🎙 "The Bull Market is Intact for the Next 10 to 20 Years; We are in a Secular Shift:" Arca's Jeff Dorman

In this week’s episode, I interview Jeff Dorman, chief investment officer at Arca, an investment management firm focusing on digital assets. Jeff has been valuing assets for the past 20 years, from investment-grade bonds, to high-yield debt and equities, and now he’s doing the same for crypto.

We talk about the recent selloff; he thinks the big crash is over but that doesn’t mean we’ve seen the market bottom. Still, Jeff says this is a buying opportunity and he gives insights into which sectors will outperform and underperform.

We also talk about valuing cryptocurrencies and blockchain protocols. Jeff says some DeFi companies have fundamentals and multiples that are hard to come by in traditional finance. As an example he names SushiSwap, which is generating 1 billion in revenue and paying dividends.

Jeff says he can apply tried and true methodologies from debt and equity, but he’s most excited about finding new valuing techniques as crypto has its own characteristics, for example, the fact that a token can combine utility with financial ownership. To him, learning to analyze a space like DeFi before most have even heard of it where the real alpha come from.

Jeff’s clients are hedge funds and traditional investors, and he says they’re getting increasingly interested in decentralized finance —they find DeFi protocols are a lot easier to grasp than cryptocurrencies because they're more similar to tangible companies. He says asset managers will probably very soon start getting involved in yield farming and staking.

Jeff believes we’re heading to a 10 to 20-year secular bull market in crypto, where there will be a decoupling of sectors and where DeFi continues to grow.

The podcast was led by Camila Russo, and edited by Alp Gasimov. Transcript was edited by Owen Fernau and Dan Kahan.

🎙Listen to the interview in this week’s podcast episode here:

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• The DeFi Pulse Index, a capitalization-weighted index that tracks the performance of selected DeFi assets across the market.

Camila Russo: Jeff is the Chief Investment Officer at Arca, an investment firm focusing on digital assets. And while his focus is in crypto now, he was formerly a TradFi guy with jobs at Lehman, Merrill, and Citadel. So really interesting, well-rounded perspective on the market. He has obviously been following the recent gyrations very closely. So first off, I usually start by asking my guests to give us their background and their story on how they got into crypto. But this time, I'll just start with the question that's on everyone's mind, which is, is this sell-off over? What do you think?

Jeff Dorman: Good question. Is this the bottom of prices? I have no idea. Is the sell-off over? I think yes. And what I mean by that is, you've mentioned my background a minute ago, I have a background in distressed and special situation investing. And generally, when you get into crisis-type modes and crisis-type trading, in the traditional world, it often lasts 18 months to two years.

You go back to 2008, for example, the first hiccup at Bear Stearns was in June of 2007. And the financial crisis really didn't end until about April of 2009. So it was a long, painful road down. What we find in digital assets is, a lot of times, this happens in two to three weeks, then it's over and we go right back up. Sometimes it can be longer, like 2018. But for the most part, these are usually quick.

“I think it's over in terms of the reasons and the flushing and everything that caused the selloff. But I don't know if the prices are at the bottom yet, and neither does anybody, and you shouldn't worry about that. You should just buy the things you're comfortable with.”

In terms of trying to find a price bottom, that’s really, really hard. But what you do as an investor is, you just find the assets that you believe in, the ones that you really, truly have a view for why they're going to be higher in 6 to 24 months, and you don't really worry too much about the price that you're buying it. So if you're buying at three different price points along the way down, so be it. Each time you buy in a downward environment like this you're going to feel like it's a terrible investment, but in six months from now, they're all going to be good. And that's the mindset you have to go into this.

I told a story on Twitter the other day. I personally sold Carl Icahn, one of the largest distressed investors ever. Back in 2009, he was buying MGM casino bonds, and his first purchase was at $0.80 in the dollar. And he bought at $0.80, $0.70, $0.60, $0.50, $0.40, $0.30 in the dollar, all in the same week. Those bonds ultimately matured at par. So he made a lot of money. But his first and subsequent purchases were all terrible. It takes a special kind of conviction to buy that way on the way down.

So I think it's over in terms of the reasons and the flushing and everything that caused the selloff. But I don't know if the prices are at the bottom yet, and neither does anybody, and you shouldn't worry about that. You should just buy the things you're comfortable with.

CR: So if you think the selloff is over, but prices aren't at the bottom, that means that we could have a few weeks of a rebound, but then another crash?

JD: Well, when I say the selloff is over, what I mean is the crashes. The crash was facilitated for a variety of reasons. And I think that is over. But in terms of prices going up and down, some people conflate that when the selling is done, it doesn't mean buyers are necessarily back. So I think they forced selling from the liquidations. We had $10 billion of liquidations last Wednesday. That is over. Most of the leverage has been flushed out.

The rationale that has been piling on from Elon Musk and Tesla deciding that Bitcoin is all of a sudden bad, to the news out of China late Friday night, local time in China, I think a lot of this news is now in front of us, and anyone who has been a force seller who has been thinking about selling, for the most part, has sold. The question now is, when do the buyers come back?

And what happens if you're a market maker, whether you're a human market maker or an algorithmic bot driven market maker, it's all the same thing, which is, at some point, you have to find where that market equilibrium is. Even though the selling might be done, maybe you have a little inventory that you got hit on and you're just continuing to take the market down until you find buyers. Or maybe you're a short seller, and you're just going to keep shorting on the way down until somebody stands in your way, and as soon as somebody stands in your way and starts buying, then you turn around and cover all your shorts.

“I think a lot of this news is now in front of us, and anyone who has been a force seller who has been thinking about selling, for the most part, has sold. The question now is, when do the buyers come back?”

So I think we're in the eye of the storm right now, where the selling pressure is done. But it might take days, it might take weeks, it might take hours or months for the real cavalry to arrive and start putting significant capital to work.Don't forget only two or three weeks ago, we heard a headline that A16 raised $2 billion. Who knows when that money is closing, and when that money is coming to work? Or there are significant hedge funds that have been raising money and getting institutional capital every month for the last nine months. That money is going to get put to work. It's just a matter of when.

I don't think institutional buying is done. I think it's just a matter of when it happens. And in the meantime, prices can be very choppy while markets try to find that equilibrium. So again, that's why I would say selling pressure, absolutely done; prices, hard to know. It could oscillate for a while.

TradFi to Crypto

CR: Perfect. Super interesting take. So now, I will go to my initial question of your story. Love to hear your background in all these great TradFi institutions and what got you from there to crypto?

JD: Sure. So I started my career about 20 years ago as an investment banker at Lehman Brothers. Back 20 years ago, getting a job in investment banking was actually like a cool and hard thing to do. Now, obviously, most people would prefer to go into software development or go to Apple or Google than to go to a JP Morgan or Goldman Sachs.

But back then, that was a prestigious job if you were interested in finance and economics. I started as an investment banker, then moved into capital markets where I was helping to underwrite debt and equity issuances. And then I went into bond trading where I traded investment grade bonds down to high yield and distressed. That was the first 10 years of my career at Lehman and Merrill. Then I went to the buy side after the financial crisis, and I worked for Citadel and a couple other smaller hedge funds as well.

So the first 15 years of my career was always value investing, fundamentals, CFA, studying, reading Graham and Dodd valuations, all the boring financial stuff. But it really gave me a pretty good, solid background understanding what drives value.

Ironically, the reason I left the hedge fund industry in 2013 was because all of those skills that I had worked on no longer mattered once the money printing started in 2008 and 2009. I found that understanding balance sheets and income statements and how capital markets work really doesn't matter anymore, because all people cared about was what the Fed was saying. And it became pretty uninteresting to me.

At that time, I went into FinTech with a friend of mine who started a company called Harvest Exchange. He wanted me to help work on it. It was catering to financial services, but it was basically a software company. And it was then that I started working with developers for the first time. They were all using GitHub and open source code. They were all raving about the sharing economy. A lot of them were mining for Bitcoin and Litecoin and Ethereum at the time.

“But it was really understanding when I learned about Ethereum, and I learned about smart contracts, and I saw how much more potential there was for digital assets to really replace a lot of legacy systems that just never really made sense in the first place.”

And I started personally investing in Bitcoin because it made sense to me from a macro standpoint, this idea that you can't just print money forever. At some point, inflation really does happen. But more importantly, I was doing that while working with developers who understood it for completely different reasons.

And like most people, my trek into Bitcoin was I heard about it in 2013, I laughed at it, I dismissed it, I thought it was stupid. 2015, I took it a little more seriously, started reading more. 2016, I made my first purchase. And then two years later was when I first actually heard about all these other things that were happening outside of Bitcoin, and that's what really got me interested in this professionally rather than just as a toy investment. Bitcoin was great. Bitcoin was an on-ramp. Bitcoin was exciting, to learn about blockchain and how to actually transact. And I still think Bitcoin is a great investment as a part of your portfolio, not as the entire digital asset portfolio.

But it was really understanding when I learned about Ethereum, and I learned about smart contracts, and I saw how much more potential there was for digital assets to really replace a lot of legacy systems that just never really made sense in the first place. That's when we started Arca. I think we officially founded in early 2018, and that's when we officially formed Arca to help other investors understand what we knew, which is that you don't necessarily have to be a software developer to understand the digital asset ecosystem. You could also take a financial approach to this asset class and understand revenues and cash flows and how markets work and how prices trade based on events and catalysts and fundamentals.

There really weren't very many people attacking it from that way at the time. There were a lot of VCs who were predicting the future 10 years out, and there were a lot of ALGO and quantum traders that were trading volatility. There really weren't a lot of people who were saying hey, what we did in the debt and equity markets, looking at fundamentals, can it be applied to this asset class as well?

Two Sides of Arca

CR: So a bit more on what Arca does: you structure active funds for institutions? Can you talk about what funds you're providing, like who your clients are?

JD: Yeah, from a structural standpoint, we are designed to look like a boring asset manager. And that's by design. You know, we are catering to institutional investors who require a certain level of fiduciary and regulatory and compliance knowledge that we all have from our TradFi days. But inside, the different types of funds that we're offering are designed to offer different exposure to different pockets of this ecosystem.

So we have two sides of Arca. We have the Arca of funds businesses, which is what I run as the Chief Investment Officer. And here we have different hedge funds and private vehicles, where we're investing in the ecosystem that already exists. Our core flagship fund is a digital assets hedge fund, which is a long-biased, fundamentally-driven, catalyst-driven investing vehicle. We also have the Bitcoin passive vehicle for those who just want to own Bitcoin and nothing else. And we have a couple other niche strategies that are yet to be announced that we've been running with internal capital, things that have more to do with the NFT ecosystem, and generating yields within DeF,i and in other areas as well. So we'll be rolling out other funds on that side.

And then the other side of our business is Arca Labs. This is where we are using blockchain as a wrapper, or as an infrastructure, to create traditional products. So the best analogy there would be, the ETF is just a structure, but what you put in the ETF is what matters. You can put healthcare stocks in there. You can put bonds in there. You can put gold in there. We did the same thing using blockchain, we created a structure called Blockchain Transferred Funds, or BTFs, intentionally designed to sound like ETFs, where it is the same type of a structure. It's a 1940x regulated product, but you can put anything inside of it.

The first one we created was ArCoin, where you put government bonds inside the trust. And the ArCoin token, which is an ERC token, is how you actually transfer and trade the vehicle. But over time, we'll have new additions to this BTF structure as well.

“The ETF is just a structure, but what you put in the ETF is what matters. You can put healthcare stocks in there. You can put bonds in there. You can put gold in there. We did the same thing using blockchain, we created a structure called Blockchain Transferred Funds, or BTFs.”

CR: Interesting. I wasn't aware of these tokenized funds. Are they traded on decentralized exchanges? Or do you have to be an accredited investor to buy that?

JD: You don't have to be an accredited investor to buy the BTF structures. But these are registered securities. So this is the same problem as those who still use the tZERO term security tokens. The infrastructure is not nearly as well built out for that as it is for the traditional tokens that are in more of a regulatory gray area. So like others in the space, from tZERO to TokenSoft and others, we're continuing to work on the infrastructure and build out a more robust security token landscape. Right now, most of it is trading peer-to-peer or directly through our website. But over time, we are working with partnerships and other areas to ultimately give investors more access to these products.

Lasting Impact

CR: Okay, cool. And then I really want to hear your take on the drivers of this sell off. Like you mentioned, you look at the market from a fundamentals perspective. So did the things that were driving the different price action make a lasting impact in crypto?

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