March 6, 2018

Q&A with Ari Paul, CIO of BlockTower Capital

What advice would you give to an aspiring crypto analyst/trader/portfolio manager ?

This is an open ended question, so I’ll offer a little high level advice. First, we’re in the 3rd inning of the birth of a new industry. I don’t know who came up with the line, but I read it from Peter Thiel: it’s easier to become a big fish in a big pond by starting as a big fish in a little pond, or at least as a little fish in a little pond. Crypto is a little pond, which means it’s a wonderful opportunity for the ambitious. Go “all-in” in terms of your time and energy. It’s a small industry, so try to meet everyone. Connecting with leaders of all types (developers, investors, service providers) is critical to understanding the industry and finding a place in it and then excelling. Figure out where your passion and skillsets fit within this industry. Crypto is quite broad – it needs marketers, fundamental investors, quantitative analysts, developers, investment bankers, hardware developers, etc.

What do you look for when evaluating crypto investment opportunities?

For long-term investment, I bucket things into two categories. 1. Those use cases that truly need to be decentralized within that category, investments that have a good chance at being somewhat “winner take all” within some niche. For example, we’re unlikely to end up with 30 privacy coins. But we have a few that are differentiated. What are those possible differentiators that will create defensible “moats”? For example, LinkedIn and Facebook are both social media monopolies but with differentiated offerings such that they can both thrive. 2. Everything else: there are plenty of fine investments that don’t fit category 1, but those need to be underwritten at much lower valuations. For example, most utility tokens are similar to companies in the sense that they may offer value, but probably not $10 billion worth of value (there aren’t many $10 billion companies in the world.) A key for looking at these is competitive strategy. It’s not enough to find a good team and tech, we have to ask, “why will this team and tech beat all the existing competitors and those competitors that will arise?”

If the real ‘Satoshi Nakamoto’ suddenly back, and doing AMA, what question would you ask?

Love this question. I’d ask Satoshi how the natural economies of scale of PoW mining that have become evident shape Satoshi’s thinking on how Bitcoin can and should evolve, and if he* would support major hard forks to change the structure of Bitcoin (even as extreme as a change to the consensus mechanism, to say, proof of stake) under some condition. I’d also ask if Satoshi thinks there’s room for competing cryptocurrencies and how they need to differentiate to add value. Not at all suggesting Bitcoin should or could. Just curious if Satoshi would even be open to thinking about it.

What skills are most important for non-technicals to develop if they aim to build a career in the crypto/blockchain space?

Really depends on your targeted career. For example, OTC trading desks need back office support and marketing. Crypto funds need investor relations, etc. One key thread is familiarity with the industry as a whole. Get out a meet people. Meet the devs, the fund managers, the service providers, etc.

When can we hope for parts 3 and 4 of “How To Think About Investing In Cryptocurrency” šŸ™‚

The comical delay was caused partly because, well, I got busy. But also because I’m genuinely stumped. I don’t want to put out a part 3 without feeling it will genuinely add value, and I encountered a few questions I couldn’t answer. For example, to forecast whether crypto’s store of value is mostly “winner take all” or if there’s room for tons of competitors, we first need to answer if there are viable consensus mechanisms beyond proof of work. To me, this remains an unanswered question. I’m not suggesting the answer is no, I simply don’t know. Part 3 will likely take the form of “if-then”, as in, “if the technological and game theory answer is that only PoW is secure, this is how I expect things to play out.”

Do you think technical analysis works on crypto?

Very much so. On very short time intervals, technical analysis becomes self-fulfilling and it’s a zero sum game of short-term traders gaming one another and trying to front-run “whales.” On longer time frames, technical analysis reflects basic psychology. I suggest reading introductions to behavioral finance. All of the biases, such as “anchoring” result in technical analysis trades.

How did you get into crypto?

Post 2008-crisis, all the world’s banks were printing massive amounts of money. I started thinking I’d want an asset that couldn’t be depreciated into worthlessness. 2. The birth of a new asset class is an amazing opportunity for intellectual exploration as an investor. 3. I had relatives that had to flee Nazi Germany. I understand that we can’t take freedom for granted, and the ability to escape an oppressive regime with your wealth via a password in your head is a wonderful defensive weapon against tyranny.

Do you think banks fear cryptocurrency?

Definitely. Even for the most dismissive among them – it’s something they’re not profiting from, they don’t understand well, and that is making them look bad. Their clients are asking their wealth advisors why they told them not to buy the most profitable investment of the decade.

Hey Ari, you recently mentioned you’ve been living out of hotels for the last 7 months and it’s removed your desire to shop for ‘stupid stuff’ – have you decided where you’d like to reallocate that capital?

Mostly in crypto (both directly as an investor, and in investing in building out BlockTower). I’m also a believer in effective altruism and just like how investment compounds capital, so too does investing in philanthropy compound social good, so there’s no reason to wait to give.

UChicago student here – how long(in terms of milestones, not necessarily time), if ever, will it take more institutional investors like a university endowment fund to start investing in crypto.

The major obstacle is custody. My best guess is that we’ll have the start of decent third party custody solutions for a broad variety of crypto assets in 6 months, and then it will take another 12 months for those to be well tested and trusted and hopefully insured. At that point, institutions will feel far more comfortable investing.

 

What crypto-security measures you can’t do without?

Hardware wallets.

How do you envision crypto and the blockchain will change our world?

cryptography generall, and cryptocurrency specifically are “defensive tools.” All tech can be used both offensively and defensively, but some is naturally defensive. In a military comparison, a carrier fleet is offensive since only the richest governments can afford them. In contrast, a sniper rifle is defensive, since it can be used by a much weaker military to threaten a larger one. Cryptography and cryptocurrency are incredible defensive weapons that level the playing field. One effect I think this is likely to have is to reduce the size of governments generally in the long-term.

 

Patrick OShaughnessy recently complimented you on the progress you’ve made in your career over the past 9 months. What were the primary drivers of that progress?

A lot of luck at being in the right place at the right time and having a fairly unusual skillset for the industry at the moment. I have a mix of trading, portfolio management, and economics, and just enough understanding of cryptocurrency to combine those 4 aspects coherently. Fairly soon, that combination will be very common, but a year ago, it was a rarity. Also…I will pat myself on the back for recognizing that this industry was about to go parabolic in all regards and working appropriately hard. It’s been a lot of 17 hour days, learning everything I could and connecting with everyone I can.

Could you explain the BTC call option with $50,000 strike price that you bought, and the hedging strategy behind that?

There’s currently very, very little liquidity in crypto options. But…that will change. The BTC call option was a “hedge” against one specific scenario – where Bitcoin rallies parabolically. As an active trader who’s focused on risk management, it’d be very hard for me to not substantially underperform in that scenario, so the call option partially hedges that one scenario. Over time, there may be other valuable uses for BTC options in a portfolio.

 

Took your twitter statement “I’m going to want exact details on the structure of the capital raise and token issuance.” – could you give an example of a well structured one:

– how do you evaluate how much money they actually need to build the project since a lot lot of teams are asking for way more money than they actually need

– what is a fair initial distribution (quite a few proejcts selling under 30% of all tokens)

– what is a reasonable pre-sale discount and is it a function of the time between pre-sale and main event (isn’t anything over 100% absurd)

It would be great if you can elaborate on under what circumstances would any of the above be ok

 

I’m ambivalent on many of these questions. For example, yes, projects raise way more money than they need. But if they artificially limit the size of their sale, that produces a benefit to “access.” If a project is 10x oversubscribed, whoever gets in will make lots of money selling to the later buyers. So, you can argue that it’s more fair to have a totally open uncapped raise. As for discounts – this would match the stage of development. It makes total sense for a Seed round to be 1/3 the series A, which is 1/2 the series B, etc, if those are each raised after major milestones are hit. Discounts that are large and separated by short periods of time and little changes in development are indefensible.

Given the recent correlation between all cryptos, as a purely crypto hedge fund how do you justify your management fee(if you have one)? This question is based off the thought that you cannot go short, and basically how do you get ‘alpha’ in the crypto market?

Correlations are very high day to day, but very low over 6 months. For example, it’s easy to find major crypto assets that are up 2x and others that are up 20x over the last 6 months. If you invested in mostly the latter, you added alpha. Additionally, the hypervolatility means there’s lots of room to trade in and out. For example, if you sold BTC at $15k and bought it back at $8k you added lots of alpha.

What are you views on big investor getting huge discounts for ICOs and ICOs not mentioning this sometimes?

I support transparency in all regards.

 

You wrote about The Coinbase Effect after Coinbase added LTC (https://medium.com/@AriDavidPaul/the-coinbase-effect-2ace0b86b7d3).

Can you speak more to this effect in light of adding Bitcash, Brian’s promise to add more coins in 2018, and if / when other exchanges (centralized or decentralized) can mitigate it?

Part of this effect is the genuine value-add of liquidity. A more liquid asset is fundamentally more valuable. Additionally, Coinbase is easier to use and safer to use than plenty of other exchanges, and these differences should be reflected in price to some degree. The extreme size of the “Coinbase effect” should diminish over time (and I think we see that happening somewhat) due to people like myself “arbitraging” it by anticipating major exchange additions, as well as by having more of a spectrum. Instead of it being “Coinbase or nothing”, it’s gradually becoming a long list of valuable exchange additions, which mutes the effect.

 

Best thing you’ve read lately (can be a book, article, or Neeraj tweet)

Just finished Margaret Atwood’s Handmaid’s Tale. It was phenomenal.

How do you differentiate between a great project and a great investment? Specifically, what factors do you look for to determine if value will accrue to the token-holder? Thanks for doing what you do!

For utility tokens – I don’t know. We don’t have a single successful data point. There’s a rough consensus that there needs to be a clear mechanism by which demand for the network will translate into demand for the token, something like staking, vesting, or burning. But…if these are too onerous, the network may be forked. A great project is tackling a tough an important technological or game theory problem. A great investment solves a real problem for people with far greater value than the current implied value of the crypto assets, has a team that can execute on that vision, and has some “moat” that will prevent competition from other projects.

The ICO market is disappearing. Should AI requirements in US be loosened?

I think it will be re-born as registered security offerings towards the end of 2018.

Although Satoshi created $BTC, is it more appropriate to have a new dominant coin that has an actual known float? Since we don’t know if Satoshi’s account can transact the captured supply.

Most people estimate satoshi’s stash at ~1 million coins. This is a fairly small percentage of the total. I don’t view it as critical.

 

Internet protocols were open source and free, but the trend in crypto is allegedly the opposite, where for the first time you can invest in a protocol level? which is in your opinion going to be the dominant protocol? and what projects, aside from stablecoins, excites you the most?

One of the few things I’m confident in, is that most crypto value will accrue to one or several “store of value” coins. Bitcoin is an obvious frontrunner to win that, but any coin with a reasonable chance at winning that mantle is probably undervalued today.

 

In your view, what does the path of beginner to advanced look like in terms of developing a deep understanding of cryptocurrenices and blockchain?

I find there are an abundance of resources which attempt to solve the basics but little material targeted towards those who want to progress further. My favorite intermediate/advanced resource is the “Bitcoin and Cryptocurrency Technologies” MOOC by Princeton.

We’re all beginners today. Really. Crypto is at the intersection of so many disciplines, there are no experts in all of them. Only advice I can give is to learn as much as you can about all of them.

Given the upcoming ETH Casper hardfork, what are your thoughts on PoS vs. PoW debate? Which method will win out over time in your opinion and why?

This is an unanswered question for me. And I’m not the guy who can answer it (that would be someone brilliant at both the game theory and technology, and those people seem to disagree with one another currently).

What question in your mind you can’t solve these days?

..most of them. I’m very curious which consensus mechanisms will end up being workable (PoW, PoS, proof of space/time, etc), whether blockchain is the ultimate cryptocurrency architecture, and whether there’s a better governance approach than “governance by exit” that Bitcoin has.

Hi Ari, do you think ICOs are in a bubble?

Definitely.

 

Can you elaborate on your thoughts regarding the impact that this will have to status quo power structures.

I expect it to ultimately be very, very disruptive, but it’s not just crypto in isolation. As more work becomes virtual and as more of our lives become virtual, we will increasingly be earning and spending in a non-localized fashion. For example, a facebook programmer might live in Siberia and spend her money on VR entertainment. That means that an increasing amount of economic activity can happen on blockchains, and potentially anonymously…which means, that things like anonymous transactions may seriously hamper government’s tax revenues and enable people to much more easily “shop” for places they want to live and the governments they want to live under.

With the lightning network (and similar 2nd layer solutions) popping up, Iā€™m interested to hear if you think a cryptocurrency like Bitcoin can act as both a store of value and medium of exchange simultaneously? Sure, the lightning network allows for instant, no-fee txs, but who in their right mind is going to spend an inflationary currency like Bitcoin? Do you ever see Bitcoin coming into enough of an equilibrium to justify widespread use of lightning? If so, when?

 

Blockchains are horrible, horrible payment channels. There may be fundamental technological changes that facilitate level 1 scaling sufficiently, but it’s at least plausible that the optimum solution is layer 1 as settlement, and layer 2 as everything else. I see nothing lost from this. I don’t need a $1 billion insurance policy for my $20k car, and similarly people don’t need ultimate security and decentralization for coffee. Whether it’s LN or something else, I expect layer 2 scaling to provide “best of both worlds.” There may be a variety of layer 2 options that cover the spectrum of fast/cheap decentralized/secure.

 

Question regarding Ethereum – and other cryptos such as Cardano, and NEO. Linked currencies (e.g., Ether, ADA, Lumens) allow people to buy computing resources on these networks. If these platforms sell decentralized computing power – a service one could purchase as easily from Ethereum as one could from Cardano (just as one can easily select between AWS and Azure), why should we expect the cost of this computing power to rise over time? DApp developers will have an array of choices on where to run their applications and choose the cheapest. There should be perfect price competition among decentralized computing networks to offer computing resources at the lowest price. Are there any network effects that would allow Ethereum, for example, to charge a premium and be worth more the larger its network gets?

 

I don’t think these services really offer computing power. It’s hard to think of a use case where you really need meaningful decentralized computing power. Rather, I think they offer just enough computing power to accomplish certain simple dApps, where the value proposition is really the decentralization. Most computation can be moved off-chain and then hashed or settled to the chain.

What lesson do you wish you learned sooner as you fell down the crypto rabbit hole?

Love this question, don’t have a clear answer. Probably differs by person. In my case – I was weirdly slow to dive into the foundational white papers. Can’t beat reading Satoshi, Ethereum, LN, etc. And read them repeatedly.

Do hedge funds benchmark themselves against BTC? An index of the top 10 cryptocurrencies? Regardless, what if they can’t justify their fees vs. the benchmark?

I joke that we’ll be benchmarked against whatever wins with hindsight bias. 6 months ago, investors mostly benchmarked funds against BTC. With BTC falling to 35% of the total network value, this is less obvious. The extreme volatility of the space means that there’s room to add value via trading in and out (e.g. selling BTC at $19k and buying it back at $6k, for the psychics).

 

Wilson

Wilson is a 3x Startup Entrepreneur. He is passionate about the cryptocurrency space. You can catch him tweeting about cryptocurrency often @itswilson8

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