B2C019: Yield is King (w/ Jeff Dorman of Arca)
Jeff Dorman, CIO and Co-Founder of Arca joins host Peter Hans for a conversation that gets back to their fixed income roots: they’re talking about low-volatility yield. Everyone gets into the crypto and digital assets market because of the upside and the technology, but this episode explores the many ways you can generate safety on a relative basis and earn high single- to low double-digit yields.
Visit www.realvision.com/crypto to join the crypto revolution.
Jeff Dorman, CIO and Co-Founder of Arca joins host Peter Hans for a conversation that gets back to their fixed income roots: they’re talking about low-volatility yield. Everyone gets into the crypto and digital assets market because of the upside and the technology, but this episode explores the many ways you can generate safety on a relative basis and earn high single- to low double-digit yields.
Dorman and Hans talk about the following during the episode:
JEFF DORMAN & PETER HANS
REAL VISION 00:00
Welcome to The Real vision Podcast Network.
PETER HANS 00:11
Hi, this is Peter Hans and welcome to this week's episode of Between2Chains. We're getting back to our fixed income roots today, I'm joined by Jeff Dorman CIO and co founder of ARCA, and we're talking about what most people don't think about when they think of digital assets and crypto, yield low volatility. Now, everyone gets into this market because of the upside and the technology. But what we're exploring today is the many ways in which you can generate safety on a relative basis of course, high single to low double digit yields. I hope you enjoy the episode and learn as much as I did and make it Thank you.
REAL VISION 00:53
Before we get going, we want to remind you that Jeff Dorman is the co founder and chief investment officer of ARCA funds, and Peter Hans is ARCA funds Managing Director. The commentary and opinions expressed in this podcast are solely those of the podcast participants and do not necessarily reflect the opinions of ARCA funds or its affiliates and are subject to change for any reason without notice. Any discussion of investments or investment strategies within this podcast are for informational purposes only, and not to be construed as a recommendation to buy or sell any particular investment, security, digital asset or strategy. Investing in digital assets involves a high degree of risk and volatility, including the risk of the total loss of principle. And now enjoy the show with your host Peter Hans.
PETER HANS 01:42
Jeff, welcome back to between two Chains How you are doing this morning
JEFF DORMAN 01:45
PETER HANS 01:48
Doing well doing what else for the audience. This will come out on Monday, but today is Friday, April 30, wrapping up another crazy month in the digital assets world. So one of the things I wanted to bring you on and talk about Jeff is put put back on, let's put back on our old fixed income hats for a little bit here. I've been talking a lot to different investors, LP's prospective investors, and you know, a lot of these conversations stem around the yield environment, certainly, you know, kind of legacy financial product yield environment, but as that migrates over to the digital asset world, it's kind of unique, because you can, you know, do things like BlockFi or, you know, DeFi protocols like off and get what are incredibly attractive yields through lending predominantly stable coins. And, you know, it seems like the the major risk of that is obviously counterparty risk, which we've, we've touched on before. But I just want to pick your brain a little bit about yield opportunities in the asset class. And you know, what, what you see surrounding stable coin demand and the yields played out, you know, kind of why that exists, and maybe what other opportunities there are to generate yield in this in this market?
JEFF DORMAN 03:07
Sure, yeah. And obviously, this is an incredibly important topic, given that there is, I believe, somewhere between 15 and $20 trillion of negative yielding debt in the world at the moment. And I believe even short duration tea bills here in the US just went negative from a real rate standpoint, just this morning. So clearly, there's an entire world out there who is yield starved, and it's, you know, it's no surprise that you're starting to see people in the traditional financial world start to, you know, pay attention and care about what's happening here in the digital asset world. You know, it took, what, 10 years for wall street to finally care about Bitcoin. And you know, what, five months later, they're already talking about DeFi and the yield opportunities and, and lending. So it's good to see. But there's also a lot of impediments before traditional finance can really get into the space.
And I think we've talked about this in prior podcast, but you know, the pipes just don't really blend between the way the traditional banking and brokerage system works compared to, you know, what is this new workflows with regard to asset transfer here in the digital asset world. So what you end up with is this really odd dynamic where everybody currently in the digital asset world is shooting for 100% weekly returns and couldn't care less about a 5% or 10% yield. Meanwhile, the rest of the universe with $20 trillion of negative yielding debt is starving to just to get four or 5% and can't do it because those yields don't exist in that world. So how do we bridge that gap? I mean, it starts with education. I think JP Morgan, just last week, wrote a report talking about some of the yield opportunities in this face. focusing specifically on just spot futures arbitrage, not really addressing some of the other opportunities, but it's a start right once you start to identify that these yields exist. Then all of that money from the traditional world starts to try to figure out well, how do I take advantage of that in this new world? And these opportunities are probably not going away, you know, for years, until a bulk of that money finally enters the space.
PETER HANS 05:15
What went negative this morning? That that's crazy? I didn't see that. Because I see I see overnight rates at like, five, six basis points. Is it? Was there something else that went went negative
JEFF DORMAN 05:26
Real rates based on spread
PETER HANS 05:28
Okay, got it. got it got it
JEFF DORMAN 05:29
got real rates based on the fact that inflation expectations are changing?
PETER HANS 05:33
Okay. Yeah, of course, of course. Interesting. Yeah. Well, because economic numbers are, you know, continue to look pretty strong. I mean, obviously, we saw consumer spending this morning as a result of stimulus tax and others, and we're getting paid, you know, four basis points on overnight rates. So yeah, that from a, from a real respect, that is, that is certainly negative. freakin crazy. So that's interesting. So you think it's really just kind of a lot of the the the fact that it's structural, you know, you can't very easily go from digital assets to fiat currency and back again. So there is demand for essentially, dollar stable assets. And in the digital world, well, is that just just all leverage based primarily?
JEFF DORMAN 06:19
Well, not necessarily, I mean, I think a lot of, you know, you first have to break down where the yield opportunities come from. And then each one of them has a different dynamic for why it exists and how you take advantage of it. So the easiest and most simple one is, you can learn dollar based stable coins, meaning tether USDC dye, you can lend those for anywhere between, you know, called seven and 10%. Right now, and the reason for that is twofold. One is the rest of the world outside of the United States is starved for dollar denominated assets and dollar exposure. So there is a real demand out there in other countries, especially countries with depreciating currencies, just to get dollar denominated assets. So that has nothing to do with leverage that literally has to do with protecting purchasing power and having something that is spendable that's not being inflated away from you.
And quite frankly, to get outside of your own local government regime, which again, outside of the United States, there's a fair amount of people in the world who don't trust their governments and for good reason. So that's part of the demand right there. The other part of the demand, as you mentioned, is leverage. You know, anytime that you are in an environment where you're earning double digit weekly returns, like the digital asset market has been providing over the last six to nine months, you don't really care what the rate is that you're borrowing, you know, you'll borrow 10 20 30%, if you're making 50 to 100% annually, so there's definitely a leverage component to it. And the third part of it is as collateral, right, one of the ironies of this digital asset space isn't, you know, we all talk about how you have real time settlement, you don't have T plus one equals T plus two T plus three. But at the same time, as a result, there's no prime brokers and everything has to be effectively settled in real time, which means that you always have to be over collateralized.
And as a result, even if you're not intending to use leverage, you have working capital issues, if you're a broker dealer in the space, or an OTC desk, if you're at the asset management firm, you know, even if you're just a retail investor using some of these things, you often have to have collateral in multiple places to because you know, there's so there's such a fragmented universe of where these different opportunities come from, to put assets to work. So let's say you're trying to put a million dollars to work, well, you might have to have a million dollars at Coinbase a million dollars of binance a million dollars at FTX a million dollars at the CME a million dollars at interactive brokers, because you actually never know where you're going to put those assets to work. Right, if all of a sudden GBTC Falls 30%, you might want to put your money to work at interactive brokers and buy that but if all of a sudden, you know Bitcoin futures break down, you might want to put it to work at FTX in finance, or if all of a sudden spot futures spot Bitcoin falls, you might want to put that money to work at Coinbase. And you never know where those opportunities are gonna come from.
And you can't just leave it at a prime broker and say, Hey, when those opportunities come, I'm gonna go buy it and you settle it later, you have to have those assets ahead of time at those places in order to effectively do those trades in real time. So there's a massive need for over collateralization, even if you don't use the money right away, simply to have the ability to transact in this market. So some of that opportunity may close over time. But again, the workflows and the pipes are just so different that I don't think that closes anytime soon. So there's going to be a constant need for borrowing assets in order to collateralize the investments in the trades that you're doing in this space. So that's a lot of the reason that this leverage that these yields exist. And, you know, there's only a handful of players right now who are trying to take advantage of that.
PETER HANS 09:47
So the I understand kind of the the over collateralization. But you know, there's one thing that's kind of ironic to me that, you know, help me help me wrap my head around this a little bit. We're creating In a financial ecosystem that sits outside of calling fiat currency, yet, the over collateralization is all essentially in fiat currency, right? Yes, it's in it's in a stable coin, but that is essentially US dollars, right? Why? Why not? eath? Why not Bitcoin just purely volatility?
JEFF DORMAN 10:23
Well, there's very there's much less demand for Bitcoin because it's not as useful, right? Bitcoin for the most part can only be used for trading on spot exchanges and a few futures and derivatives exchanges.
PETER HANS 10:37
Bunch of clowns who are gonna come after you on Twitter? Well, it's not doing that, as usual decided
JEFF DORMAN 10:41
it's not as useful for this purpose. Right? Like, honestly, Bitcoin has the most simple investment thesis in the world. You either believe it's digital gold, or you don't and that's it. Right? It's a one liner.
PETER HANS 10:52
I thought it did everything. I vaccinated myself.
JEFF DORMAN 10:56
One day probably, or at least you'll have a you'll have a record of it on the Bitcoin block chain move. But the you know, the reality is there's no demand for Bitcoin. I mean, we're seeing it BlockFi lowers their rates seemingly every week at this point, you know, Genesis just lowered their rates there's no real demand to borrow Bitcoin there's nothing to do with it once you get it other than you know, use it on a Bitcoin denominated a spot futures trip. The only real use case for borrowing Bitcoin historically had been the GBTC arbitrate and that is gone forever now that GBTC is trading at a massive discount to nav and that's never coming back until you know, an ETF is approved, which is probably three years away. So the the biggest use case for borrowing Bitcoin in the market is gone. By there is demand for eath. Because eath is certainly more useful, right? DeFi is now I think, what $50 or $60 billion and tvl, across all the different DeFi protocols. And eath is is certainly being used in that capacity. So there is much more demand for eath. Now, you know, I certainly think eath and Bitcoin are completely different assets with completely different value drivers. But there is a reason why, you know, the crypto Twitter continues to try to call eath money. You know, they're trying to compete with Bitcoin in terms of the narrative of eath as money. And this is why eath is actually more useful as money, certainly within the decentralized finance ecosystem, it is not more useful outside of that, right? The traditional macro world is still focused on Bitcoin only. But there is an argument for why people believe that eath is a better form of money. And this is why There's more demand for eath because there's more transactions on eath. Because there's more to do with eath.
PETER HANS 12:25
Sure, yeah, that makes sense. I mean, there's an element of that whole narrative just essentially being data semantics, which is, you know, not not something like philosophically, I really want to go down that road. But okay, yeah, I mean, I mean, that, that, that definitely makes sense. In terms of, so, how long do you think this persists, like that this this type of environment where you're looking at, like, 1000 basis point differential, and in, you know, kind of kind of interest paid? And, and, you know, if this dynamic exists, and we have all these kind of demand for dollars, as you're talking about internationally, you know, one of the first thing that came to my mind was like, Okay, well, why are Treasury yields so low? And I guess, to your point, like treasuries are not spendable, technically but, but stable coins are spendable as a unit of currency in a specific ecosystem?
JEFF DORMAN 13:22
I suppose. Treasuries are in great demand. That's why yields are as low as they are. Right. I mean, the Fed has been buying this as the Fed is the Fed is buying almost all of the newly issued foreign governments around the world who are still massive buyers of treasuries, right. That's why you'll note that they are in high demand. But that is the
PETER HANS 13:43
I haven't I haven't had my coffee yet this morning.
JEFF DORMAN 13:46
Price up yield them. But the you know, that's why that's mostly being bought by banks and central banks, and you know, big institutional buyers, right? The normal, you know, retail investor or consumer is not out there buying treasuries to spend or to use, right, you are starting to see that now, though, with dollar stable coins, you're starting to see it, you know, in the obvious places, right? Venezuela, Turkey, South Africa, places where there's been massive depreciation of the local currency. But you're starting to see it elsewhere as well. I mean, you know, it is actually very easy to move money into $1 based stable coin and to use it in a variety of different ways and to send it much cheaper and much quicker than anything you can hold in a bank account. So there is real use cases. But there's there's more yield opportunities beyond just the stable coins, right? I mean, this is one of the most volatile asset classes in the world as well, well, you know, dust out your Black Scholes model and you know, what, what happens when you have high volatility and low interest rates, you have a high options pricing, and what does high options pricing do? Well, that leads to yield opportunities as well, right, whether that's covered, whether that's covered calls, or others, you know, volatility strategies, you know, these are yield based opportunities. So, once again, that creates demand right.
If you have eath or Bitcoin that you are borrowing, you can now use that as collateral added. Arabic or at an OTC derivative shop or you know, the likes to put on multiple strategies. And as long as volatility is high and interest rates are low and time to expiry is infinite, which is basically what digital assets are right there. They're really just long tailed call options that will never go away, therefore, their expertise is infinite. You're going to continue to have high volatility, you're going to have yield opportunities within the options market. And then again, we've talked about spot futures arbitrage plenty of times, but it's the same thing, right? I mean, there's a reason that the futures market is constantly in contango, which means that, you know, US futures are trading at higher prices than the spot, right? It makes no, it makes no sense intuitively, right? Because when you think about oil and commodities, the reason that curves become in contango is because their storage costs because there's opportunity cost that doesn't exist in the digital world, there's no storage costs to owning Bitcoin, there shouldn't be contango, but there is because this is a cash starved ecosystem, there's just not enough money in collateral out there relative to the people who want to buy, you know, this is a Bitcoin, for example, is a trillion dollar acid, there might be $4 trillion in demand for Bitcoin, you have to use futures and other synthetics to get that exposure. So as a result, you have these curves.
And when you have curves, you have riskless arbitrage opportunities. Now I use riskless in quotes, which nobody can see in the podcast, because nothing is truly risk free. There's counterparty risk, and we discussed that, you know, a few months ago on a previous podcast, but from a price standpoint, it's riskless. From a Counterparty standpoint, there's plenty of risk. But the bottom line is, you know, I just don't think these yield opportunities will really go away until there's complete cross modulation between the traditional world and the digital asset world. And as we know, and as everyone else knows who's in this ecosystem, you know, that that is not going away anytime soon, right? We're just not even close to the traditional world and this new digital asset world being integrated in any meaningful fashion from a from a flow of funds flow asset standpoint.
PETER HANS 17:02
So what is what's implied vol on on Bitcoin right now?
JEFF DORMAN 17:06
You know, depending on the maturities, we'll just work one month out,
PETER HANS 17:09
JEFF DORMAN 17:09
but you know, one month out is somewhere between 60% and 80%, depending on the strike. You know, historically, historically, you know, it's been as low as 30% or 40%. It's gotten as high as 120%. But it's definitely, you know, larger than anything that most options traders are used to, which is why so many options and derivatives traders have come over to this new world. I mean, they're seeing opportunities in this space that just don't exist in, you know, equities and traditional commodities,
PETER HANS 17:40
Is eath these options look similar in terms of implied value?
JEFF DORMAN 17:43
PETER HANS 17:45
Yeah, I was gonna say, I thought they were more expensive.
JEFF DORMAN 17:47
Yeah, it's a smaller market. But to you know, the volatility is almost, you know, probably at least 25% in some places 50% higher.
PETER HANS 17:59
Wow. Hmm. And, and in from a counterparty risk standpoint, what I mean, that I would think that looks a little different with CME involved in the options market than it does say in the, you know, stable coin lending market. I mean, even though BlockFi might be a big startup, there's, you know, it's not Goldman, there's still some counterparty risk there comparatively, or do you not see it that way?
JEFF DORMAN 18:25
I mean, you can certainly see it in the rates right now. If you're looking at one month, Bitcoin spot futures difference right now, all of the traditional, you know, so cracking is 14%, that would be your us Counterparty. Debit, okay. x and Hawaii are between 20 and 24%, annualized, right? Those that's your, you know, Asian foreign Counterparty. And the CME is 4% annualized, right? So you can see a huge difference right there in terms of how the market views counterparty risk. But also, that's a, you know, that's also an element of just the fragmentation of this market, right?
The only people who really use the CME to trade Bitcoin are people who are not traditionally in this world, right, they're only the only venue to do it is the CME because their compliance and regulatory departments approve it, whereas those who are fully integrated in the digital asset world have a much larger choice of venues, and there's also a lot more interest in, you know, using leverage and looking for those greater returns in the space. So part of it is simply, you know, we everyone's read a Random Walk Down Wall Street and have heard about, like, you know, efficient market hypothesis. It just doesn't exist in a market that is one brand new. Now, of course, you know, it's global. It's 24X7, there's different parties using different systems. You know, you see it every day in terms of, you know, look at Robin Hood, for example, a few weeks ago when Dogecoin was going crazy.
You know, what went higher immediately after Dogecoin rising it was the only six assets that were available on Robin Hood. Right? Well, how does that happen? Right? You know, somebody opens their phone The next morning, they go to their crypto app on Robin Hood, they see that Dogecoin is up 50%. So what do they do? They immediately snap by the only other six assets to Robin, right? Right.
PETER HANS 20:11
It makes no sense by Bitcoin cash,
JEFF DORMAN 20:13
Those, those assets have nothing to do with Dogecoin. And they shouldn't be higher, but they're higher simply because Robin Hood has a different audience than what coin base as which is different than binance different than CME. So, you know, usually when you see market inefficiencies, for a variety of different reasons, it creates dislocations, and it creates yield opportunities. And this is, you know, arguably the most inefficient, you know, global fragmented market that we've ever seen. And that's why these opportunities exist.
PETER HANS 20:40
Right, Well, you can't have an inefficient market without, you know, access to a full range of market participants. Right, you know, you know, obviously, I don't think there's any really, truly efficient market, per se, maybe treasuries or something, but, but you know, equity markets can certainly be more efficient, because you have, the entire population has access to trade. equities, right, you know, including like big institutional investors, big institutional investors in the US have no access to trade, most digital assets, right. So like, because it's just a different infrastructure, so you can't possibly have an efficient market with inefficient participants. So that's the CME,
JEFF DORMAN 21:23
I would also just go back to the counterparty. I'd also just go back to the counterparty risk thing for a second as well, though, right? I mean, again, it was only 12 years ago, when Lehman Brothers five year CDS was trading at nine basis points. I mean, it was literally summer of 2007, Lehman Brothers CDS was trading at nine basis points a year, a year later, a year later, it was the largest bankruptcy in history. Right. So you know, counter, we can laugh and look at the CME and be like, Oh, well, that's, you know, that's basically was free.
That's so safe is like, you know, is it? I don't know, I mean, I don't see CME's working capital issues and their balance sheet every minute of every day, it probably is, but yeah, you know, you just never really know, or you never know, what's under the curtain until it's too late. And anybody who, you know, goes back to their 2007 2008, even 2011 2012. You know, it became a story of not what you own, but who you own it with, right? If you had exposure to Lehman, or bear or MF Global, or even Jeffrey's or Knight capital, you were, you know, you had a compliance officer and a risk officer with a shotgun to the back of your head, you know, checking what your risk was. So, you know, again.
PETER HANS 22:25
That has to be a compliance violation.
JEFF DORMAN 22:27
It really, I think, I think in 2011 2012, compliance officers had a free pass to put that in the bag here.
PETER HANS 22:33
Today, that would be frowned upon.
JEFF DORMAN 22:36
But it was no, you know, it can be scary, right. And the point is, you know, these are most of the counterparties in the space are new. I mean, finance is a great example, finance is probably worth $250 billion. From an enterprise value standpoint, when you combine the BNB token and the the equity of that company, they do somewhere between five and $10 billion of revenue a year. But finance is what three years old. I mean, these are, these are, these are startups that are handling billions of dollars of transactions. So, you know, again, you put all of that together, right, you put the working capital in efficiencies, the fragmentation, the counterparty risk, the, you know, leverage opportunities, the dollar based opportunities, it just, it creates an environment where you can, with a good professional risk manager and a good process for what you're doing, you can generate yields that investors are starved for, and do it in a way where they can feel comfortable earning those yields.
So, you know, I think more and more investors are going to start realizing that you don't have to come to the digital asset market, just because you see, Dogecoin go 50% a day, you can come here for that fixed income exposure that you physically can't get anywhere else right now. And I remember when my grandma before she died before my grandma died a few years ago, she was looking for utility stocks that were paying her 4%, you know, dividend and she was living off of that. And that's the majority of the retirement world starving percent and they physically can't get.
PETER HANS 23:59
Yeah, no, it's just that's absolutely true. Yeah, my grandmother buys a boat. Yeah, she's in her 90s and buys, you know, bank CDs, you know, same same thing. Alright, so we're looking at kind of seven to 10%, on on stable coin lending, which is, you know, you have some counterparty risk, of course, what do we what are we looking at in terms of, you know, playing playing this, this basis trade and kind of the options market? And, and it seems like that, that difference? The difference substantially depending on that exchange? So, one is that not really available, you know, say on CMA, right. So, it's not like anyone can participate in that trade. It takes, you know, it takes a certain type of entity or manager and then, and then, you know, what, what are you looking at if you're doing that on terabit, or will be or kind of one of the exchange with larger spreads.
JEFF DORMAN 24:53
Yeah, I mean, like you said, it changes constantly, but, you know, a few weeks ago, it was as much as 40% and to do three months spot futures arbitrage on some of the Asian exchanges. And then what happened is the leverage built up in the system eventually had a leveraged unwind and futures crashed and you ultimately came down from 40% annualized to actually a 20% discount. So imagine if you put that spot futures arbitrage trade on where your long spot and short futures, not only did you basically guarantee your risk free 40% annualized return was subject to counterparty risk, of course, but you actually could have monetized that three weeks later for a massive return because it shifted so fast. Even right now, you know, again, right now, it's down to just 25% annualized. And you know, I say that jokingly, because 25% annualized is still amazing. But it's down from what it was a few weeks ago, when you're looking at like one in three months. opportunities here.
And I think, again, going back to why the CME is so different, it's again, because of the players, right? If you have access to the CME as a traditional hedge fund, right, traditional bank, you are dying for seven to 10% yield right now you are going to crush that arbitrage the first second you get the players, of course, players in the digital asset space are not thinking that way. They're like 25%, annualised there's nothing I can make that in three days if I buy the right token. So you just don't have the same people in the digital asset space, taking advantage of that trade as you do that in the traditional world. And that's why you're going to constantly see a difference, and you'll produce like I was laughing the other day, I think JP Morgan came out with a with a yet another laughable product, you know, their first laughable product was, you know, in an ETF basket of stocks that have exposure to digital assets, and literally not one of the companies in that basket had anything to do with digital assets, other than, you know, very loose affiliations. Their next product they came out with is they're announcing an actively managed Bitcoin fund.
And, you know, what does that mean? We know, we know JP Morgan can't actually buy spot Bitcoin, they don't have the custody, they don't have the ability to do it. So what are they going to do, they're either going to be speculating on futures moves on the CME, or they're going to be playing, you know, these arbitrage opportunities, right, they are literally, using an incredibly limited playbook with limited trading hours and limited vantage points, to offer an actively managed product, it's the equivalent of like, you know, opening up an ice cream store, but only selling ice cream when it's cold out, it makes no sense. But they're using the toolkit that's available to them, that's all they have available. So, you know, again, like the people in the traditional world are dying for this yield, and they're going to go crush any arbitrage spread that exists.
PETER HANS 27:22
Everyone's playing the CME I mean, I've got a buddy here who ran the ran the Citadel, energy energy pod, and and now has his own fund. And he was my he is he coached with my daughter's softball team with me because they were there in the same class. And, and, you know, his head, he says, I'm doing really well. But you know, one of the things he's playing he's an energy trader, it's been an energy traders career, and he's playing, you know, spot futures are buying Bitcoin in the CMA for, you know, these kind of kind of yields you're talking about, because in the traditional world, that's, that's great, you know, especially you can, you know, use leverage and doing do that. So to your point, right, like, you go to where you go to where the opportunities are, you know, to get to where other people don't have access to I think it's everyone's trading Bitcoin options.
JEFF DORMAN 28:11
Yeah, I agree. And I think I think you know, you'll see it in places that maybe others aren't thinking about to like, look at GBTC, for example, we talked about historically, that was one of the best arbitrage trades, because GBTC traded at a premium to nav and you can, you know, you can borrow spot Bitcoin converted into the GBTC Trust, sell it six or nine months later at a premium and make what you know, in theory, a risk free trade. Well, we all know how that ended. Now, GBTC is trading at a 15% discount. But what does that mean? Think about that for a second, like a Bitcoin ETF is probably three years away, right? I know a lot of people are talking about being six months away, but that's not realistically, probably three years away. So let's just look at what that means for a second.
If you have a 15% discount to net asset value. And you assume that discount is only going to close in three years when an ETF is issued, what you're really doing if you're buying gbtc is you're basically buying a three year zero coupon bond with a warrant. So what I mean by that is if you buying it, if you're buying a bond at 85 cents on the dollar, the IRR sucks. Well, it's a 7% annualized return, if you're buying if you're buying a bond at you know, between 80 and 85 cents on the dollar with a three year maturity and no coupon you're getting somewhere between a five and 7% annualized return on it.
PETER HANS 29:16
Which if you're going to play in Bitcoin, like I mean, I guess you could seek out you could seek capital appreciation in the.
JEFF DORMAN 29:22
Well that's where the warrant comes in So basically, what you're here basically what you're doing if you're buying that if you're buying a three year zero coupon amortizing bond with a warrant attached and that warrant attached is the price appreciation potential of Bitcoin. So if you're bullish on Bitcoin, and you have a long term time horizon, that's a great three year bar. Sure. That's a great play for a fixed income investor right? You might not be.
PETER HANS 29:43
what are they charging you 2% a year? Yeah. So you have to factor that into the to the IRR as well
JEFF DORMAN 29:47
Sure for the point is like a yield investor that is actually bullish on Bitcoin. That's a great trade. You're making four or 5% annualized, maybe 6% annualized, plus, you're getting this kicker if Bitcoin continues to go higher. So like, there's all these different opportunities depending on what what field you're playing And what your risk return is and what your goals and what you're, you know what you're trying to achieve.
PETER HANS 30:06
But Alright, so I do want to touch upon the DeFi environment as well, because I know from a yield standpoint, that's rather juicy. But that said, like GBTC I'm just not buying the whole ETF conversion. I mean, if you're gbtc, and you've basically locked in this 2% management fee for eternity, because you provide zero liquidity. You know, why in the hell would you convert to something where you now offer redemptions and can lose, they have no pressure on management fees? They offer no liquidity, like, yeah, you rip people off, but okay.
Got it, you know, like, I mean, yeah, I wouldn't have done it in the first place. But like, now that you have it, why would you ever do that? Like, this is nothing more than posturing, it has to be posturing to try and say, like, Oh, we promise we promise we'll take care of you. Meanwhile, like you're clipping 2% management fee on whatever they're, hey, us. And they're a whim. If you believe Bitcoin is going higher, they're a US only grows. So like. I mean, it was it was the most brilliant investment product structure, potentially of all time. Yeah, it's just the right place. right time. Why would you ever exit that?
JEFF DORMAN 31:21
Yeah, no, I agree that it's one of those products
PETER HANS 31:24
of investment products.
JEFF DORMAN 31:25
Yeah, exactly. It's, it's the best product ever, for the issuer, and not the best product for the buyer. But anyway, we digress. But yes, I agree that they're probably just posturing in that sense. But the point is, again, you know, there's dislocations everywhere. And there's yield opportunities everywhere, depending on what you're looking for.
REAL VISION 31:43
You're listening to our show between two Chainswith your host, Peter Hans.
PETER HANS 31:52
Alright, let's talk DeFi Alright, so it's all free. here's here's the way I understand kind of the the the the yield opportunities here. It's leveraged based, there's landing, there's rewards, there's different protocols. Certain protocols are going to pay less that you know, are in you know, that that are more established, certain that are trying to launch and build a community are going to offer higher yields. One thing that I'm a little confused on is what are these yields actually paid in? So if I launched a DeFi protocol tomorrow, and I offer, you know, 12, notes, 20% APR, and my pain and like my native token, which may or may not have value, or my pain in ether, you know, how does that whole process?
JEFF DORMAN 32:46
It depends on the protocol depends on on the token structure. But ultimately, what you're doing here is the whole idea of issuing a token is you're trying to incentivize all stakeholders, right? We've talked about this before, right? The tokens are the greatest capital formation and customer bootstrapping mechanism ever, because you are incentivizing your founders, your developers, your early investors, your customers, your liquidity providers, you're incentivizing everybody through this token. And once you get critical mass, that's why we see explosive growth in these communities. And in these projects, because you are, you know, again, you're incentivizing everybody to not only be a customer, but to be an evangelist and get others in there because they're being rewarded financially for when something works.
So to start off, if you're trying to build assets within a protocol or trying to build customers, what you do is you give hefty rewards, right? It's basically a marketing discount to get people in the system. What you're giving away is your native token or some other token, have a partner of some other protocol or project that is using your your, your your DeFi protocol. So the yield is certainly variable based on the demand for that token. So what do you have to do, you have to then create other demand for the tokens. So for example, compound is the best example of this compound basically invented liquidity forming, or yield forming rather where, you know, if you were one of the first people to use compound, which is a lending borrowing platform, and you started to put assets into that protocol in order to lend and borrow you were being rewarded with the comp token.
And the comp token, in theory has no value, right? Why wouldn't have value it's being literally farmed just just to sell, right? So you know, how do you sell the comp token, you have to develop a buyer of it. So initially, you know, the buyers are speculators. But eventually compound is now spitting off, you know, hundreds of millions of dollars of revenue, just like a lot of these defy protocols. And now you can start to invent other utility benefits and other pass through reward benefits to the actual passive investors in the comp token. So this can go both ways, right? Like Wi Fi was a great example when when urine finance came out, which is basically a robo advisor looking for yields in the space. Initially Wi Fi, the Wi Fi token went straight up because you were earning rewards in something called curve. The problem was there was no organic demand for the curve tokens. So those yields organically started to go down because every curve token that was issued to Wi Fi participants was just getting immediately sold. on the market, and as the current price went down, the yield went down.
So there's this dynamic that you have to create both right? You have to incentivize the people using the DeFi protocol with this inflationary reward from the new tokens that you're going to farm. At the same time, you have to create organic demand from passive investors into that token, to make sure that the price doesn't just crash. And that's where, you know, that's where the intricacies come from, like, that's what we always talk about. digital assets are more like fixed income, right? Just like you know, equity is boring equity is equity. But fixed income has all these different nuances to it, right? You have different coupons, different maturities, different call structures, different covenants, different seniority is the same thing with token, these token issuers have to come up with that demand side of the equation, what are they going to do to make that token, either useful as a utility, or make it economically viable as a financial instrument to get that organic buyside demand so that the yields that you're generating by using the protocol actually have value?
PETER HANS 35:56
So how does this go back to compound, how do they make better they make money are they charging, spread is in essence, on on each kind of?
JEFF DORMAN 36:07
just like any financial firm, it's a transaction fee. So that transaction,
PETER HANS 36:10
they're charging that.
JEFF DORMAN 36:11
transaction fee is generated to you know, I don't actually know the split off the top my head, but there's a split with regard to where that where those fees accrue to, right, and you can see it across all defy, right. And sometimes the fees accrue 100%, to the liquidity providers. Sometimes it accrues 100% of the stake, or sometimes it goes nowhere. And it's just being held back. You know, there's all again, that there's all these different variables that are going into play and all these different permutations of how that that revenue can be distributed. And that's what each of these, you know, companies and protocols is trying to do, they're trying to find that equilibrium, where you make everybody happy, you make your passive token holders happy you make your liquidity providers after you make your customers happy. And ultimately, you have to figure out how to how to distribute those earnings that are created, but the earnings are real, right, there's, you know, hundreds of billions of dollars of transactions that are happening across these protocols. Some of them are more organic than others.
You know, uniswap is a great example, we've talked about that, in the past as well, like uniswap has done really nothing to incentivize people to use it other than offer a good product, you know, whereas others like compound and some of the others have, you know, in some ways, or artificially created demand through these rewards, and through these, you know, yields of their offering. But, you know, just like you get always here, fake it till you make it, if you do fake it enough, and get enough people on the platform eventually hit that tipping point, or that critical mass where it starts being used, you know, independent of the rewards. And that's kind of, you know, what you're trying to do here, you're trying to build up that audience and build up those customers and build up those evangelists until eventually, these protocols are standalone, and people are using it just for the merits of the of the offering, and not for the rewards and the discounts that are being offered.
PETER HANS 37:47
Right, that makes that make sense. In essence, you have compound right to compound token is basically issued to the customers of the of the of the platform. And then there's some sort of revenue split. So the customers of the platform are receiving the benefit of the platform. They're getting paid out in interest in compound or in or in other
JEFF DORMAN 38:10
in comm tokens
PETER HANS 38:12
In cost, that they're getting paid on comm tokens, which then also accrues. So it's basically like a kickback of their transaction fees, in essence,
JEFF DORMAN 38:19
and that's that, I mean, look, what you just said, is 100%, what defy is right? It is simply simply that redistribution of whatever is being generated amongst your various stakeholders, your stakeholders, being your developers, your liquidity providers, your customers, your founders, your investors. And there's, you know, every company has a different formula for what that mix should be. But ultimately, that's what's happening as you bootstrap, as you bootstrap these networks, and you bootstrap these companies, it is creating some economic value and then economic value has to be distributed in some way that keeps everybody happy. You know, it is a it is a true Nash equilibrium that you're going for.
PETER HANS 38:55
Sure. And then the sort of like the juiciest yields in in DeFi, will typically be found in the newest protocols that are basically trying to, to build a following. So you really have to kind of exactly find those understand them.
JEFF DORMAN 39:12
Yeah, 100% and that's why and that's why these assets are so fluid is because you know, a lot of times there's no loyalty as soon as the next high yield comes up, you pull all your assets out of one place and you put it in the next place. You know Binance smart chain is a great example. A lot of the Binance smart chain ecosystem is growing faster than anything we've ever seen. It's the first true competitor to ethereum. Even though almost every application on Binance Mark chain is basically a complete knockoff of what has been built on a theory right you have lending lending and borrowing protocols that are similar to often compound now on Binance market, you have dexis that are similar to sushi swap and uniswap that are now on Binance marching. And because they're offering these insane rewards, people are coming in droves to get those yields. Now the question is, will they eventually offer a good enough service which I think they are so far that people will stay? And that's the you know, that's what you're trying to do, right? You're on set, you're heavily incentivizing people to come, and then you have to actually prove the worthiness to get them to stay. And, you know, it's super interesting, right? Because and by the way, it doesn't, it doesn't just apply to define it. Celsius is probably the best example of a centralized company that did this. You know, cells
PETER HANS 40:16
Binance, merge chain is decentralized.
JEFF DORMAN 40:18
PETER HANS 40:18
I mean, that's not decentralized.
JEFF DORMAN 40:20
Celsius has been around for, you know, two, three years now. And they did the same thing, right Celsius was just a blending borrowing platform. But why was Celsius able to offer the highest rates when you lend your Bitcoin and eath. It's not because they were doing anything differently than BlockFi or anyone else. It's because they were printing money out of thin air with their Celsius token, they created a Celsius token out of thin air, they were offering that as part of the yield and the rewards. Therefore, you know, when you're, when you're when your cost of capital is zero, and you're printing it out of thin air, like you're the Federal Reserve, you can offer higher, you can offer higher yield.
And that's what they did. And they did it so well, that they now have this incredibly loyal community. And they have, you know, 10s of millions of users, I think, that love it. And all of a sudden, the Celsius token now has real economic value, because of the earnings that are actually been split off. So you know, again, this element of fake it till you make it is tried and true. And those who pull it off, are pulling it off in a huge way. Now, again, obviously, there's risk if you're faking it till you make it, then if you don't make it, then you know, you're left holding the bag. And that's what analysts are trying to do to figure out where the real viable viability is and where it isn't. But there's this real fluidity of assets across these different platforms and companies and protocols to try to find that next yield opportunity. And to basically be the evangelist and customer have some sort of early stage product that eventually will have no staying power.
PETER HANS 41:35
How do you calculate a yield on an asset the print out of thin air that has no economic value? Because I mean, in order to calculate the yield you need, you need to have a numerator and a denominator that have that have a tangible value. And it's it seems like, in this case, the the numerator would have no value, or I guess it does trade in the market. So even if it's like,
JEFF DORMAN 41:55
PETER HANS 41:55
100th of a penny,
JEFF DORMAN 41:56
well, that's your that's your answer at one is there's an observable price. Now, you could argue that that price shouldn't exist, but that price does exist, and therefore you can calculate a yield based on that price. The second, the second is the word value is a little bit of a misnomer, right? Like, Amazon Prime has no financial value, but it certainly has a lot of utility value in the sense that most people who are Amazon customers love being a Prime member, because of all the different discounts and rewards and movies and Whole Foods discounts on all the things you get, right.
So a lot of times that is financial value, whatever the value is different to different people, right, that's the point is like, that's a different value to different customers, depending on how much they use Amazon, and how much they value movies and music and things like that. So when you're when you're thinking about value, you can't just think about the dollar, you have to think about the other tangible benefits that are coming from this. So the point is, it's different. It's different yields for different users. You know, there's also, you know, a lot of people joke about, you know, Millennials caring more about experience than they do about, you know, assets.
That's why they forego buying a house in the car to instead go to a concert and take an Instagram picture. So you know, you're seeing the same thing. And some of these new protocols and default, like a lot of people really want to be one of the first customers and brag about it on Twitter and talk about how they show their show their ether scan or their blockchain explorer transactions with their wallets like there is value beyond just the financial value. I mean, look at Dogecoin, right. Dogecoin is probably the best meme ever, where people enjoy being a part of the Dogecoin community, even though they all know that it's kind of a joke in one day, it might actually become real because the Joker,
PETER HANS 43:23
I don't I don't think they I don't think they all know that.
JEFF DORMAN 43:25
Well, anyway. But you get the idea, right, that their value is different to different people. And I think a lot of what this DeFi ecosystem is proving is that you can bootstrap a network pretty quickly, through a variety of different tools from financial yield to utility yield to you know, you know, just customer experience. And that's why these yields are variable. And that's why it's exciting. And that's why these opportunities exist to earn yield in this new environment.
PETER HANS 43:48
So just before we wrap up, what do you think? I mean, there's obviously a wide variety in terms of DeFi protocols and risk metrics. But what do you think a that you would be comfortable with? But in your kind of credit hat on, of a of a blended, DeFi yield?
JEFF DORMAN 44:09
That's a good question. Right. And, you know, obviously, we have a full team at ARCA, whose job is to do this due diligence and to do these analyses. And it's you know, it's certainly not for the faint of heart, you need to have a pretty strong financial background and team to understand what these right risk reward payouts are. But the short answer is, as you said, the yield should be higher in the early stages than they are later on, because you should be appropriately compensated for the risk that you're taking.
And if you're an early user of a protocol or platform that maybe hasn't had their code audited or maybe hasn't had the traction yet, you deserve to be compensated with a higher yield for taking that risk. And these yields really are variable based on the opportunity said and based on the risk that you're taking. So you know, again, I'm not going to answer that with a number but I will tell you that the yields are double digits and often triple digits for a reason.
PETER HANS 44:58
So what are we talking about a range give me range of like safest DeFi protocol to like, you'd have to be insane to use this protocol,
JEFF DORMAN 45:04
The safest tried and trued protocols are sometimes in the three to 7% range. And some of the new ones. Some of the newer ones are often triple digit API's. Now, it doesn't doesn't it doesn't last very long, right? That goes away pretty quickly, but they definitely start there with.
PETER HANS 45:17
Like the Turkish Lira DeFi protocols.
JEFF DORMAN 45:19
In some ways yeah.
PETER HANS 45:22
Interesting, Cool, Well, Jeff, this was a it's fascinating, you know, I never thought you know, really kind of diving full full on into this into this asset class that here I would be sitting, talking about yield again, like it was like it was, you know, 2020 years ago, but, but that's exactly what we're doing. But it's fascinating. It's just this is just this asset class, is constantly evolving, constantly maturing. And, you know, it's just so clear that we're at the precipice of something something really, really special before we sign off, Kevin Porter Jr. So, ironically, Cavs trade him to the Rockets for literally nothing, and maybe even negative, and he just broke lebrons record as the youngest player ever to score 50 and grab 10 assists in a game.
JEFF DORMAN 46:16
Well, as everyone who knows me knows I'm a diehard Cleveland sports fan, but there is a caveat. I'm a diehard browns and Indians fan. I'm a fair weathered cast. And so I only care about the Cavs when they're good, and they're not good. So, congrats to Kevin
PETER HANS 46:27
That while you're wearing a craggy low jersey right now,
JEFF DORMAN 46:30
I think he was fairly he was wrong for Michael Jordan shooting over him. There was a lot of other factors that play besides the besides ILA. But yeah, when the Cavs are good, you'll you'll hear me talking about them all day long right now. Congrats to Kevin Porter Jr. and the rockets.
PETER HANS 46:45
Is it true you hired Matthew dellavedova is our newest analyst.
JEFF DORMAN 46:49
The he wanted to go to the hospital for dehydration after having one of the greatest gutsiest playoff performances ever. So yes, I will hire Dell Nova
PETER HANS 46:58
Kelly probably makes like 9 million a year so I don't know Kenny does
JEFF DORMAN 47:04
not have a strong Cleveland Australian presence that will take Matthew Dellavedova this is easy.
PETER HANS 47:08
And I'll see I didn't know that?
JEFF DORMAN 47:09
PETER HANS 47:10
Good Aussie basketball players. Were good man is a good talk as always, and you know, let and let everyone know where they can find more of your of your digital assets of wisdom.
JEFF DORMAN 47:22
Yeah, for sure. Check out our firstname.lastname@example.org we have a blog called That’s Our Two Satoshis! that goes out every Monday. And you can follow me @JDorman1 on Twitter.
PETER HANS 47:34
Thanks, Jeff. And if you enjoy the episode, please rate us five stars like it. Download it. If you hated the episode, do the same thing. Thank you so much. Bye.
REAL VISION 47:52
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