From the desk of Arthur Hayes
Co-founder & CEO, BitMEX
From The BitMEX Research Desk
I was staring at my plush toy cactus, and I thought has anyone tried to decentralise zero? Later, I was messaging Meltem and through our conversation, the following ideas manifested themselves about the absurdity of 2018.
I dedicate this newsletter to the concept of zero. I have seen the future, and many crypto investors will become familiar with this round number, although they might not know it yet.
Overheard in St. Patrick’s Cathedral in New York City.
Judas is an Ethereum developer; he’s had some bad luck. He is now at Church giving a confession.
Father is the Bishop.
Judas - Forgive me Father, for I have sinned. It has been one year since my last confession.
Father - Welcome my son, please tell me how you have sinned.
Judas - Well as you know, I am an Ethereum developer. But I believe I have given false witness to another god.
Father - Who would that be, the Devil, Satan himself?
Judas - No Father, my faith strayed. I believed in Decentralisation.
Father - Huh? Not sure I follow. Please explain.
Judas - I am an Ethereum developer. You know, the world’s virtual computer. I believed that using the Ethereum protocol I could decentralise anything. And I was specifically interested in the trading of financial assets, like stocks.
Father - Ok, but what would a decentralised stock market look like?
Judas - Well, anyone, anywhere could exchange stocks. You wouldn’t need to get approval from any government or a traditional exchange like the New York Stock Exchange or Nasdaq. It would also allow anyone to sell equity in their project to anyone in the world. In short, true financial freedom for everyone, everywhere.
Father - Heresy. You planned to usurp the Angels, the NYSE, and Nasdaq. Did you not consult the good book about our Lord’s relationship with those organisations?
Judas - I did, but I thought because I used the decentralised world computer, Ethereum, that our Lord and Saviour would not mind.
Father - Son, you did not read the Gospels close enough. Specifically, the Gospel according to Howie.
Judas - Well, I thought my lawyers were well versed in the Gospels. They told me that because it was decentralised, the Gospel according to Howie did not apply.
Father - [Shakes his head in sorrow] In my last sermon, I preached that the Lord’s children must be vigilant against false prophets. Specifically those wearing Brioni suits, and white Church’s shoes. These white shoe lawyers, care not for your soul, but only for their pockets.
Judas - Oh, I missed that one. I was too hungover after a night at the Box. We were celebrating our ICO.
Father - Ah, the ICO. I also lead a vigil against that tool of the Devil. But son, how is your project decentralised, if you personally launched an ICO, and profited from it? Surely, a truly decentralised project has no identifiable leader, and no one entity profits from its operation?
Judas - I realised the errors of my ways now.
Father - How has the Lord made you repent?
Judas - The Lord decreed that I must pay a large sum of money to absolve my sins.
Father - Better that, than the Lord sending you to Sodom and Gomorrah, a.k.a. Rikers.
Judas - I know, I am forever grateful to the mercy of our Lord.
Father - I am glad you have learned son. Our Lord is merciful. But he will strike rath down upon those who threaten his kingdom.
Father - Let us pray to our Lord and Saviour. In nomine patris et filii spiritus sancti JAY CLAYTON.
Polly Pocket Has Liquidity Issues
Overheard at the recent Polly Pocket Investor Day.
Polly Pocket is the managing partner of Polly Pocket Capital. The fund invests solely in tokens.
Schmuck is an investor in the fund.
Polly - Welcome everyone to our Investor Day. 2018 has been a challenging year for our fund but we are fully confident in our ability, over the long run, to deliver superior returns.
Schmuck - Speaking of performance, can I get some more colour on what your fund actually holds?
Polly - Great question. As you know, we don’t disclose exactly what we own, but I can give you a taste. Our fund is divided into listed and unlisted tokens.
Schmuck - Ok, what do you mean by listed and unlisted? I thought the mandate only allowed the fund to invest in tokens that are already traded on a secondary market.
Polly - Well, that is true. But we saw some great deals, so we created a side pocket. The side pocket contains all the pre-ICO deals that we invested in.
Schmuck - Hmm…So you basically can invest in whatever you like, regardless of the fund mandate?
Polly - In a nutshell, yes.
Schmuck - Greeeeaaat. How do you mark these illiquid, unlisted tokens?
Polly - As you know, due to our amazing connections, we get in on deals well before the unwashed masses. Typically we get a 70% - 90% discount to the last round where most of the plebes purchase these tokens. We then mark the value of the token to the last round price.
Schmuck - So if you invest a price of $1,and the last round which could be a very small amount of the total float, is sold at $10, you record a 10x gain?
Polly - Yes.
Schmuck - Does that also mean that I get charged management fees on the 10x value?
Polly - Yes.
Schmuck - Your liquid token portfolio got molly whopped this year, correct?
Polly - Yes.
Schmuck - So the AUM will get bled at an accelerated rate due to the marking of the side pocket? I’m am paying 2% on a 10x marked up illiquid token with no secondary market, and there is no visibility as to when it will actually list?
Polly - I mean that sounds worse than it is, but you are essentially correct.
Schmuck - Do you apply a haircut to this valuation because there is no liquidity, and an indefinite time to listing?
Polly - No. We believe there is extreme value, and this is reflected in the last round price. Our team of token experts really knows how to value these things.
Schmuck - Maybe, but the management fees paid on these side pocket investments could consume the entire value of the investors’ capital. What happens if I would like to redeem?
Polly - We would sell our liquid tokens first. Once that pool of capital is exhausted, we would be unable to meet your redemption request.
Schmuck - Is there no way to sell your interest in these projects? Have you ever tried?
Polly - Legally we can’t. The SAFT term sheet does not allow us to transfer our interest before the token lists.
Schmuck - So basically you are telling me, I’m up shit creek without a paddle?
Polly - I wouldn’t put it that way. Sometimes we suffer liquidity issues.
The BitMEX Research team has compiled a list of tokens that raised over US$50 million that have yet to list.
These deals have massive valuations, and many of the most venerated token funds took down large chunks. It is unclear when, if ever, these deals will ever list on the secondary market.
Given the large amount of token supply out there, who will buy this shit?
Can you really mark these investments to the last round price?
There are anecdotal reports of funds attempting to sell their SAFT interest, and the prices offered were way below the last round price.
2019 is going to be the year of reckoning for many funds. You can mark something to an absurd level in year 1. But the meter starts again on January 1st. If these things come to market, there will be no accounting tricks to hide the gargantuan losses that these funds will post.
Remember BlockMEX? Well the firm has limped along for several years. They have tried various business models. None have made any money. But that doesn’t matter, VC firms continue to shower the company with cash, and its valuation continues to rise. The CEO now has a great new idea. Let’s listen in on the recent board meeting.
Billy - Billy is the CEO of the company. He just joined as the previous dude got ousted. The VC firm The Blind Fund, who supplies most of the cash, ousted the previous CEO in favour of Billy who they thought would play ball better.
Kaiser Soze - One of the general partners at The Blind Fund.
Kaiser Soze - So Billy, what are we going to do to get some traction? It’s been over four years, and BlockMEX still makes zero revenue. You guys need to do something new.
Billy - Well, I have a new idea. ICOs are toxic. The projects are trash, and the regulators hate them. What about STOs, Securities Token Offerings?
Kaiser Soze - Tell me more.
Billy - Ok, so imagine you want to buy a fraction of a piece of real estate. And then you could trade your fractional ownership, which is represented by a token.
Kaiser Soze - Call me old fashioned, but isn’t that just a Real Estate Investment Trust (REIT)? Most stock markets around the world already have those.
Billy - But do REIT’s ride on a Blockchain? Do they use Distributed Ledger Technology to hold the record of the title?
Kaiser Soze - No, but they trade billions of dollars a day already, and you can easily trade them with your local broker almost everywhere in the world.
Billy - You don’t get it. If the token rides on a Blockchain, like the Ethereum protocol, then they reach help anyone anywhere. Like those poor investors in North Korea who have nowhere to put their savings. Now they can own a token.
Kaiser Soze - Anyone, really?!! It’s pretty clear these are securities, right?
Billy - Yes.
Kaiser Soze - So that means they are regulated, and in most places the exchange needs some sort of license.
Billy - Yes, that’s correct.
Kaiser Soze - The same license the incumbent exchanges already possess?
Billy - Correct.
Kaiser Soze - And the technology stack that operates the matching engine must also be approved by the regulator, right?
Billy - Correct.
Kaiser Soze - So you are replicating the same technology, getting the same license, to go after the same client base?
Billy - Correct.
Kaiser Soze - Ok, sounds like a winner. We can keep pumping money in, and make it up on volume. [The Blind Fund never saw a negative gross margin business they didn’t like.]
Billy - Exactly what I was thinking. Everyone is talking about STOs and how they are the future. Another type of STO is an equity offering of a startup.
Kaiser Soze - So how would that be different than doing an IPO?
Billy - Well many companies these days are staying private, the cost of doing an IPO and all the regulatory and compliance costs, are daunting—-especially for smaller companies. There should be a way for smaller technology companies to raise funds by selling some type of equity.
Kaiser Soze - Would these companies pay dividends? I’m assuming these are unprofitable companies.
Billy - Not only would they not pay dividends, there would be no audited accounts, or any duty to really explain anything to their investors.
Kaiser Soze - Wow, that’s amazing. How would this STO thing fit in on the balance sheet?
Billy - Not sure on that one yet.
Kaiser Soze - Traditional financial theory would suggest that this token is worthless because there is no cash flow.
Billy - Come’on Kaiser. We have been through this before. Traditional finance is dead. We are in a new paradigm. Don’t be a luddite.
Kaiser Soze - I know, I know. But if you are selling equity like securities, wouldn’t that need to be registered with a national regulator?
Billy - Shhhhhh.. Don’t tell anyone. We are just going to shoe horn this one in. Because we use a Blockchain and or Distributed Ledger Technology, those rules don’t apply. The best part is, we can absolve ourselves of any legal liability by basically telling investors when they buy these things they actually have zero rights. ROFL.
Kaiser Soze - Man, this Blockchain shit is LIT! You can do anything.
Billy - I know, right? Maybe the only thing we can’t do is become revenue positive.
Kaiser Soze - Don’t worry about that. I know some people in the desert, who have more cash than brains. They won’t let us down.