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Today's episode is with Michael Sonnenshein, managing director of Grayscale Investments. Grayscale is the asset management subsidiary of Digital Currency Group. They currently manage $2.4 billion in assets across 10 products, including the Bitcoin Investment Trust. This includes $53.7 million, which was raised in Q1. And Grayscale recently released their Q1 report, which we talked about in this episode. In this episode, we also discuss Grayscale's approach to building an asset management franchise, the types of investors that are beginning to deploy in crypto assets, and Michael's outlook for the industry going forward. This episode was a lot of fun. So, without further ado, here's our episode with Michael Sonnenshein.
Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping in to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more into Britain's ailing economy with a new round of quantitative easing. You print a couple trillion dollars and all of a sudden people start to worry. So out of this worry, we have something called a Bitcoin.
Michael, thanks so much for joining the podcast today.
Thank you so much for having me on. It's great to be here.
Yeah, there's a lot to talk about. I wish we could have done this in person. How are you adjusting to working from home?
I have to say it has been challenging, but I cannot tell you how well myself and honestly the entire Grayscale team has adapted to working from home. We're a tight-knit team and folks that really thrive off physically having each other near one another. And so to see everyone step up and make the best of what's certainly been a difficult situation and Zoom and WhatsApp and email and all these other ways of staying in touch has been great and been keeping up our momentum and had a very busy first quarter.
Yeah, you definitely had a busy first quarter and excited to talk about the digital asset investment report that you guys put out with record AUM. How's that been in terms of raising capital throughout this time period where you can't meet people in person?
It's been really positive. Thinking back to 2019, we had a record year at Grayscale, bringing in over $600 million into our family of products. And we've been noticing a couple of trends over the past couple of quarters. One being ever more institutional interest in digital currencies and in particular expressing that view through access products like Grayscale offers. And we've seen that tick up, you know, quarter after quarter. And also seeing a lot of those same investors really begin to think about not just having exposure to the space, usually which initially comes in the form of Bitcoin, but then also seeing that there were added diversification benefits of having exposure to more than one crypto. And so a lot of that momentum really did continue and probably ramped up into Q1 where we actually raised over half a billion dollars in Q1 itself. And even as things got rocky in the markets amidst COVID and the pandemic and this kind of massive deleveraging and rush for liquidity, we saw pretty consistent inflows into our products amidst all of that.
And so does that manifest itself from a sales perspective in terms of actually being in front of these customers? Are you doing a lot of Zoom calls right now? How has that changed?
No, I think our investors are really great at getting on the phone or getting on Zoom. I think a lot of these investors, what we really learned from markets becoming a little bit rocky and then certainly seeing the VIX spike and oil come down to record lows is that they are really now more than ever using these drawbacks and drawdowns in price to tactically add to their positions. And so we're seeing not only existing investors use these periods to add strategically, but also it's actually opened the door for some new investors to come in who are using this time period to start building positions.
That makes sense. So I want to just take a step back and maybe set the stage a little bit in terms of what Grayscale does. I think there a lot of people have heard about the Bitcoin Investment Trust, might not be familiar with the broader corporate enterprise and know that you're under DCG's umbrella. So maybe could you just set the stage and tell us a little bit about the company and the product lineup?
Would love to. So Grayscale Investments is a New York-based digital currency only asset management business. We manage about $2.5 billion across a family of 10 investment products. The firm's inception goes back to late 2013. We really started to recognize investors wanted exposure to digital currency but would have difficulty figuring out where to purchase it, how to transfer it, store it, safekeep it. And to address those challenges, we began developing a family of products that mirrors the product structures that investors are used to seeing, particularly around commodity-based products. And so since 2013, we've developed now 10 different products under the Grayscale umbrella. Nine of those products give investors exposure to a single digital currency. So just long only passively managed strategies and that's for assets like Bitcoin, Ethereum, Ethereum Classic, XRP, Litecoin, etc. And then the 10th product we manage is a diversified basket that has as its holdings the assets which constitute the upper 70% of the digital currency market and holds them on a market cap weighted basis. And having these 10 products has allowed us to serve really the entire gamut of investors because we both offer private placements for accredited investors to purchase these products from us but then we also have some of our products so far trading on the public market where they have reach of really anybody anywhere that has access to the US securities market.
Thanks for that background. One of the interesting things to see is just the amount of people that were working at Second Market over the years and also your trading affiliate Genesis. You know, a lot of those folks were working on something totally outside of crypto and found themselves really wrapped up in the crypto scene eventually once Barry started to really focus on Bitcoin. So I'm curious from your perspective, what was your origin story in terms of how you came to be interested in crypto and what was the path that led you to your current role?
I was working at a bulge bracket bank in late 2013, was in the middle of getting my MBA and wanted to find something where I'd have a lot more impact on my organization. Through LinkedIn of all things I found a role at Second Market which as you mentioned was our founder and CEO's first company, Barry Silbert, which was really focused on providing liquidity to private companies and helping them facilitate buyers and sellers, companies like Facebook, Twitter, things like that. And he had really pushed the firm in 2013 to get involved in digital currencies and Bitcoin specifically. So our trading desk had started trading Bitcoin in 2013 and we had also started the first investment product that's now under the Grayscale umbrella which is the Bitcoin Trust. And so in kind of looking for a new role at the time, wasn't particularly interested in Bitcoin, maybe saw it flash up on CNBC from time to time but other than that was not necessarily looking to get into crypto. And when I got called in for an interview at Second Market I had the very fast opportunity to not only just meet a couple members of the existing team that were working on the Bitcoin Trust, but then I got to meet Barry right away. And I'll never forget what he asked me, which was whether or not I wanted to join him to be a part of building something and helped me recognize how rare it is to be given the opportunity professionally to get in on the ground floor of something. And Barry said, 'You know what, Michael? You can go work at a hedge fund. You can go find other jobs that may pay better, but you will very rarely, if ever, have the opportunity to join something like this at this stage. So, why don't you take a chance, come help me build something, and if it ever feels like it's going off track, go for it. I'll give you a good recommendation, and you can go on to your next opportunity.' And about seven years later, haven't looked back once, stomach a lot of volatility in the crypto market and have now become managing director of the firm and oversee Grayscale's day-to-day operations.
Well, that's an awesome story and you guys are definitely building something huge over there. I would love to just talk a little bit about how these products work. I think a lot of people are probably familiar with the Bitcoin Investment Trust because it trades under GBTC. You can buy it in a brokerage account, but other folks might not be familiar with your other products and not all these products are actually available on retail brokerage platforms. So, can you explain sort of how the product works from buying it at NAV and then the eventual transition to some of those shares being tradable? Can you just walk through how that works?
So all 10 Grayscale products can be purchased at their daily net asset value if you're an accredited investor and investors can buy those shares directly from Grayscale. None of the products have a redemption program. Rather what we've done is we've been able to obtain public market liquidity for these products. So four so far that have public quotations are the Bitcoin product which trades under GBTC as you said Matt, the Ethereum product which trades under ETHE, Ethereum Classic trades under ETCG and our diversified offering the Digital Large Cap Fund trades under GDLC. And so anybody who's accredited and purchases shares in those private placements has to wait a mandatory holding period before they can then sell them in the public market. In the case of the Bitcoin fund, that's only six months that they have to wait between buying privately and then selling publicly. The other three products, Ethereum, Ethereum Classic, and the Large Cap Fund, you have to wait 12 months based on Rule 144 before you can sell in the public market. Now, if you're not an accredited investor, or even if you are, either way, anybody anywhere with access to the US securities market can buy freely tradable shares of those products in any size. There's no minimums, there's no holding periods, etc. And those trade every day that the public markets are open. So, yet another way for us to access other investor audiences.
Thanks for walking us through that. One of the things that I get asked a lot from people that are actually pretty sophisticated investors is just why you can have kind of a product like GBTC but the ETF is not approved. You know, we see there's clear demand for these products in the retail channel just by virtue of looking at how they trade. So, at any given moment, GBTC is typically trading at a premium to the underlying, which to me would indicate there's a big appetite for exposure to crypto assets from the retail public and they're just not getting that exposure in a way that they want. And I know that you guys have applied for an ETF in the past. So, would be curious your view on just why other kind of exchange traded products have not been approved by the SEC and what barriers you're monitoring that would lead to the growth in some of these assets.
Well, I think Matt, our regulators have done a really good job in terms of keeping pace with the industry, which is certainly from your day job and I certainly know from mine is moving at breakneck speed. And it's been really fascinating to see them keep pace in the way that they have because the crypto market represents just such a tiny fraction of some of the other markets that they're responsible for surveilling and kind of creating regulation around. That being said, I think our regulators have made it quite clear that in order to see some exchange-traded products, they're really looking for a little bit more of maturation in the underlying assets themselves in terms of there being, you know, a domestic surveillable market, information sharing agreements, things like that. And I believe over time those things will come. An ETF will be a matter of when, not so much a matter of if. And I do think you hit it right on the head, which is that some of the Grayscale products that have persistently and currently do trade at a premium, we have no control over the price at which those products are trading. We don't dictate those prices. Those are entirely dictated by the market. And so where they're trading on a given day is really a function of how much demand there is for digital currency exposure through an investment product, right? And we have investors being able to get exposure to crypto without them having to open up wallets or open up accounts at exchanges or other service providers they may not be as familiar with, but rather they can get that exposure right alongside stocks, bonds, and other things that they're already invested in. And I think it's important for the industry to take notice of something that happened at Grayscale recently, which was that this past January, the Grayscale Bitcoin Trust became an SEC reporting company. So now that means that product has the same level of disclosure and reporting requirements that you'd see from any other public company or registered product that trades on a national securities exchange. And we file now 10-Ks and 10-Qs for the product. And that's a really big step in terms of giving validation not only to the asset class but also it should give everyone in the investment community a really strong signal that there are in fact ways to work with regulators within the existing regulatory framework around this new exciting innovative asset class.
And is that the reason why the GBTC product is freely tradable after six months because it's a reporting entity?
Correct. So one of the functions of becoming an SEC reporting company was that Grayscale Bitcoin Trust statutory holding period for private placement shares dropped from 12 months to 6 months.
So when people ask me sort of why would people want kind of a titled security that they're paying the 2% management fee on versus holding the underlying, I often talk about what you mentioned around custody so you don't have to worry about holding the underlying asset. You can hold it in a brokerage account similar to all your other assets. But a big thing to me is also just you can hold it in a tax advantaged account. So you could hold these type of products in an IRA. So is that something that you're seeing across the suite of products that people are taking advantage of the fact that you can hold some of these things in a retirement account or an HSA I guess for that matter?
Absolutely. And that's actually Matt one of the things we wanted to highlight for investors in our quarterly report that we just published earlier this week. Looking back to the firm's inception, about I think it was 45% of the assets that we had raised from individual investors into our product family were done through tax advantaged accounts, IRA, Roth IRAs, 401(k)s, things like that. It's virtually impossible for investors to gain exposure to digital currencies in those types of accounts because they're generally so limited to publicly traded securities, bonds, things of that nature, mutual funds. And so that's been definitely another big value proposition that our product family has brought to the investment community for sure.
I want to talk a little bit more about that report. $53.7 million raised this quarter. So staggering amount. It looks like a big chunk of it was raised from hedge funds. Can you talk a little bit about some of the drivers that you see for why some of these hedge funds are seeking this exposure?
I think hedge funds are looking for digital currency exposure for a variety of reasons. First and foremost, I think for a lot of these funds, it's difficult for them to be able to buy, hold, store, safekeep digital currency directly. And so the Grayscale family of products works really nicely for them in terms of having a family of instruments that allows them to put on the exposure without them having to directly touch or handle the digital currency. And then also comes along with audited financial statements and really something that everybody from the PM to the chief legal officer can get comfortable with. It's interesting that as we unpack the hedge funds that we have been interacting with that such an overwhelming majority of them are asset managers and hedge funds like multistrat versus such a low percentage of them being crypto-focused hedge funds. And so the reason behind getting the exposure will differ quite a bit. There are certainly those who have been able to and are excited about the digital gold narrative and looking at digital currencies like Bitcoin as a store of value. There are others that are concerned about the proliferation of digital currencies and blockchain technology and how they will influence some of the existing investment and exposure that they have. But ultimately, I think as we see investors having to navigate an ever more challenging market, they're looking for ever more diversifying return streams and they see that digital currencies may very well offer that in a way that other assets or other asset classes may not be able to.
One of the really clever and unique things about DCG is that all of the companies sort of interact nicely together. You have the venture unit, you have the trading desk, and then Genesis has also built out a lending function. And so in the prior reports, you'd kind of had this disclosure around paid in kind, which is basically borrowing crypto assets to put them into the trust. Can you speak a little bit about how you work together with the trading desk and the lending desk on the asset management side?
Grayscale is a wholly owned subsidiary of Digital Currency Group. Digital Currency Group or DCG is a holding corporation whose mission is to accelerate the development of a better financial system. And so we work very closely at the Grayscale level with another one of DCG's wholly owned subsidiaries which is called Genesis. So Genesis is a registered broker dealer. They're likely the largest over-the-counter digital currency trading desk here in the US. They also have probably the most robust digital currency lending and borrowing practice. And so as investors come to Grayscale looking to deploy capital into our products, they're actually using not just Grayscale but also Genesis because if someone gives us cash to subscribe to a product, Genesis is the one that is going out and sourcing the requisite amount of digital currency to match that investor's investment amount and thus for us to be able to create the shares for them. In other instances, when investors aren't subscribing in cash, they're oftentimes borrowing digital currency from Genesis and using the borrowed coins to be able to invest into the products. And then we're also seeing in some instances investors who may already own digital currency and maybe don't want to any longer task themselves with being responsible for holding and safekeeping those assets. Not to mention if they contribute those assets they already own into the Grayscale family of products, the products and the exposure are now inside of a titled security that's in the investor's name. And so perhaps they have concerns over the transferability of these investments over to their beneficiaries, which may be difficult if they're still owning digital currency outright, but a lot more straightforward and a lot clearer if they're holding it as a titled security and can be passed to their beneficiaries under estate laws. And so it's a really close working relationship between the Grayscale and Genesis teams and all of course under the DCG umbrella.
