines since 2008

Wallet bug causes theft at Altex

GH PRs referenced

Scam wallets

Links:

QuantLayer Email Campaign — https://us13.campaign-archive.com/home/?u=4293092e2bbb9b345f19ee4ab&id=802cc2c274

Keynote from Crypto Hedge Fund Summit 2018 — https://gist.github.com/vikram7/1dc85d35d19d1456afd98aec73e928a3

Trade Terminal — http://www.tradeterminal.io/

SEC Rule in 2010/2011 — https://www.sec.gov/rules/final/2011/ia-3220.pdf

State of Blockchain Q2 report — https://www.coindesk.com/research/state-of-blockchain-q2-2018/

Internet protocol suite — https://en.wikipedia.org/wiki/Internet_protocol_suite

Hey everyone, this is Vikram again. Thanks for listening to us. If you’re

an exchange, a trader or working on a crypto project get in touch with us.

You can reach us on twitter at https://twitter.com/quantlayer or email us

at podcast@quantlayer.com.