MELTEM DEMIRORS: If we don't understand the history of banking, I feel that we are doomed to repeat many of the same mistakes just with a different asset, and perhaps in a slightly more theatrical and entertaining way.
While I appreciate that the arc of time is long, and there is an evolutionary component to what we're doing, if we don't stay honest with ourselves about what we're building here, then what we're building is going to be no different than what we've had for the last 500 years. That's not why I'm here.
Do we all want to get rich or do we want to get free?
Hi, my name is Meltem Demirors and I'm a Chief Strategy Officer at a digital asset management firm called CoinShares. Before CoinShares, I built a business called Digital Currency Group that was also an investor in the digital currency space, where we invested in companies, we built companies, we also invest in digital currencies. Prior to all of that, I was doing something very different. I was in the oil and gas space primarily focused on oil and gas exploration production and M&A activity. I lived a very different life, where instead of operating in this digital realm, I was on oil rigs, I'm in refineries, looking at pipelines and thinking about how to finance very expensive, very ugly infrastructure projects. Very different.
The world is such an interesting place right now. There's so many different things happening but what I think we're really seeing is the beginnings of a revolution. Trust is at an all-time low, people no longer trust institutions. I think over the last 10 years with Wikileaks, with revelations made by Edward Snowden, with the leak of the Panama Papers just two years ago, people are becoming increasingly aware of abuses of power at the highest levels of government, at the highest level of institutions, but it's happening not just at that high level, but at local levels as well.
I think generally, the ability for people to access information anytime, anywhere through the internet, the rise of social media, the rise of the democratization of information, but also the increasing balkanization of the internet and how people aggregate and congregate in the way they think has led to some really interesting tensions. We're seeing those tensions now boil over.
We saw Brexit happen. That was an event I think no one would have anticipated five years ago. We see what's happening in Hong Kong today. We just had the first protestor fatally shot in that ongoing escalation of tension. That's been an interesting thing to watch. We see what's happening in Venezuela, with the Maduro regime being toppled and some of the tensions there. Here, in this country, our sitting president is about to be brought to trial as at the start of an impeachment hearing.
The world we knew five years ago is not the world we live in now. I think for a lot of people, the question is, what next, and we see this in global markets. Markets are in turmoil. There's a lot of uncertainty. There's a lot of fear and there's a lot of doubt which we call FUD my industry-- so fear, uncertainty, doubt for FUD, and I think anytime you have a lot of fear, uncertainty and doubt, you see really strange things start to happen.
How are past civilizations the prologue to Bitcoin?
Before we talk about the history of money, it's just interesting to think about the history of human society and human organization. When human society started, we were nomadic, we were tribal, and you would only really have contact with a small group of people that were in your nomadic tribe. Then people started to intersect with other nomadic tribes as their world started to expand and become bigger and bigger.
When that started to happen, you started to see the emergence of trade, bartering, then you need to trade. When you trade, you need a universal medium of exchange. You saw people using different things for money or to exchange value, salt, shells, other different assets, things that were valuable, things that were useful and had utility at that time.
Then as he started to see the rise of more agrarian society, as you started to see new means of production emerged that allowed larger populations to exist in the same physical footprint, you started to see the emergence of monarchies or kingdoms and really the first form of social organization. I think an interesting thing for me to always go back to because I think history is such a great guide for us, and unfortunately what little we have to study is fairly limited, but it gives us great insights.
There's this great idea called the Kyklos cycle or the Polybius cycle. It's basically this concept of these iterations of human organization that we go through. It starts with monarchies. You see a ruler or a leader emerge. Typically, they assert their leadership by printing their face on a gold coin, or some form of exchange. Then that monarchy continues to grow and grow in lineage, pass the monarchy from the parent monarch to the child and historically in our world, and those have all been patriarchal monarchies.
We see this monarchy in this lineage. Then the children and the children's children start to lose the original ideas of the republic, or whatever this civilization was all about and some of those principles, and we can talk about growth and principles. Then you start to see it go into more of a tyrannical leadership. Then all of the oligarchs or the wealthy merchants or the people of the ruling class, just right below the monarchy rise over and overthrow these tyrannical despots, the children who have gotten lazy and spoiled, and they take over and then you see the rise of an oligarchy.
Then that descends into tyranny again, then you see the rise of yet the lower rung or the middle class in the form of a democracy. That's really what America was at its beginnings. It was this idea of, hey, we want to overthrow the monarchy and these wealthy oligarchs and create this new country that has different values and you live in a democracy for some time. Then the democracy starts to become more and more fragmented as different special interests take over. Then you get to the stage called ochlocracy or ruled by mob, which is about the loudest voices are really ruling and that's the age I think we're in now with Twitter and social media and the way information spreads and the facts that most information is like factually incorrect, or based on assumptions rather than corroborated fact or throws these ideals out the window.
The ochlocracy eventually descends into just absolute anarchy, complete chaos. This is where we go from an ordered system to completely disordered system. When you have chaos, there's a natural tendency for things to tend towards order again, and typically what you is reaggregation of power and the rise again of another monarch. The idea of this cycle is as we as human civilizations repeat the cycle, and each iteration, we may do few things differently, we may have different tools.
The world we live in now, we have very different tools than the world we lived in 3000 years ago. It'll be interesting to see what that looks like. Generally, I think a lot of the history of money is predicated by the needs of human society as we grow, as we expand, as we become more interconnected. It's been interesting to watch Bitcoin in the context of what's happening in our world. I think when you start to think about it through that lens of how humans organize and the tools we need to enable these different phases of human social organization, what Bitcoin means, because it started with libertarians and anarchists.
It's like money for the revolution, which was really fringing out there. As more and more people started getting into Bitcoin, the message became more socially acceptable, it became broader, became more appealing. In the 10 years that Bitcoin's been around and in the seven years that I've been in the Bitcoin community, it's been really interesting to watch the messaging and the principles of Bitcoin evolve and change, as it needed to become more appealing to a wider and wider group of individuals.
How is central banking relevant to crypto?
I studied math and economics in university and I was fortunate to spend a year studying in Cambridge in the UK studying Keynesian economics and the history of the banking system and all of these things, but if you work in capital markets, you know. That's part of what you need to know. What's so funny is crypto and Bitcoin has basically made it cool and sexy for an entire generation of entrepreneurs and technologists to learn about central banking, which is so hilarious to me. I think all of these textbooks but nobody ever wanted to read about like the structure of the modern banking system, or market microstructure, people are now starting to understand.
In a way, crypto has forced an entire generation, my generation, millennials, to learn about how banks work. In a way, it's been really funny just to watch over the last 10 years, like the things I would talk about and think were fun and interesting have become topics of conversation we talked about online. I think that's fascinating, really funny. If nothing else, an entire generation now understands banking and Basel, hopefully Basel III, like that's the next step. I want to teach everyone about Basel III regulation and liquidity, but we'll get there eventually. People are like, shut up, Meltem. Go back in your box. Weirdo.
Is crypto replicating the traditional banking system?
One of the things we like to say in crypto is down with the banks or some people say short the bankers and there are variations on this. Look, the world is changing. That's something I think we all sense and feel. It goes back to the earlier comment on fear, uncertainty and doubt. We've gone from 9 trillion of negative yielding debt, now 15, what, six months later. It's pretty scary. Helicopter money doesn't feel like a pipe dream anymore. It actually feels like a reality.
We have presidential candidates who are campaigning on a platform of helicopter money, which is fascinating. It goes back to Keynesian economics. Now, let them dig holes, so entertaining, but what I think is really deeply troubling, maybe troubling is the wrong word-- what I think is one of these ideological traps, one of these deep idiosyncrasies that we need to resolve is in the act of building tools and products and services that allow people to interact with Bitcoin. What we have effectively done is rebuild things.
What I think is so deeply disturbing to me is the level of cognitive dissonance in the Bitcoin community when it comes to the reality of what we're building. The premise was that we wanted to disintermediate central banking and remove the power of banks. What we've actually done is just rebuilt banks in our asset class.
We recently did an analysis of all Bitcoin in the world that's been mined today, it's about 18 million Bitcoin. Where are these Bitcoin now? About 20% have been lost, we presume. About 7% are in custody with Zappo and/or Coinbase, which are now one entity because Coinbase acquired Zappo's institutional custody business. About 1% is in the GBTC product, about half a percent is in our product, XBT provider. We have about three to 4% in exchange hot wallets as far as we know, about 1% is in the Mt. Gox's trust, so Mt. Gox as you recall is the exchange that was hacked and that Bitcoin is now sitting with a custodian as that court case gets resolved.
When we tally it all up, about 18% of all Bitcoin in circulation, according to our estimates, is currently in the control of a third party. It's probably more than that, because there are intermediaries that are unaccounted for, but fully 18% of this asset that has these really unique features around self-custody is in this central custodian. What's really interesting to think about, I'm going to tie together three ideas-- bear with me here.
First and foremost, let's recall what happened in this country during the financial crisis in 2008. We created a new designation for banks, called SIFIs and SIFIs were Systemically Important Financial Institutions. SIFIs really, what that was intended to do is to look at where risk in the financial system was aggregating and to ensure that those institutions were more responsible about how they manage that risk, but also that our government and our regulators were more informed about the level of risk in these institutions. We see these SIFI risk composite scores getting published.
What's interesting to note is we also have SIFIs in the crypto ecosystem. Let's talk about these custodians that hold really large percentage of the world's Bitcoin. Now, the other thing that's really interesting-- so that's idea one, it's like we have SIFIs in the traditional banking system. We also have them in crypto.
Idea two, let's talk about bailouts. In '08, when the SIFIs were in trouble, what happened? Our government bailed out these financial institutions by infusing capital into them, and by lowering interest rates to spur more lending and basically, trying to restart the economic flywheel. We've seen bailouts happen in the crypto industry as well. If we take a little walk back to 2016, we'll recall in the Ethereum community, there was a new type of decentralized funds that was created called the DAO or the Decentralized Autonomous Organization.
Fully 15% of all Ethereum in circulation at that time was invested into the DAO. At that time, that was around $150 million, wasn't a lot because the ecosystem was still teeny tiny. Fully 15% of all Ethereum in circulation was put into this contract. The smart contract was not audited very well, and there was a bug in it that allowed a hacker to exploit the contract. They used it in the way it wasn't intended so I refused to call it a hack because it was just the smart contracts being used in a way that it wasn't intended to be used. A hacker started stealing the funds in the smart contract.
The Ethereum community held a vote and decided collectively that they were going to roll back the blockchain to a time before the DAO hack happened. This is an example of what happens in a network that's supposed to be decentralized. That's one of the features we talked about, being actually quite centralized and when something significant, economically significant happens to that network, a group of people who were quite powerful and held a lot of that wealth and had a lot of control unanimously came to this decision, and they basically bailed out all of these individuals who would have otherwise lost their money. That's the first example of a bailout.
Then I go to event number three. In May of this year, in May of 2019, one of the largest exchanges Finance, which is an exchange based in Asia, had their Bitcoin hot wallet hacked. The hot wallet is where they keep funds that are moving in and out on a daily basis. Then cold wallets or cold storage is where people store funds longer term, typically a lot more controls around moving those coins, but their hot wallet got hacked. At the time, their hot wallet held 0.03% of all Bitcoin in circulation, so not a lot.
It was interesting to see, when Mt. Gox got hacked in 2015, when it went bankrupt, nobody talks about rolling back the chain. Nobody even talks about it, thought about it, but now that that idea has entered our consciousness, and now that it's been done in another network, one of the interesting things is people online were proposing, well, why don't we roll back the Bitcoin blockchain? This is the danger of ideas. This is why history doesn't repeat, but it certainly rhymes.
If we connect these three ideas together, ultimately that idea by the way of rolling back the Bitcoin blockchain, it was discussed. It was ultimately rejected for a good reason, because it's a ludicrous idea, and it would invalidate the entire value proposition of Bitcoin. The fact that it was discussed and the fact that it was not immediately rejected, gives me great pause.
What I think is interesting as we look at what started to happen as we look at where I believe the future is going, because I work in this asset class, and I'm building my career and my business in the space, we look where we're headed. If we don't understand the history of banking, I feel that we are doomed to repeat many of the same mistakes just with a different asset, and perhaps in a slightly more theatrical and entertaining way. It's important to look at what we're building and ask ourselves, is this actually any different?
If we take 50% of the world's Bitcoin and we put it in custody with a custodian that's regulated by the New York Department of Financial Services, the Fed and all of the powers that be and we take these bitcoins, and we put them in a vault somewhere and we lock it up and we add security guards and all of these diversions and tricks to keep hackers out, and then we issue Bitcoin depository receipts, pieces of paper that allow us to trade the underlying bitcoins sitting in a vault somewhere but we never actually exchange Bitcoin on the Bitcoin network, is that still Bitcoin?
These are the types of questions I want us to be asking. By the way, as an asset manager, we are a part of the problem. I don't claim to have a grand solution, but I think it's important to ask ourselves as the industry grows, as the industry matures, and particularly as many Wall Street types come into the industry who don't share our values, who don't share our principles, I like to say they're LARP-ing, they're live action role playing. I'm a gamer, so I'm going to nerd out a little.
They're dressing up as their favorite crypto character and they're like, I'm a crypto person, but in reality, everything they know, everything in their DNA, everything they've done is in the banking sector. What we're going to end up building, it's going to smell, it's going to look, it's going to feel, it's going to taste like a bank. It is a bank. It's not Bitcoin, and while I appreciate that the arc of time is long, and there is an evolutionary component to what we're doing, if we don't stay honest with ourselves about what we're building here, then what we're building is going to be no different than what we've had for the last 500 years. That's not why I'm here.
What attributes do gold & Bitcoin share?
Bitcoin and gold is, to me, a really fun narrative. I think, really Bitcoin and any commodity is a fun narrative to go through. When we think about-- at my firm, we all come from the commodities world. Oil in particular is what we all know and love and where we all started our careers and spent a lot of our time. One of the fundamentals of the oil industry is the 3Ds and my partner Russ Newton talks about this very often. He was an oil trader.
The 3Ds are demand, so what is the demand for oil? Depletion, meaning how much oil is left or how scarce is it? Is it because it's a natural resource? And the dollar. What is the strength of the dollar and