Hunter Horsley: Bitwise Asset Management (EP.06)

Absolutely.

You bet. Glad to have you here.

Sure. Yeah. So, here at Bitwise, half the firm comes from the tech world and the other half of the firm comes from the asset management world. My background is on the tech side. I was at Facebook previously, Instagram before that and before that I was at the Wharton School. So, at Facebook and Instagram was a product manager, was really fortunate on timing. Joined Instagram at about 70 million in revenue, left at about a billion in revenue and got to work on products that were I think a quarter of a billion or 300 million in revenue. And it's actually funny, there were some moments of working on Instagram's new ad platform that remind me a little bit of crypto. In what way could it possibly be similar? The funny similarity is that giant advertisers like Procter and Gamble, they didn't trust digital ads. So they would give us test checks, small amounts of ad budget like a hundred thousand or a million dollars just to make sure it didn't disappear. And that's not dissimilar from institutional investors and CIOs and financial advisors that we work with today who often will write a test check of their own to make sure, you know, before they evaluate it for portfolio that it doesn't disappear. So anyway, sometimes I get a little deja vu and I think that's a bit of what it's from. But anyways, from Instagram, went over to Facebook. I was fortunate to get to work on a bunch of different things. Was in charge of the branded content ecosystem, which is a multi-billion dollar business on top of Facebook. Got to work on putting ads into videos. So, as people increasingly consume videos on the internet, Facebook wanted to monetize that for themselves and for publishers. So, that was a lot of fun. And then left, teamed up with my partner here at Bitwise, our CTO Hong Kim. Did software security in the military, worked at Google, longtime friend, and somebody I'd built software with in the past to start a company. And that ended up being Bitwise.

Yeah. Well, I don't know if we've talked about this before, but I actually left Facebook with Hong to start a company. So, we raised a little bit of money to prototype for a year or two years and then we stumbled on crypto as so many do. So, we were working together prototyping various things. Our initial investors were Naval and Vic who invested in us leaving our jobs and looking for something to build. So anyways, if you're in San Francisco in 2017 and you're two software people looking for something to do, sooner or later somebody says, 'Hey, do you remember that Bitcoin thing?' And so that's what happened to us. And I said, 'Gosh, I think I bought some of that on some website.' And of course, that website was Coinbase. And of course, I bought it in 2013 or something like that. And what we actually started doing was arbitrage trading. So just for fun, we were harvesting arbitrage opportunities that sometimes were between 10 and 60% in an instant risk-free. And that's not what we do today here at Bitwise. But I think for so many, there's some experience that gives them a reason to spend time thinking about crypto. And once you spend time thinking about crypto, I think many people find themselves wanting to spend even more time. And that's certainly what happened to us. It gave us pause to interact with some of the difficulties of investing, managing money in the space. Gave us time to meet people building blockchains and working on the space, pretty small community at the time and also to pause and think about why are we rooting for this de novo. I think for many people it's not clear that this is a cause that you want to root for having an additional currency. Most people first encounter crypto and they think, 'Oh, it's another currency. What do we need another currency for? That sounds like a nightmare. I already have cash in my wallet, you know, I don't want to deal with some sort of...' And so that's what drew us to it.

We launched the first and today the largest index fund in the crypto space. The way to think about us is that we strive to play a role like BlackRock or Vanguard or Dimensional Fund Advisors does for mainstream professional investors. So for financial advisors, for private bankers, for family office CIOs, for multi-family offices, that's our focus and what we try to do is to be a partner to them in understanding what's happening in the space, understanding how they can benefit from it and then getting access to the space. So we launched the first index fund, we manage a lot like index mutual funds. They're transparent, they're liquid, no performance fee, no lockup. They follow rules-based strategies. Today they're only available to high net worth individuals and RIAs who want access to the space before an ETF is possible. You know, they want their clients to have access to something that not everyone else can. But we work with that audience to help them come into the space. And I think that in crypto often times we group all investors together and we talk about them as a whole. We say investors, but there's quite a spectrum, right? So there's self-directed individuals. They in the US manage about $3 trillion. They might be on Robinhood buying Lyft's IPO. They might be on the Schwab brokerage. There's four million Schwab brokerage users. They trust themselves with investment decisions. They may not trust other people with decisions. They're nimble. It's their own money. That's really the first audience that came into crypto. And they're using Coinbase and Gemini and Kraken and Ledger and Trezor and doing research on Onchain and CoinMetrics and so on and so forth. On the other end of the spectrum, you have institutional asset owners, pensions, endowments and foundations. At some point, insurance companies, hospital systems, sovereign wealth funds. These are paid professionals, very sophisticated investment committees. Many of those groups like investing through venture managers and liquid fund managers. But in between, so that group, pensions, endowments, and foundations manages $24 trillion in the US. In between, so you got three trillion with people who trust themselves investing their own money, comfortable using a mobile app, comfortable starting with a credit card, comfortable with a $10,000 minimum and then uploading their driver's license to get that higher. On the other end of the spectrum, you have endowments working with people like you and other venture managers. In between, you have mainstream families and individuals who are working with a financial advisor. That audience is about $22 trillion in the US. It's not widely spoken about in the crypto space. That's fine with us, but that's who we serve and that's who we're focused on making sure has the opportunity to take advantage and participate in the opportunity of crypto.

Yeah, I think a good proxy for people in the crypto industry to empathize with this audience is to imagine somebody talking to you about CRISPR gene editing technology. It's a breakthrough. It's the basis of a few multi-billion dollar companies. It is changing people's lives, fundamentally changing the development of some pharmaceuticals and therapies. And you can start from that exciting kernel and you can then alienate people by going into too much jargon and too much complexity or you can find a way to relate it to what people are familiar with. And I think one of the accidental sins of much of the crypto industry is that there's more damage than good done with the opportunity that the industry has right now to tell its story to people who are curious. So I think for this audience, you need to be very mindful of the fact that they're interested in the same way they're interested in CRISPR, but they don't have that much time. It's maybe 1% to 5% of the portfolio. They have a family. They're trying to recruit new clients. They're servicing their existing clients. They're dealing with changes in Fed interest rates. They're looking at the equities market. And so this is one of a thousand meetings they're going to have this month. And they're just going to have one on crypto or two on crypto. So the first, I think most important thing regardless of the analogy you use or the way you frame it up is just to keep that context in mind. I think for so many of us in crypto, it's easy to get excited about the details and lose track of that. So, with that said, I would say that most advisors, family offices that we interact with, they're interested in crypto. They're trying to follow along, but they're not full-time, and they got a lot of things going on. So, they're actually not following most of the day-to-day narratives on Twitter or in Telegram groups or on trade publications. And a lot of them actually are essentially they know what they learned in 2017, when they heard about it for the first time between the summer and Christmas during the runup. And then they know that it didn't end up going to zero. So they backed away from the tulip bubble stick that plagued the first six months of 2018. And they've heard this steady drum beat of, you know, I think a number of institutions that I respect, I think someone like Fidelity or maybe New York Stock Exchange, but you know, not 100% sure what has actually changed. And that is usually where you're entering the conversation with most advisors and certainly there are exceptions. How do we frame it up? Depends on the amount of time. But generally we say the thing that I like to say is that the right analogy is to think a little bit about oil in the car. Before 1895, gasoline was a waste byproduct. Between 1895 and 1910, there was experimentation with the automobile. There were three competing technologies. There was steam power. There was electric. Believe it or not, 1902, you could take an electric car from New York to Philadelphia, charge it at Edison electric charging stations along the way. Some things haven't changed. And then there was a new technology which was gasoline combustion which had an explosion of gasoline and that ended up emerging as the winning technology. And in 1910 Ford popularized the automobile with a gasoline combustion engine and did multiple orders of magnitude of availability of the automobile. And suddenly gasoline became valuable. Why did it become valuable? People wanted to use the automobile. Tons of obvious benefits. You can get long distances. You can carry heavy payloads. You don't have to feed it so to speak. Worry about it, you know, like you would an animal. But in order to use and receive the benefits of the automobile, you needed to buy gasoline. And so gasoline has been invaluable for hundreds of years. But since the turn of the century is intuitively something that we regard as valuable now involved in other industrial use cases. All right. So why am I sitting here talking to you about oil? I think that it confers most of the right mental model for thinking about crypto assets. There's this new type of program. It's called a blockchain. In the same way that there is software that runs on servers, it doesn't have an interface or any buttons you can click, but it's software. There's software on your phones, we call it apps. There's software on the web. We call them web apps. There's a new type of program. We call it a blockchain. And the blockchain is like the car. It has certain benefits. If you want to use it, you got to buy the fuel, which for the car is gasoline, which wasn't valuable before the car. And for the blockchain, it's cryptocurrencies or crypto assets or coins, which weren't valuable before the blockchain. So, if we can, and that probably I don't know if you're timing me, that took me maybe 3 minutes. If we can, then that's the mental model I like to try and get across. We of course have different blockchains trying to do different things and therefore different coins associated with those, but I prefer that to the digital gold analogy. If there isn't enough time, then digital gold will suffice.

It's significant. Yeah. I think if you speak with advisors a common question is what am I not doing that everyone else is doing? It's a really fragmented, particularly for independents, RIAs. It's really fragmented and so they're always trying to make sure that they're delivering the best service, the best practices and so they're always looking at what are the things that I need to be getting ahead of. That being said, so often times the urgency comes from fear, but then when they look at it, there are a huge number of merits. So we run a survey every year that benchmarks financial advisor attitudes towards crypto. We ran one last year. It's online available for free. And just to share a little bit from that, 80% of respondents said they were getting questions from clients. So the first thing is it's on their radar. It's something their clients are talking about and they're not stopping. A second stat that stood out from that that was really interesting is that a third of advisors said that their client just went ahead and bought it without them. So what does that mean? That means that it's a part of their investment portfolio that the advisor now has to worry about but doesn't have any insight into, doesn't have any control over, can't help manage towards their financial goals. At some point the client might say, 'I have this huge problem. Can you help me?' And it's going to be a hassle for the advisor. So a third of advisors said their clients were just going ahead and doing it without them. Another third said that they don't know. They think their clients are doing it without them, but the clients won't talk to them about it. Either because they're not comfortable or because they're afraid or embarrassed to talk to their advisor about it. And then a third said their clients aren't doing it. So what that means is 80% are getting questions from clients. And somewhere between a third and two-thirds their clients are just already doing it. And so I think that that is a strong impetus. We meet with hundreds of advisors every month. That is a strong impetus for most of them to say this is something I should be looking at. And now advisors are allocating. It's the early adopters of course and they have a few different, the ones that are allocated have a few different motives. So they listed three, the top three in the survey. Number one was low correlation to other asset classes which I think will ring familiar to any professional investor or allocator. They're interested in the role it can play in hedging a portfolio either just quantitatively the low correlations do nice things for max drawdown, volatility, Sharpe ratios or from a macro perspective, you know, it's not an asset whose returns are driven by interest rates or corporate earnings growth or employment or that rely on the stability of the financial system. So that's number one and the vast by margin. Number two is returns. Everyone who's, you know, trying to help people save for retirement goals, college etc. is thinking about how can we help people manage their wealth towards that. You've probably seen studies like this before. A 1% allocation to crypto through our index fund holds a meaningful portion of Bitcoin over a really tough period 2017 through 2018. So including the drawdown, if rebalanced quarterly, I believe 360 basis points of total return to the portfolio. That's a 1% allocation. So in the worst case scenario, everyone's wrong. Matt Walsh is wrong, Nick Carter is wrong, Fidelity Digital Assets is wrong, New York Stock Exchange is wrong, Jane Street's wrong. Everyone's wrong and it heads towards zero. You lose 1% of return for the year and that assumes that you're the last person out. But if that doesn't happen, it has the opportunity to really contribute to returns and that again is a goal for most clients and also for advisors, something that they say we can help you manage your portfolio to deliver that. The third motive is particularly for independents which is our main audience today, RIAs. They want to have a way of appealing to the next generation of aging families. They want to be able to better serve millennials and tech-savvy clients. They want to build their book of business and they want to have something that the wirehouses don't have. So because we don't have an ETF, it means that the local wirehouse advisor couldn't offer it if they wanted to, which is structurally perfect for an independent, an independent trying to differentiate from a Morgan Stanley advisor or Wells Fargo advisor. So this is also something that they can offer. It's liquid. People size it usually with a very small allocation. It allows them to accomplish attracting new business, differentiating. So those are the three reasons. Low correlations, returns, attracting new business, serving clients. The ones who do end up allocating usually do. But it often starts from I've heard clients asking for it. I hear that they're doing it themselves. And then they, you know, have moments of a little bit of fear. They hear about somebody local who's allocated or they hear about endowments allocating or they hear about Facebook launching a cryptocurrency and they say, 'Oh, wait a minute. Are other people moving ahead with this and I'm not?'

Absolutely. So there's a process to launch a publicly registered regulated product which an ETF would be. You know we have the first set of review dates for that. We've been working closely with the SEC over this past year. Actually one of my colleagues just shared with me this year we've written over 500 pages of research for the SEC on the ETF filing. We've had eight meetings with different constituents. You wrote a letter about the state of the industry as it pertains to questions around the filing and about eight letters that were written. So we've been trying to do the work to help the regulator who's an ally ultimately to all of us understand what's happening and there's a lot of great improvements to understand, somebody just needs to do that work. But anyways, to answer your question about process for an exchange traded fund, an ETF, you team up with an exchange. For us, it's the New York Stock Exchange. There's another filing by a great traditional firm, VanEck, with CBOE. And then your exchange partner in conjunction with you files what's called a 19b4. And the 19b4 goes through a 240-day review process. That process has four windows. So, there's a 45-day period, a 45-day period, a 90-day period, and a 60-day period. And at each of those windows, as you see in various headlines, the staff approves, denies, or delays. The default assumption for a novel product, which a cryptocurrency ETF, I think would be. What do you think?

Yeah, I consider novel. Yeah.

We have gold ETFs. Oh, absolutely. For a novel product, the assumption is that you would take the full 240 days. And so, it's not really a strong signal if you delay from one window to another. So, that's the process. You have meetings and again you try and provide the context that the staffers need to understand what they're looking at.

Yeah, it's incredible how far we've come. So the Winklevoss filing, I should say the very first Bitcoin ETF filing was 2013 which is hard to believe, 6 years, extraordinary to contextualize that. I'll say that it took several years for the first fixed income ETF, took several years for the first leveraged ETF, several years for the first gold ETF. So anytime, and actually just recently we have the first actively managed non-transparent ETF and that took about eight years. So each of the ones I mentioned took somewhere between three and eight years. So crypto we're now six years into this project and that really, you know, I think for people who are less familiar with the ETF space is normal and to be expected and I think we're seeing the progress we'd want to see. Hard to imagine a filing in 2013. In 2018, the Winklevoss filing, as you've mentioned, was rejected formally by the SEC. They wrote 90 pages of a response in August. And the benefit of that is they made very clear the things that were on their mind, which was custody, market manipulation, how do you price Bitcoin? And those have really continued to be really the issues that are the things that the staff is trying to understand better and will ultimately have to get comfortable with. In May, we wrote about 180 pages that responded to every single question in the Winklevoss rejection that's public and again it is part of our effort to be a partner to the SEC and in getting answers to understand how the space is evolving. In terms of how the space is evolving along those two dimensions, custody and market manipulation, it's amazing. It's amazing. In 2017, just to give some examples along these lines, in 2017, there were three custodians that had, let's call them regulated, they had trust charters. Very safe to call them regulated, compliance requirements, surprise exams, certain filing requirements. Fast forward to 2019, we have eight and we have seven or eight that have insurance policies. So think about that's 12 to 24 months the number of regulated custodians has over doubled and now they have insurance policies, custody billions in assets, several of them are custodians of billions of assets. They're familiar names doing custody now, Fidelity of course. So that has gotten so drastically better, so much better just in the past year that it's a fantastic thing for the possibility of an ETF which of course needs to know that there's a reliable third party custodian that can hold the assets. In the case of the Winklevoss filing if I'm remembering correctly custodian was the Gemini company. So they were using their own company to hold the assets. Our filing generally tries to stick to standard best practices for ETFs. We don't try to do anything sort of clever or unconventional. Crypto itself is, you know, whole new things. So we try to stick to, you know, regulated third party custodians, pricing off of, you know, public spot markets and a number of other features. So custody has gotten just drastically better. And then on the market manipulation pricing side, the markets have matured incredibly over that period of time.

We're long-winded here at Bitwise.

It would be as absurd as if that same group of four people in this dark room said, 'Let's set up a US equities trade volume reporting site.' And then they reported the trade volume on Tesla stock and they just multiplied it by 10. It's not like every ETF issuer, every trader, the industry wouldn't freak out and go, 'Oh my gosh, wait a minute. We're confused.' You know, does Tesla have 10 times the volume? The appropriate response is to ignore. There's no reason to take it seriously. But what we tried to do with this report, because everything in crypto is so new, most people haven't heard of any of these exchanges, we tried to draw a line and say these are the ones that we can confidently say have real trading activity. Digging into that a little bit, so these crypto assets are bearer instruments. So it's unlike a stock in the sense that you wouldn't see exchanges like this popping up for stocks because ultimately the certificates are held with the DTCC.

Gold is trading around the world. Might be two individuals who are making an exchange of gold. So I think as a proxy what you're saying is right.

I think that what has been publicly articulated is that they need to be comfortable that a material proportion of the market is sufficiently surveilled. So if you wanted to, you know, maybe you could find a million dollars of buy or sell orders somewhere, but if you wanted to really push the market around, you would ultimately have to interact with the surveilled portion of the market. And so that's sort of the framing that intersects with the topic that you're bringing up. The surveilled portion of the market has been rapidly expanding over the last year. So end of 2017, CME launches surveilled market. Today CME hovers around 30% of the total value of the real Bitcoin spot market. So CME alone is a very material chunk of that market. Of the 10 exchanges that we talk about in our research and we put together this site, bitcointtradevolume.com, you go to and it just shows the 10 exchanges, their volumes, makes it simple to look this up. Of those 10 exchanges, I have to check the latest, but six or seven of them have BitLicenses in New York. A similar number, might be eight, have surveillance programs in place, either surveillance from NASDAQ Smarts program, which you can license. There's one or two others. Much of that volume is also surveilled. And if the SEC or an enforcement agency needed to pursue enforcement action, they would reasonably be able to get a hold of the relevant, the important information. So I think that that's drastically maturing. I think it's wrong to expect that you will ever be able to root out 100% of trading activity and exchange activity in the same way that you could just, you can never do that for gold or other commodities which obviously have markets both in person and outside of the US. But what's important rather, so the right heuristic is not is all of that going away. The right heuristic is is the regulated surveilled market growing to be of material size and that's happening and so we're really optimistic about that and I think the whole industry should be proud and optimistic about that. Ultimately to take a step back, I think for everyone who is long crypto, long Bitcoin, for it to become the asset class and the liquid instrument that people want and hope it to be, it will have to slot into regulatory compliance. So I think that this is a good development.

Yeah, Matt, I frequently feel, I mentioned we got started in 2017. I frequently feel that amidst the headlines about price, behind the scenes, almost everything that you could pray for to go right has happened. It's almost unbelievable. I mean, you know, Fidelity custody is one that comes to mind. People underwriting insurance for custodians, the amazing collaborative way in which the SEC has come into the space, set up FinHub, continued wallet growth, continued developer growth, firms like Square coming in the space, Robinhood, and then of course, you know, if you said which organization would be best suited to teach consumers how to use this new thing for the first time, Facebook would be on that list somewhere and for them to proactively embrace it is a huge deal. So yeah, we, as you know, we write a monthly letter to investors, our clients, and there's about 10,000 others who read it. We wrote about Libra being a big deal in February. We wrote about it again in May. And then in June when the rubber hit the road, they unveiled the consortium. They unveiled the architecture for it. And then there was that huge response. We wrote about it as well. And I would say that the mainstream world took note in June. The House Financial Services Committee obviously had them come in for a hearing. The Senate Banking Committee, the US Secretary of Treasury made a statement on it. The IMF spoke about it. President of the United States of America tweeted about it. You know, less pro. Those are some massive institutions. But I think what we saw is as an anecdote, we host private launches around the country, St. Louis, Denver, Chicago, Columbus. We saw turnout double. So I think what that did for many professional investors is I talked a little bit before about the journey that most people are on. Again, if you pull up that, you imagine yourself again thinking about CRISPR. You heard something a few years ago. I wonder what the latest is with CRISPR. Didn't a company go public for a few billion dollars? Is it Editas? What? I wonder what the latest is. And then you hear that, I don't know what company you admire, you heard Facebook is working on new CRISPR implementation to help save and you're like, 'Oh gosh, maybe I should catch up on what's really happened there.' And so I think that's the experience that many people had. They'd heard sort of in the background a faint volume of the steady drum beat of progress and Facebook gave them the reason to return their focus and get an update. So I think it's a big deal. There's a lot of ways in which this is a big deal. I have more thoughts on it. But at a minimum, I think one of the really significant things is that it just, I think it caused people to say, 'Okay, wow. If Congress is taking it seriously, if one of the largest companies in the United States is taking it seriously, might be time for me to make sure that I know what I really think here.'