🎙 "ETH and Most DeFi is Trading Cheaper Than Web2 and With Better Growth:” VanEck's Matthew Sigel

In this week’s episode we speak with Matthew Sigel, head of digital asset research at VanEck, an asset management firm overseeing $80 billion, which has shifted its focus heavily into crypto. They started out with investments almost exclusively in Bitcoin,...

Matthew has a very methodical way of analyzing cryptocurrencies, applying the same rigorous methods used in traditional finance, and so it becomes even more compelling to hear him make the case for Ethereum’s market cap growing to $2 trillion. He also believes even after this year’s bull run, Ethereum and most DeFi protocols are trading cheaper than Web 2.0 and with better growth.

We also talk about how to best capture DeFi’s growth and Matthew believes investors should have exposure to Etheruem and the top smart contract chains, because he's found that while Eth is the market leader, the smaller coins have historically outperformed. Still, Matthew wonders whether all the growth of TVL isn’t just essentially venture capital being pumped into these protocols. Even if that’s the case, he says, it’s not so bad if that means DeFi will be able to get some leverage in Washington, which he believes is pushing investors into inferior crypto products. That’s what VanEck is trying its best to improve while following the rule book.

The podcast was led by Camila Russo, and edited by Alp Gasimov. Transcript was edited by Camila.

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Matthew Sigel: Sure. So my early work experience was as a financial journalist. So I covered markets at Bloomberg, CNBC, NHK, the Japanese broadcaster. And working in media, especially TV, there's so much effort that goes into the logistics, as you know, of getting sound and video on air, that was especially true in the early part of my career before the internet was so widespread, and it started to get kind of frustrating as to the depth that I could explore any one topic.

I got tired of interviewing people with bigger balance sheets than me all the time. So I had this itch to try managing money and did what a lot of reporters do, which is make relationships and network and started studying for the CFA, found myself at AllianceBernstein for interviews and in front of Cathie Wood, and she just picked me out of obscurity. Because Cathie is the kind of person who looks for nontraditional backgrounds, and then kind of trains her people.

“I got tired of interviewing people with bigger balance sheets than me all the time.”

So, I spent four years there. Originally, we were managing a US thematic portfolio. We launched a global fund in the beginning of the crisis, bought a lot of Web 2.0 names, a lot of China, had great performance for a couple of years with that Global Fund. But I just found myself missing things about journalism that you can find on the sell side, so writing things and getting feedback from people instead of just prices, which I guess at that young age I found stressful, and a little lonely.

So I moved to the sell side, spent 10 years at a Hong Kong-based broker called CLSA in a variety of sales and research roles, eventually settling into writing a weekly market newsletter, macro-thematic in nature that tried to combine some top down themes with like bottoms up security selection. And this is how I pivoted into crypto because in 2017, I wrote a piece called “Google is Evil,” which by now is very consensus. My piece went through all of the natural monopoly characteristics of these Web 2.0 giants and some of the destructive impacts that they were having on my old industry, the journalism industry.

And the conclusion of that piece was “Google is Evil,” buy Google. But I also timestamped my first Bitcoin buy in that piece, because I started thinking about what are the technologies and the market-based solutions that will eventually disrupt these platforms, because the high return on capital would invite competition eventually. And to me, Bitcoin seemed to be the embodiment of the killer app that would leverage that decentralized technology to eventually threaten these profit pools. And that was early days. But I kept crypto and Bitcoin on my radar and owned Bitcoin by then, so I was monitoring it.

And then in 2020 when COVID hit and the world kind of turned upside down and watched even further erosion of credibility by mainstream media, at least as far as I was concerned, there was just a wider and wider gap between what people were actually believing and what they were reading in the media. And that's, for me, one of the primary narrative arcs of crypto is that for some, it's a play on disillusionment. And that's not all it is, but it's part of what it is, on any side of the political spectrum, together with the Fed's monetary policy and the upcoming Bitcoin having, that seemed to be a perfect backdrop for crypto and I started pounding the table and buying more, writing more, meeting more people and landed here at VanEck shortly thereafter.

“And that's, for me, one of the primary narrative arcs of crypto is that for some, it's a play on disillusionment.”

Avoiding Innovators’ Dilemma

CR: Very cool. And there’s an interesting Bloomberg connection there. Can you explain more about VanEck itself? What is it, what does it do, and is its main focus on digital assets?

MS: Sure. VanEck is a New York City based asset manager. We manage around $80 billion US. The majority of that is in passive strategies, so ETFs. But we also have a handful of actively managed products with good performance, long track records.

The firm is privately held. And it got its start in the 1950s, but really took off in the 70s as the first international fund, and one of the first gold funds. So the founder had a thesis about the US going off the gold standard and what that would do to gold prices and gold miners. That really made the firm and caused the initial asset gathering success.

And when Bitcoin came around, the CEO, Jan van Eck really latched onto Bitcoin as a potential store of value, you know, the fundamental case, but also I think he's someone who grasps the pitfalls of innovators’ dilemmas. And that if we didn't embrace this new technology than our existing profit pool, heavily centered in gold and gold mining ETFs not exclusively, but certainly well situated there, could be a risk for us, and it would make sense to really explore some of these decentralized innovations starting with Bitcoin.

But we realized thereafter that there would be opportunities and disruption across payments, lending, banking, Web 3.0 and that maybe the entirety of our business would be at risk if this bank-less thesis kicks off in full flight. So we have a range of strategies in digital assets, perhaps we're best known for our Bitcoin ETF application, which has been pending in front of the SEC for years.

“...we realized thereafter that there would be opportunities and disruption across payments, lending, banking, Web 3.0 and that maybe the entirety of our business would be at risk if this bank-less thesis kicks off in full flight.”

But we've not stood only on that potential, but have also launched Bitcoin and Ethereum ETFs in Europe, where the regulation is a bit more friendly. You'll be seeing more single coin ETPs from us in Europe very, very soon. We have recently launched what we call a new finance lending hedge fund, it’s where we're going to lend dollars and stablecoins to some of the larger centralized intermediaries in crypto. And we can lend overnight unsecured at quite attractive interest rates and low volatility. So we see that as kind of a building block, lowest risk, lowest return type of product that you could offer in crypto.

We own an index provider, MVIS, which was the first index provider regulated by the EU to create digital asset indices. So they have about 10 digital asset indices with 3 billion in assets tied to those. And so you'll be seeing more indices from us on that side.

And then we have also seeded a new venture capital firm called Cadenza. So they're in the process of raising a new fund. We’ll be the largest investor in that fund and we are co-investing in some seed rounds with them as well. So taking a pretty hands on approach to some of these seed firms, and I think that really speaks to the scope of the disruption that we see that we're going to spend time on some of these startups and try to hit some 100 baggers.

So as an example, we participated in the FTX recent capital raises, and have a handful of early to mid stage startups... we’re trying to focus outside the US, because we can feel with great experience, the challenges from the US regulator, not just with the ETF, but this entire ecosystem is behind in the US. So we're focused in Latin America, in Asia, where the exchanges are growing with fewer headwinds.

“...we’re trying to focus outside the US, because we can feel with great experience the challenges from the US regulator, not just with the ETF, but this entire ecosystem is behind in the US.”

Building Financial Products for Crypto

CR: Right now what's the share of crypto focus versus traditional assets and gold focus on VanEck?

MS: Well, of the 80 billion in assets, I guess, if you add up all of our crypto assets, maybe it's 400 million. So it's but a tiny fraction. But we're planting the seeds for a lot more growth. And the team is five people or so. We haven't seen any traditional finance companies really take the leadership reins in this industry to be that bridge between crypto and mainstream finance. And we're thinking, why not us. So devoting significant resources to bolstering the team and trying to come up with an array of intelligent products for investors that can fit a variety of risk-reward parameters.

I get a lot of questions from financial advisors, like what's the best allocation to crypto? What's the one thing I can buy? And it's such a difficult question to answer, because I see this technology as so decentralized and therefore very participatory. It's really the type of technology that you get down and dirty with yourself, you download your own MetaMask wallet, and you start trading this stuff and get to know what you like.

“It's really the type of technology that you get down and dirty with yourself, you download your own MetaMask wallet, and you start trading this stuff and get to know what you like.”

And it's not so easy to outsource because everything is so unique. There's an unlimited amount of assets, you can create anything. So it's not a one-size-fits-all dynamic. And we're trying to put out an array of products to address all aspects of the market.

CR: Great. And so far the products that you do have for investors to get exposure to crypto, you said are Bitcoin and ETH ETFs in Europe. And then you said you have ETP, so exchange traded products, not specifically ETF, but kind of functions like ETFs in the US? Is that right, your current offering for institutions?

MS: Right. So for institutions, we've got Bitcoin and Ethereum exchange traded products that are trading in Europe on a dozen exchanges or so. We have a Bitcoin limited partnership in the US that's kind of a niche product, because perhaps there's a limited audience for a Bitcoin product, which is not liquid, like buying it on exchange would be or like an ETF would be, but that product exists.

We own 10% of the Canadian Bitcoin ETF issuer. So we got a stake in that market as well. And then we've got for this lending hedge fund in the US that we've recently stood up. So that's the one where we're lending dollars and stablecoins to some of the larger exchanges and OTC players, the regulated exchanges and OTC players in the US. It's not dissimilar from what someone could get by just putting their money on the BlockFi earn product.

But our idea is to bundle loans to several of those counterparties together, do some research on who has the better loan books and who's more likely to avoid a blow up, stick with the regulated players and offer the diversified solution to institutions who maybe don't want to go on those platforms directly, don't have trust in some of those new brands and want a low risk, low return entree into crypto that maybe more resembles a private credit fund. Because we're basically just a short-term creditor to companies like Coinbase, BlockFi, Gemini, Genesis, and the like.

CR: So this hedge fund lending product, is it institutions, OTC desks, they are borrowing stable coins? Or are you lending their funds into blockchain based lenders to get them that higher rate?

MS: So we will take client money from pension funds, endowments and then make short-term loans to crypto exchanges. We're going to start denominating those in dollars. There's a shortage of dollars in this ecosystem. The banks are not doing business with these intermediaries. I'm calling them intermediaries because it's a mixture of exchange and OTC players, right. And then they will basically put that money on the blockchain, convert it and lend it out to their borrowers.

CR: I see. Okay. Oh, that's interesting. Okay. So you are being an intermediary to traditional finance institutions like pension funds who want to lend out their capital to cryptocurrency intermediaries. And they are lending it at lower rates than what these crypto intermediaries can in turn lend that capital out to their clients?

MS: Yeah. So if you were to go on, say, like a Celsius or Volt, you might find 8%, 9%, 10%, 11% rates for your USDC. And BlockFi, Gemini, maybe those are 7%, 8%. So our idea is, if we can pick the best of those intermediaries, manage the counterparty risk and diversify, we can offer, call it 6% plus, at very low volatility to our customers.

CR: Okay, that's interesting. And that's something that you just started to offer now?

MS: Yes.

Self Disrupting

CR: Do you see this side of the VanEck business, the crypto side, is the goal for it to, or is the plan for it to overtake the traditional asset business?

MS: That would be something. I'm not sure that's in our business plan. But we definitely see an enormous disruption to traditional Wall Street profits because of cryptocurrency, blockchain, and some of these new exchanges and asset managers that have been growing quite rapidly. And part of this is hedging our inevitable risk if that scenario comes true, and trying to grow a business line that would grow alongside it. So there's a lot of things that we can't predict. We're definitely bullish that crypto is going to grow faster than traditional finance and we want to have as many pies in the oven to benefit from that.

“We're definitely bullish that crypto is going to grow faster than traditional finance and we want to have as many pies in the oven to benefit from that.”

CR: And what do you think about DeFi disrupting your very business model? Have you considered how that can play out when there are protocols that enable a more seamless creation of funds, a more decentralized, democratized way so now anyone can be an asset manager and create their own fund on a Balancer pool or a Set protocol. Do you see VanEck or your competitors ever not just offering digital assets and crypto to clients, but adopting this technology as your own rails and maybe becoming a protocol at some point or just allowing anyone to create funds or just directly investing in your funds.

MS: Yeah, that is something that we are actively working on. We have to consider the possibility that every asset, security or not, will be tokenized and trading on the blockchain. And that's one of the reasons why we invested in FTX, that's one of the reasons I own Solana is, FTX could be just the Trojan horse for this super-fast Layer 1 that would theoretically turn NASDAQ into a zero, because you could tokenize any asset, security or not, and trade it on a decentralized exchange powered by Solana as an example.

“FTX could be just the Trojan horse for this super-fast Layer 1 that would theoretically turn NASDAQ into a zero, because you could tokenize any asset, security or not, and trade it on a decentralized exchange powered by Solana as an example.”

So we've thought about, should we do a token of tokens? What would a VanEck token look like? Is crypto even the type of ecosystem that can support a brand when everything is open source? We saw a couple weeks ago, the SEC is investigating Uniswap, well, is it the protocol? Is it the lab? There’s a lot of uncertainty still about how brands will adapt to that open source world. And then there's a lot of uncertainty around how to deal with the regulatory challenges of calling something a security or not calling it a security.

But the prospect that we have to start running nodes and think about designing tokens or letting our clients design their own tokens with our guidance as an index provider, these are all definitely on the table. Because we're very cognizant of the existential risk to our business if this ecosystem takes off as I think that it is, and it will.

Bitcoin in El Salvador

CR: Super interesting. Shifting gears a little bit, I saw you just recently returned from El Salvador, I would love to get your take on what your findings were there on the ground?

MS: Sure. I just came back from four nights in El Salvador. So I spent two nights in the capital, San Salvador meeting some government officials, and I waited online at banks and talked to tellers. I walked the marketplaces and I talked to dozens of people. And I just felt that because of the political polarization, and because of how the Biden administration and the IMF have reacted to El Salvador's Bitcoin gambit, that maybe the whole story wasn't being told in the mass media, and I just had to see it for myself.

So two nights in San Salvador, and then I went to El Zonte, which is where Bitcoin Beach was set up, to talk to some of the organizers there and figure out if these people are being coerced, or if they're actually going to take up the technology. And I came back, quite bullish. I found people who are pretty well attuned to the tradeoffs between risk and reward, pretty open to admit that they don't know that much right now but are open to adopting Bitcoin more widely as time progresses.

“I came back, quite bullish.”

And even those who objected seem to do so more from the perspective of nostalgia or anchoring, but not with a real philosophical objection to skipping a technology, which is how I see it, is that when you've got an emerging market with an income level that is 10% of the OECD average, I mean, this is an extremely poor country, sometimes the best thing to do is just skip the middle technology and go straight to the future and see if you can make a go of it.

“...this is an extremely poor country, sometimes the best thing to do is just skip the middle technology and go straight to the future and see if you can make a go of it.”

And we've seen emerging markets attempt that throughout history, and it's a slightly higher risk, higher reward gambit. But we'll see how it plays out.

But I thought it was a very encouraging trip, and I found a lot of future Bitcoin buyers, so it was very bullish.

CR: And are people already using it? Can you already buy stuff with Bitcoin at a supermarket or restaurants? Are things already set up with the lightning payments, the wallet and all that stuff?

MS: So most of the multinationals, McDonald's, Starbucks, were early adopters. And I used Bitcoin at several multinational stores like that. Some of the smaller, more local vendors did have considerable trouble downloading the government wallet. The Chivo wallet was overloaded immediately. And a small percentage of people actually were able to download it and receive their $30 worth of Bitcoin. So the local adoption will take a bit longer.

I did speak to several locals who were using Bitcoin. I met the manager of a boutique in a hotel in El Zonte, who had just gotten several of her first Bitcoin customers, and then she turned around and spent the Bitcoin at Zara in El Salvador. So she was recycling some Bitcoin. But really, most of these El Salvadorians are so poor that whatever money they earn that day or that week, they spend. So even those accepting Bitcoin are basically converting it to dollars right away and spending it and that makes sense — savings rates are lower among the poor than they are among the rich.

But when you ask them what's your plan for the future, right, even those who didn't want to accept any Bitcoin right now, or didn't have any spare money to buy any Bitcoin right now acknowledge that it's probably prudent for them to acquire some and hold some as a proportion of whatever savings they are able to accumulate.

“...even those who didn't want to accept any Bitcoin right now, or didn't have any spare money to buy any Bitcoin right now acknowledge that it's probably prudent for them to acquire some and hold some as a proportion of whatever savings they are able to accumulate.”

Other Countries Will Follow

CR: After your experience in El Salvador, what are your thoughts on other countries adopting Bitcoin?

MS: I think it's inevitable. On the plane back, I saw the news that Ukraine may be the next country in 2023. That was a media report from last week. It was combined with information that Ukraine had sent a delegation to El Salvador to do some due diligence on how it's going. The President of Ukraine just got back from Silicon Valley, where he reportedly met with Tim Cook trying to draw Apple as a hyperscale customer for five new nuclear power plants that Ukraine will be building.

So these countries that sit in between spheres of influence, you know, El Salvador has this long history of being in the US shadow, but they just took $500 million in financing from China, so they're trying to play both sides in their best interest. And Bitcoin is almost like a balancer that restores some autonomy and bargaining power to a country that when completely dollarized, doesn't really have much. Ukraine is kind of in a similar situation. They're caught between Russian aggression on one side, NATO uncertainty on the other. How do they bolster their place on the world stage and give a little bit of autonomy and bargaining power in global negotiations?

“Bitcoin is almost like a balancer that restores some autonomy and bargaining power to a country that when completely dollarized, doesn't really have much.”

And I think Bitcoin helps countries do that. And it's easy for the US and other developed nations to shake their heads at that and think that it's going to be destabilizing, but that really misses, I think, the need for sovereignty that every country feels. And when they struggle with how to express that or display that to their own citizenry, then Bitcoin becomes an appealing option, especially for countries that are rich in natural resources, like sun and wind and geothermal, but who are just too poor to build out the infrastructure that it takes to turn that energy into electricity.

So, whether it's Belarus or Tunisia or Ukraine, I think we'll see another sovereign in the next 12 months go legal tender.

“...whether it's Belarus or Tunisia or Ukraine, I think we'll see another sovereign in the next 12 months go legal tender.”

CR: That’s so interesting. So Bitcoin becomes some sort of neutral world currency. Do you think Bitcoin is the right cryptocurrency to adopt considering scaling issues, volatility?

MS: I think as a legal tender, the proof of work model. We know how much thermodynamic energy was used to create each Bitcoin. And that can be verified. We know that a lot of work goes into that. It can't be gamed. There's a limited number. I think it is the best choice for now, for cryptocurrencies. Now, what we know, we can talk about city coins as well. Miami just raised $4 million, and has a whole bunch of innovative use cases that they see for their city coin.

But in a world in which El Salvador owes basically a billion dollars to the IMF, needs to renegotiate that, if they're going to circumvent that type of multilateral pressure, I think it makes sense to go with the tried and trusted Bitcoin, where you already have a global community of whatever it is, maybe call it 60-80 million active Bitcoin users who might buy an El Salvadorian bond on the blockchain. And that's because of their faith in Bitcoin, right?

But if El Salvador created some brand new sovereign currency or went back to the colón or what they used pre-dollar, there'll be a whole long period of time when the market would want to see whether that money was sound and how the new central banker was acting and all those Fed-watching things that no one wants to do anymore, because the Fed’s always wrong, and the dotplot is never accurate. And we'd rather just know that there's 21 million of these things, and to produce one, you have to put in this much thermodynamic energy, and here's a country that's going to respect that code based rule and not throw banana republic central governor at us. So, yeah, Bitcoin is the right one.

“And we'd rather just know that there's 21 million of these things, and to produce one, you have to put in this much thermodynamic energy, and here's a country that's going to respect that code based rule...”

Two Trillion Bull Case for Ethereum

CR: Super interesting. I wanted to also talk about your thoughts on Ethereum. You mentioned in a report, you have a 2 trillion bull case for Ethereum . I'd love to hear you expand on that.

MS: Yeah, price targets for Ethereum. I'm trying to approach this from a kind of traditional finance perspective, and figure out what's the equivalent of earnings estimates and a target multiple. And that was reasonably easy to do under the Ethereum proof of work model. Because you can just look at the total fees paid to miners, you know, block rewards and gas and annualize that and you'll come up with a top line number, which is basically the same as earnings for a protocol like Ethereum that has no costs and stick a multiple on that. And you will find that Ethereum and most DeFi protocols are trading basically cheaper than Web 2.0 and with better growth.

“And you will find that Ethereum and most DeFi protocols are trading basically cheaper than Web 2.0 and with better growth.”

And the number that I got to for this year 2021 was $18 billion top line for Ethereum. Now, getting to that $2 trillion price target is more of a supply-side exercise. So I looked at the total pool of banking and payments top line and assumed that open source blockchain protocols would capture 5% of that value over time, and that of that 5% Ethereum would capture, call it, two-thirds. So I was working off the Pareto principle that one player captures the lion's share of the economics, which is what we've seen in Web 2.0.

But to be honest, I don't know if that's the case in blockchain. I don't think anyone knows. It might be a fair fight, or it might be network effects on steroids and one player does take 60%, 70%, 80%. So to get to that $2 trillion number, it was the blockchain goes from 50 basis points of the banking profit pool to 5%, Ethereum, kind of cold share at 65-70%. And that's how you get to 2 trillion.

But well, let me just add, though, but when you try to do the next year number, the 2022 number for Ethereum, and work off the proof of stake model and the ETH 2.0 models, what you find is that the model is just horribly reflexive, and really, it depends on what Ethereum price you plug in. And no one wants an earnings estimate that depends on the price of the security itself. So you've run into this extremely unsatisfying, circular exercise, where it's either number go up or number go down. So it hinges on transaction growth and gas fees, and the ETH price. And the ETH price, you can't use the ETH price to predict the ETH price. So I'm definitely struggling to come up with a 2022 proof of stake methodology, but getting close, so…

CR: Nice. Sorry. And to clarify, 2 trillion, that is your estimated revenue for Ethereum?

MS: No, that's market cap.

CR: Oh, I see. Okay. And that would be in what timeframe?

MS: Well, how long will it take for open source blockchain protocols to reach 5% of total banking profits? I'd say, five to eight years.

CR: Okay. And then with that, I think that's pretty conservative, like in 5-10 years of blockchain tech having just 5% of traditional finance, and then Ethereum having two-thirds of that. So you said you don't know whether that will be the case.

But what are your thoughts on that, on Ethereum primacy so far in capturing developer activity, and decentralized finance, and NFTs and most of the activity and innovation happening around open finance? How likely do you think that will continue and what do you think about some of the other competitors, like you mentioned, Solana, and so many other Layer 1s that have been just booming, at least looking at their prices in the past couple of weeks.

MS: Well, Ethereum market share, however you want to look at it, but let's use total value locked in DeFi as one proxy, last I checked it was 72%, and it's been trending lower basically every day and every quarter, but the overall market is growing. So we're in that classic conundrum of, do you buy the leader in a growing market, even though they're losing share, because the overall industry tailwinds are positive enough, and as the biggest player maybe their gross margins can be higher than their competitors? Or do you try to pick like the upstart based on a product cycle or a belief that they'll have a series of product cycles that will change the competitive dynamics completely?

“So we're in that classic conundrum of, do you buy the leader in a growing market, even though they're losing share, because the overall industry tailwinds are positive enough, and as the biggest player maybe their gross margins can be higher than their competitors?”

And on that, my inclination is that you don't bet on just one, that there's going to be a handful of smart contracts, Layer 1 protocols that will all in absolute terms trounce the returns of Web 2.0 and S&P 500, and that mainstream investors can't even tell you what a Layer 1 protocol really is. So there's still a huge amount of education that has to go on.

And it comes down to the risk reward desires of the investor. So, from my perspective, it's bullish on multiple Layer 1 chains, unwilling to short Ethereum by saying oh, they're the market share loser don’t own them. That doesn't make sense in a market that's growing this fast. So it's maybe not that sophisticated an answer, but own more than one.

Building Indices For Web 3.0

CR: You're in the business of creating indices and funds, would your ideal fund be, if you want the exposure to kind of DeFi and growing Web 3.0, would it be like a market weight Layer 1 fund, basically just ETH, Solana, Cardano, Avalanche, Polkadot, I don't know, all the other Layer 1s market weight?

MS: You should have come to our morning meeting this morning, Camila, because we are hotly debating this precise topic. We've spent a lot of time categorizing these coins into sectors that we'll be rolling out shortly. Those sectors include smart contract protocols, infrastructure applications, payments, metaverse, stablecoins.

And we are in the process of creating leaders indices that seek to institute a rules-based approach to identifying, call it the 4-6 top chains in each of those categories, and creating kind of like Lego block indices that investors can play with to express their views on those sectors.

And if you play around with the next construction of say, the Layer 1 smart contract protocols, you'll find that capping Ethereum’s weight at a certain, call it 50% or 40%, or 30% really increases returns to clients. That's what the back testing shows, right? Because Ethereum has essentially, you wouldn't know it if you were just owning ETH, but Ethereum’s underperformed everything else of the top five or six chains.

“Ethereum has essentially, you wouldn't know it if you were just owning ETH, but Ethereum’s underperformed everything else of the top five or six chains.”

So we're still thinking around the exact construction methodology, but capping Ethereum weight does seem to increase returns and points to maybe a more equal playing field among these Layer 1 protocols than the Web 2.0 analogy that I used. So I know I’m going back and forth, and I have this 2 trillion price target for Ethereum, but if it is indeed a fair fight and the last six months, and especially the last month or so and seeing the TVL on Solana just explode and thinking about what Polkadot has in store for this fall, maybe a more equal weighted Layer 1 index capping Ethereum’s weights might be the best way to think about getting broad exposure to this sector of crypto.

CR: Super interesting. And you said you're planning on rolling out indices for all of Web 3.0?

MS: Well, we have divided crypto, essentially the top 200 coins, into eight sectors — store of value, that's Bitcoin, stablecoins, exchanges. We're calling it metaverse, which is tokens that are used to reward users for content, games, gambling, social media, so you know, Brave, Axie Infinity, Flow and the like. DeFi is another sector, payments, and then infrastructure apps. So it's eight sectors.

Not all of them are appropriate for indices. So some categories like payments have a lot of meme coins in them like Dogecoin. And Dogecoin would be the largest weighting of a payments category if you were to do it based on market cap, and it's unclear if investors really have appetite for an index with that type of coin as its largest constituent, but for four or five of these categories, certainly deserve their own indices and deserve a rules-based approach for identifying who the leaders are, that includes market cap and trading volume, of course, but also maybe incorporates some of the ecosystem traction, like Twitter followers or GitHub commits, or there's a lot of data that we can play around with to try to create rules for leaders.

CR: And then from there, the idea would be to create funds for those indices, right?

MS: Yes.

CR: And that's the big question mark, is how to do that for US investors?

MS: Yeah, it seems that the regulators are leaving us with no choice, but to follow the OTC trust model that Greyscale is using for GBTC. In Europe, it's a much more friendly regulatory environment. So we'll be able to launch exchange traded products, both single coin, and potentially these sector indices as well. But you are correct that how to accomplish this in the US is a very tough task and requires inferior investor products, like these OTC trusts that can trade at big premiums and big discounts.

So we're very cognizant that these products are maybe not going to be for everyone, that the way that the regulator is approaching crypto is pushing investors into inferior products that cost more, are more difficult to manage, and are just, frankly, inferior. But that's not to say that they're not suitable for some people, right. There's going to be some segment of the market.

“...the way that the regulator is approaching crypto is pushing investors into inferior products that cost more, are more difficult to manage, and are just, frankly, inferior.”

I mean, probably VanEck doesn't want to hear this, but I own GBTC in my Roth IRA for the tax savings, and I don't have another way of getting Bitcoin exposure. And I think if Bitcoin does what I think it's going to do, then I'm going to make a lot of money in just not paying taxes on those gains. And there'll be other investors who want to get exposure to crypto in those types of maybe not perfect, but still suitable ways.

CR: Right. Not perfect exposure to crypto beats no exposure to crypto in the US?

MS: I agree with that.

Institutional Interest in Crypto Products

CR: Okay, and then I'd love to get more color on institutional interest in crypto products. What are you seeing?

MS: We're seeing venture capitalists pump money into blockchain protocols who are turning around and using it for customer acquisition. So you just wonder how much of some of this TVL in some of the newer chains is VC money trying to attract liquidity? I'm not going to hate on that, because I think it's going to work, and frankly, it's very encouraging to have the capitalist machine of America get behind this decentralization push. I think it's a great balance against Web 2.0. And it's really kind of pitting some of these VCs against each other in a way that is super competitive and very interesting, and will for me, ensure that the customers are going to pick the better product and that they won't be short of choices and the incentives to get them involved.

“So you just wonder how much of some of this TVL in some of the newer chains is VC money trying to attract liquidity? I'm not going to hate on that, because I think it's going to work…”

So, I'm just recalling the Bitcoin Miami conference, which was a while ago now, but I ran into a lot of traditional hedge fund managers and VCs that were not at previous conferences and they're writing checks. So I just think it's positive from an adoption and awareness perspective. I think it's eventually positive from a regulatory perspective as well, because frankly, those are the investors who have relationships in Washington who’re going to join us and you, and everyone who's known the story for years in amplifying the positives of crypto.

“...those are the investors who have relationships in Washington who’re going to join us and you, and everyone who's known the story for years in amplifying the positives of crypto.”

And I don't think that's such a hard story to tell. I just think it requires a lot of different people to tell it repeatedly and as simply as possible and produce fun and easy ways for regular people to on-ramp into this business. And that's what I think the VCs are helping to accelerate.

CR: Yeah, VCs are certainly interested and very actively involved in crypto. More and more funds that have been traditionally just in Web 2.0 tech are funding crypto and DeFi startups. And there's this flow of money into the space. But what about some of your other clients, you know, pension funds, hedge funds and mutual funds, the more risk averse part of institutions?

MS: I would say it has been slower. Especially some of the traditional long only managers, I think, really are in the teeth of the type of innovator’s dilemma that we have been very careful to try to avoid, which is that their PMs are loaded up on Web 2.0 names. A lot of times, from my personal experience with talking to some of these clients, they haven't put the resources into figuring it out, and they don't really have the right structures to wrap any potential product in.

“A lot of times, from my personal experience with talking to some of these clients, they haven't put the resources into figuring it out, and they don't really have the right structures to wrap any potential product in.”

Because, if we can't put out an ETF, mutual funds can't own this stuff directly. If these big long onlys are not typically in hedge fund manufacturing, like private LP business, they may lack the right vehicles to wrap these things in. There are outliers to that, like Fidelity, who has been pretty on the front foot in terms of writing thought leadership and hiring and joining us to petition the SEC on a Bitcoin ETF. So there will be a handful who manage to make this transition. But in the aggregate, I have still found just not that much work done among the traditional long onlys.

And then on the hedge funds, they have been more active. But from my conversations with my former clients who’re hedge fund managers, it's a lot of just buying Chainlink or Solana on Coinbase, and just shifting some of their client money into that, but it's not creating intelligently designed, clearly articulated processes around how to run a cryptocurrency fund. It's more like punting on a momentum story and a growth story which doesn't take that much work to figure out it's good and putting a 1% or 2% or 3% position. But when it comes to like, okay, here's our process for adding alpha in crypto, it's really the crypto hedge funds that are doing the best job.

And we saw yesterday Point72 made an acquisition of a quant trading platform. So I think there'll be catch-up M&A. I found it myself in trying to hire talent that the best young talent maybe right now doesn't really see the appeal in working for old stodgy, long only asset manager. And we'll have to be creative, the industry will have to be creative to marry those cultures. And maybe creative just means writing a big check and acquiring them. So I think we'll see more M&A. Because to answer your question more shortly, traditional asset managers are behind.

Smart Contracts Coming for Big Tech

CR: So, I mean, the flip side is there's still tons of room for them to grow, and therefore, the impact on crypto should be felt, if that continues to grow in that direction, but they continue gaining exposure, and if there are vehicles for them to invest, then that should continue to make an impact on the market?

And then we're running out of time, but just to wrap up. I wanted to end with just a longer term view on DeFi and Web 3.0. I read in one of your research reports that you said smart contracts have the ability to disrupt not only finance, but also big tech. So if you can just talk more about that and where you see Web 3.0 going, blockchain technology going, in the long term?

MS: Sure. Just looking at the take rates of the Web 2.0 companies, whether you measure it on Google and Apple taking 30% of the App Store and Google Play on Android, if you use an extreme example, like Shutterstock, if you were to sell 100 photos on Shutterstock, they would take 80% of your top line; PayPal, and Amazon and eBay, all taking high single digits, low single digits.

So I guess we're looking at it very simply. Cheaper beats more expensive. Open beats closed. So blockchain technologies, Ethereum with, as I measured, it's like a 50 basis points take rate versus Apple and Google at 30%, you know, it's a 90% savings. Some of this is theoretical, we have to get the execution right, new capacity has to come online, all that. But theoretically, there should just be a lot of cannibalization of existing profits from these lower cost open alternatives.

“...we're looking at it very simply. Cheaper beats more expensive. Open beats closed.”

And the challenge is on, of course, the regulatory side, but also the user interface, and behavioral changes. But as we've seen, post-COVID, with this mimetic economy on steroids, and capitalism's always been a fake-it-till-you-make-it phenomenon, right? The difference between Elizabeth Holmes and Elon Musk... It's always a very fine line.

And that's how I see crypto is, well, of course, on the Elon side, not on the Elizabeth Holmes side, but provide a great cheap, open product that anyone can tweak to their heart's content, create a great marketing message, right, which is decentralization and taking power back from institutions, which have been discredited, and intermediaries who are earning rent seeking rates of return, get social momentum around, changing that, and then roll out products that are hopefully, easier to use than Uniswap version 1.0, and they are getting easier.

And then it's just a matter of time before you get a spark that accelerates adoption and gets us to a billion users without breaking Solana hopefully. So I don't know exactly what's going to be the trigger or the exact timing of that, but feel pretty high conviction that it's going to happen and it's a matter of nature and entropy, and all this entropy has been built up from the discrediting of our institutions and the lack of faith in central bankers and politicians and we'll have a blowback, right. A change in the trend. And if you can catch the change in the trend, then you can usually make a lot of money off it.

“...all this entropy has been built up from the discrediting of our institutions and the lack of faith in central bankers and politicians and we'll have a blowback...”

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