Michael Sonnenshein: The Largest Crypto Asset Manager

Anthony Pompliano
Oct 9, 2018 · 36 min read
Michael Sonnenshein.

Anthony Pompliano: All right, guys. We’re here with Michael. This is going to be a great episode. Michael, thank you so much for coming.

Michael Sonnenshein: Thanks for having me.

Pomp: Absolutely. Let’s just start with your background because you’ve been in this space for quite a while. I think people probably don’t know what you did pre-crypto.

Michael: Sure. So I started out as a banker. Spent time at Bank of America, Barclays, and most recently JP Morgan. And I was looking for a challenge. I wasn’t even necessarily looking for crypto. My seat at JP Morgan, I remember sitting there looking at CNBC at the corner of my office and seeing the Bitcoin price rallying 20% or 30% or 40% and CNBC freaking out about it. But at that point, we’re talking about late 2013, no one was really asking about crypto investing or whether there was even jobs in crypto.

Michael: And I was getting ready to leave JP Morgan to work for a hedge fund and I had the fortunate opportunity to meet the founder and CEO of my company, Barry Silbert, who at the time was running Second Market. And Barry had started investing in digital currencies and digital currency businesses as early as probably about 2011 or 2012. He and Tim Draper, I think, were two of the first angels out there getting involved in the space. And at the time, Barry had already started a Bitcoin trading business through out broker/dealer at Second Market which has since become Genesis. And had started our first investment product, the Bitcoin Investment Trust, in 2013. And when I had the opportunity to meet Barry, it was a really funny story. His assistant said, “Hey Michael, did you know you went to the same university as Barry?” And I said no I didn’t. This is literally as I was walking in the room to meet him. And he and I just hit it off and he said, “Michael, come help me build something. You can always go work for a hedge fund but I promise you, take a chance and you won’t regret it.” And about five, almost five years later, I haven’t looked back once.

Pomp: Awesome. That’s so interesting how the connection between a university experience … Was there anything that you guys specifically bonded over from the time at Emory?

Michael: I think just having gone through the same undergraduate business program. Barry’s background was one of also being a banker. He spent time at Houlihan Lokey after undergrad and I think having that Wall Street background and that mentality certainly helps when you’re starting to run a regulated business the way that we do.

Pomp: Absolutely. I’ve got this thing I say, long Bitcoin, short the bankers. Right? It’s like you did that with your career.

Michael: Absolutely. Absolutely.

Pomp: Okay, so let’s talk a little bit about Second Market. When you get there, what’s going on? What is the split inside the company between crypto focus versus non-crypto focus. Just walk us through some of those early days as you got there.

Michael: Sure. So there was already quite a bit of a bifurcation at Second Market and two competing cultures. You had one side of the company that was very much working on the private company market space. They were focusing on liquidity events for private companies like Facebook and LinkedIn and things like that historically and were also helping to do capital raises and tenders.

Michael: And then you had a whole other part of the human capital at Second Market that had gotten into crypto. Barry had given our trading desk the mandate to go figure out how to buy and sell Bitcoin. And the folks at Genesis were super innovative. They mapped out who the big stakeholders were globally. This is way before the days of there being sophisticated order management systems and APIs into different exchanges and different wallet solutions. So they had already beefed up their operation. And then, there was a few people that had worked on launching the Bitcoin Investment Trust which was our first digital currency investment product.

Michael: So there was a little bit of, I guess, differences in terms of mentality and excitement about things. And ultimately, Barry stepped down as the CEO of Second Market really to focus on the company’s digital currency initiatives. And as we transitioned further towards the end of 2015, it was actually really an opportune time because NASDAQ came knocking and said we really like this private company market platform that you’ve built at Second Market and NASDAQ ended up acquiring Second Market. And that caused half of our headcount to move over to NASDAQ. And the folks that remained were the ones that were working on our digital currency initiatives.

Pomp: Got it. And how much of the experience in that regulated market that NASDAQ eventually bought helped in the early days of crypto versus is actually more valuable now?

Michael: To NASDAQ or to us?

Pomp: To you guys.

Michael: I think it was tremendously helpful, right, because when you look at the legal frameworks, dealing with accredited investors, documentation, AML, KYC. Today we run as strictly regulated a business and stay as buttoned up as we possibly can. So it was an amazing prerequisite for all the things we do today.

Pomp: Absolutely. And internally, when Barry is saying look, we’ve got our core business. It’s driving great revenue but I want to figure out this digital currency thing. What is people’s reactions? Are there people who are … There’s people who want to run through the brick wall and then they love it. And then there’s people who are detractors or is everyone on board? What’s the split there?

Michael: So that conversation slightly predates my joining Second Market but to the best of my understanding, there were definitely some folks who thought Barry was crazy. And there were definitely some folks who said I’ve worked with Barry for a long time, he’s a visionary. He’s kind of that guy who can always see around corners. I think he went to the Second Market board and said hey, I want to take some of the company’s capital and start building up some businesses and building up headcount around these initiatives. And they said go for it. And when it started to demonstrate a track record of success and started building revenues, I think people were very quick to glom onto it.

Pomp: Absolutely. And so, obviously you sell the Second Market business to NASDAQ. And then, now what is today DCG, or Digital Currency Group. Explain the structure there and how that came about.

Michael: Sure. So when Second Market got sold to NASDAQ, about half of the company’s headcount remained. And it was time for us to undertake an exercise to rebrand and repackage who we were. And Barry decided to form a holding company called Digital Currency Group. And so, Digital Currency Group or DCG is a C-corp. We hope ultimately it will at some point have public market aspirations. And I think as we decided to go, or Barry decided to go rather, with a holding company structure, he started looking at business models like SoftBank and IAC and Berkshire-Hathaway where you had this great holding company. It has a great brand. But all those companies I just mentioned, they don’t really have a product or a service per se. What they do have instead is a balance sheet that lets them buy companies, incubate companies, invest in companies. And that’s really the model that DCG has taken.

Michael: And so, when we formed Digital Currency Group, Barry did a small capital raise to bring in some kind of corporate and strategic investors. And so, we’re fortunate to have as backers of DCG folks like MasterCard and Western Union and FoxCon and New York Life and TransAmerica. And really, a whole series of strategic corporate folks who clearly could see that the proliferation of the digital currency asset class was going to effect their business positively or negatively. And so, if they were a part of the DCG family, this would give them a front row seat.

Michael: And I would say today in terms of how we’ve evolved, DCG is broadly broken down into three different buckets of assets. So the first bucket would be DCG’s venture capital portfolio. This is not by any means a standalone fund. Rather the VC investments that DCG is making are off of the company’s balance sheet. And today, Barry and our venture team have now invested in 130, I think a little more than 130 actually, digital currency businesses in more than 30 countries around the world.

Michael: And so, that certainly makes DCG the most prolific VC investor in the digital currency ecosystem. And it doesn’t actually mean that we’re the largest check writers. But I do think, obviously a little bit subjective, but I do think it means we have one of the highest quality portfolios out there. We’re very fortunate to have gotten involved very early in companies like CoinBase and Ripple, BitPay, Zappo, and I think our criteria is certainly, we look very scrutinizing of the opportunities that come our way but we’re seed-stage investors primarily. So at that point when you’re investing, we’re really looking at entrepreneurs and we’re investing in people much more so than we are cash flowing businesses.

Michael: And I think that you’ll continue to see us ramping up our VC investments over time. And it’s been a really fantastic way for us to stay squarely at the center of the ecosystem. It’s very easy, I think, at our company for all of us to come into the office every day and tell each other oh yeah, this whole digital currency thing, it’s happening. Right amongst these four walls, we can all talk about it as much as we want. But when you have portfolio companies in Kenya and Sweden, in the Philippines, and Mexico, and pretty much every corner of the globe you can think of, it becomes very validating to see what kind of volumes they’re experiencing, what kind of user growth they’re experiencing, what kind of contracts they’re landing. That’s been a really, really helpful and validating source for the DCG family.

Michael: The second bucket of assets … So outside of our VC portfolio, it digital currency directly. So on the DCG balance sheet, we have a couple hundred million dollars of digital currency. And I would say that we are pretty long term and pretty patient investors. And the digital currency portfolio is broadly broken down into five different currencies that we have high conviction in. And those are Bitcoin, Etheorium Classic, Zcash, and then we are also newer and also big believers in two less known currencies. One is called Mona which is the native currency for the Decentraland Project. And then, a currency called Zen which is the native token to the Horizon Platform.

Michael: And then, the third bucket of assets are the subsidiary businesses that Digital Currency Group owns. So the first of those is called CoinDesk. I’m sure a lot of folks listening to this and Anthony, I’m sure you as well know CoinDesk quite well so you know, they’ve done a really great job of establishing a foothold on the reporting and realtime statistics on what’s happening in the digital currency ecosystem. And then, they’ve also launched this really fantastic events business called Consensus and they run events all over the world. And CoinDesk was an acquisition for DCG in, I think, it was 2016.

Michael: The other two businesses were the businesses that were incubated under Second Market. So our registered broker/dealer, Genesis, is our trading business. So Genesis Global Trading now has probably a foothold as the second or third largest OTC digital currency trading desk globally. And I think they certainly have a competitive advantage in that they’re an SEC and FINRA registered broker/dealer. And so, for a lot of counterparties, they look very favorably upon trading with a registered and regulated entity like them.

Michael: And then, the third business is the business that I run for us which is called Grayscale Investments. So Grayscale is a digital currency focused asset manager. Today we manage probably about $1.6-$1.7 billion across a family of nine investment products. And at Grayscale, I think we are laying the groundwork or have laid the groundwork, rather I should say, for hopefully becoming what will be the I-shares or the Vanguard or the Wisdom Tree of the digital currency ecosystem.

Michael: And when you take a step back and you look at Digital Currency Group, what Barry has really done in bringing together this VC portfolio, the operating subsidiaries, our digital currency holdings, he has created a center of gravity around Digital Currency Group. And I’m really excited to see what we build from here. But we seem to have our hand in a little bit of everything going on in the ecosystem which keeps us really engaged and really involved.

Pomp: Got it. And so, as you think about this, there’s the parent company of DCG. You’ve got CoinDesk, right? You’ve got the two trading or asset management businesses. How involved is Barry and the executive team at that parent company in the individual business units?

Michael: Quite a bit actually. So Barry is definitely involved strategically in all the businesses and spends time with each of the businesses. CoinDesk has its own CEO, a gentleman named Kevin Worth who is fantastic. Michael Moro who I think you’ve had on recently is the CEO of the Genesis business. And then, actually Barry also serves as the CEO of Grayscale Investments. So he does spend quite a bit of time with each of the businesses.

Pomp: Very cool. And how do you think about asset management, venture capital investing, and then obviously you guys own a media arm, right? And so, there’s, from what I understand, some separation between the media coverage and that asset management business. But you sit on the non-media side. What is your view of how those two interact?

Michael: So there’s a tremendous amount of separation. CoinDesk, the entire CoinDesk team, and their entire operations sit in entirely different offices from Digital Currency Group, Grayscale, and from Genesis. So they have arguably their own culture, their own way of operating. There is by no means any kind of overlap in terms of business initiatives or anything like that. Certainly Grayscale, Genesis, a lot of our portfolio companies love to give stories to CoinDesk or interact with them but we really always try and be sure that there is quite a bit of separation between the two. CoinDesk is really trying to be objective in reporting on the industry in a timely and compliant manner.

Pomp: Absolutely. No, no it’s fascinating. And then, for those people who have projects or companies that they’re building and are interested in potentially getting investment from DCG, what’s the best way for them to surface those opportunities?

Michael: So I think one of the best ways that we get deal flow or project flow is actually through our existing network of entrepreneurs. So I think that the entrepreneurs that are building companies, products, services, et cetera, in the digital currency ecosystem is a pretty tightly knit community. And it’s often our entrepreneurs that are referring other folks in. That’s usually one of the best ways that we get alerted to new projects taking place. And other than that, I think DCG does a pretty good job of either hosting events or networking or being at certain industry happenings. And that’s another way that I think people get in touch with us as well.

Pomp: Absolutely. So let’s go deeper on Grayscale itself, right? So why don’t you explain what you guys are doing today, what the different vehicles are, and we’ll go from there.

Michael: Sure. So I think at Grayscale, we definitely take the view that digital currency as an asset class has arrived and that it’s here to stay. And that investors want exposure to it. Digital currencies though have some unique properties. They require some intelligence and some experience with figuring out where to buy them, how to transfer them, how to store them, keep them safe, et cetera. And I think that for us, we mostly look at other products within the investment universe that are construed as access products. So things like gold and oil that today have ETFs and that have notes and all different kinds of structures that are familiar and easy to access but if they weren’t around, investors would have a hard time gaining exposure to gold or gaining exposure to oil.

Michael: And so, at Grayscale what we’ve done is we’ve taken digital currencies and we’ve packaged them into securities, into familiar, transparent investment structures so that investors can gain exposure to them. And today, we operate eight single currency vehicles and then, one diversified vehicle. And so, our single currency vehicles are for Bitcoin, Bitcoin Cash, Ethereum, Ethereum Classic, Litecoin, XRP, Zcash, and Zen. And so, each of those vehicles solely and passively holds a digital currency. So our Bitcoin vehicle, for example, just holds Bitcoin. There’s no cash, no leverage, no trading, no arbitrage, nothing at all.

Michael: And so, if you’re an investor and you want to gain exposure to Bitcoin but you don’t want to deal with figuring out where to buy it or how to transfer it or how to store it or you’re concerned about your private keys or getting hacked or not really having the technical know-how to do so. Then, you can buy shares of the Bitcoin Investment Trust. That is a really easy and familiar proposition. And same goes for any of our other vehicles. If you want exposure to Ethereum or to XRP or whatever it may be.

Pomp: These are public vehicles.

Michael: There’s actually two sides to how people get involved with us. So all nine products …

Michael: … [inaudible 00:18:00] to how people get involved with us. All nine products have daily subscriptions. They’re private placements. They’re open to accredited investors. They have a daily net asset value. Every single day [inaudible 00:18:13] to Grayscale, buying shares of the products at that daily NAV, and then they’re subject to a one-year holding period.

Michael: Now, each of our vehicles, when they get to their one-year anniversary from their inception date, we actually then transition them out into the public market so that there is a public quotation for the shares. Today, two of the nine vehicles have been around for greater than one. Those are the only two that have public quotation-

Pomp: That is Bitcoin?

Michael: That’s Bitcoin, which trades under the symbol GBTC, and then Ethereum Classic vehicle which trades under the symbol ETCG. And so, anybody who buys shares as an accredited investor buys them through us at NAV, holds them for a year, and then is able to sell those shares out into the public market on the other side of a year.

Michael: Now, if you’re not an accredited investor and you want to be involved in Grayscale, you’re welcome to buy shares out on the public market. There’s no holding periods. There’s no minimum investment size, etc., but there has historically been a premium in the shares publicly in GBTC and in ETCG. It’s important to watch the premium and just make sure that you understand what level it is you’re getting involved in the products at.

Pomp: And so, the thought process here is, if I invest in the private placement I’m buying at NAV, right, and then if I’m buying in the public market, you get this premium, and the premium’s been pretty high right at times. How do you think about that? Is that sustainable? Where do you guys see that premium? Is it a good thing? Is it bad thing?

Michael: Well, so, one, I have to disclaim that the premium is really driven by market demand, right?

Pomp: Of course.

Michael: We are not engaged in trading the shares in the public market. And so, there has historically been an imbalance there where there is quite a high supply of shares out on the market, particularly in GBTC. It’s been quoted since the middle of 2015, but there has been not enough shares to meet that demand. And so, there has been quite a bit of a premium.

Michael: I think today the premium’s probably somewhere around 25 or so percent above NAV. This is a really unique structure. When you look back at something like GLD, the gold ETF, when that got introduced in 2004, that was the first time that an investor could say, “I own Apple, and I own Microsoft, and I own stocks and bonds and all this stuff in my account, but now I want to add gold exposure right alongside all those other things that I own.”

Michael: Similarly, GBTC and now ETCG, those are accomplishing the exact … the same kind of offering that the SPDR gold did when it first got introduced. If you have a brokerage account, if you have an IRA, if you have a mutual fund, whatever it may be, and you want to add this type of exposure, well, then, something like GBTC is the only way that people can get exposure to it.

Pomp: Absolutely. No, it makes sense. And then, how do you think about these vehicles that you have out on the public markets? Everyone is hemming and hawing about the ETFs and ETNs and all these other publicly traded vehicle treasure retail products. Let’s just say that they’re going to happen at some point, right? I don’t know if it’s a month, a year or whatever it is, but at some point they happen. What do you think that impact is on your business? Is it everyone benefits from just more retail investors in the public markets wanting digital assets? Walk me through the thought process there.

Michael: Sure. Well, number one, I think it’s no secret. Grayscale spent a good portion of 2017 working with the SEC to try and register our Bitcoin investment trust, GBTC, as an ETF. Ultimately we decided to withdraw from that process and continue building assets and building out more products. And so, we’re certainly believers in the idea of having digital currency ETFs, but as you suggested, it could take some time until our regulators are comfortable with it.

Michael: I think from our standpoint, we definitely think that having ETFs out in the market for Bitcoin and other digital assets will be net positive. When you look at what happened to things like gold, right, going back to GLD, having a instrument like that out on the market for something like Bitcoin creates an entirely new use case that doesn’t exist today, and especially for a fixed supply asset like Bitcoin, that could be really, really impactful to its price. And so, I think that Grayscale, and certainly a lot of other folks in the industry, are doing what they can to help educate regulators. We spent a lot of time with the SEC and a lot of time with FINRA trying to keep them informed of what’s happening in the space. We support entities like Coin Center down in D.C., which are doing a great job of also conducting those types of meetings, writing thought pieces and helping to keep people informed, so-

Pomp: Niraj has incredible means on the Internet.

Michael: Yes, yes. Niraj is a … Let’s call him the Twitter master.

Pomp: All right. You guys are doing a bunch of work that basically supports the overall industry as well.

Michael: Absolutely.

Pomp: And then, how do you think about the future Grayscale, right? Today you’ve got the existing vehicles. Two are public; it sounds like nine that are in the private placement space. Will you continue to go after the long tail in terms of add more private placement, token specific? Will you go more into the indexing, right? I don’t know that we haven’t talked yet about the bucket that you have for diversified exposure. What’s the future look like?

Michael: Sure. Well, one, yeah, we talked briefly about the eight single currency products we have. The ninth product we have is our digital large cap fund, which we launched earlier this year. That product seeks to have as its holdings the assets which constitute the upper 70% of the digital currency market, and holds them on a market cap weighted basis. That’s a quasi-index product, if you will, that has a rules-based methodology.

Michael: I think that our product development team really has, I don’t know, I’d say maybe 15, 20 different product ideas running on our listing. I think it’s a little bit of a struggle for Grayscale, if I’m being honest. We struggle with what it is that we see as being value accretive and things that we want to structure products around and where we think investors should be deploying capital, balancing that with what our investors and what the community as a whole is telling us they want exposure to.

Michael: I think early on, if you look at the development of the existing product set, you know our first product was Bitcoin. Our second product was Ethereum Classic. Our third product was Zcash. These were all products and digital assets around which we had conviction, and we would develop really robust investment theses around each of them.

Michael: I think that earlier this year, or maybe even late last year, we started to take a little bit more of an agnostic view about the world and say, “Well, if you look at businesses like Wisdom Tree,” they have a product for Russia, for Japan, for China, for the Philippines, etc. If they didn’t have all of those different areas of the world represented, then there would be a whole in their lineup.

Michael: I think Grayscale similarly took a view that we had to open ourselves up and upon up products for Ethereum and Bitcoin Cash and XRP, etc. And so, on a go-forward basis, I think that our eyes and ears are open. We’re always looking at new protocols, always looking at new projects, and then certainly are very engaged with our investors to understand where they want to deploy capital as well.

Pomp: Got it. And so, as you guys are doing this, moving forward, your role is unique in that you do a lot of stuff internally, right? You do everything from help manage the team to strategy to product development, and then fundraising itself, right? And so, let’s talk a little bit about, how have you guys gone from zero assets under management to $1.6, $1.7 billion? That’s not, just roll out of bed and that happens, right? How did you get there?

Michael: How did we get here? I think we’re exhausted. I don’t know. I think that if I look at how we’ve raised assets over time, one, I think we have a super high-quality investor base. We are very fortunate to call folks that are CEOs of Fortune 100 companies, family offices, hedge funds, you name it, as investors. They have been exceedingly loyal to us and have done a really good job of introducing us to other folks and making referrals. That’s been a huge help. I think when I look back at the lifecycle of how we’ve raised assets, in the earliest days, 2013, 2014, we were spending a lot more time, certainly in the Silicon Valley, San Francisco area and in the New York area, really raising money from ultra, ultra high net worth individuals and CEOs of companies that wanted exposure to the space.

Michael: I think as you transitioned to 2015 and 2016, we started to spend a lot more time with the family office set. These were folks that were very agile, and when they had a conviction about something, they would just go with it. They have a pretty high risk tolerance as well.

Michael: Throughout the beginning of 2017 through today, I think we’re spending a lot more time raising assets from hedge funds. And so, our inflows, I think even just this year, have skewed to be a little bit more than 50% coming from institutions.

Michael: Just to unpack that a little bit further, when I say institutions, I’m not talking about digital currency hedge funds. I’m talking about your typical long/short equity fund. It’s everyone who has strategies around value to momentum to global macro. There really is no one type of investor that we’re dealing with. I’d say probably over the last three to, call it six months, we’re now starting to spend a little bit more time with the pensions and endowments, and that’s really, I think, Anthony, because the once taboo nature around investing in digital assets has really been shrugged off. Every investor wants to explore this. They know it’s not going away, and they have to figure out whether or not it makes sense for them to have exposure to this space; and if they’re not going to have exposure to this space, well, then, they need to be figuring out where else in the world they’re investing and how the proliferation of digital assets are affecting certain places that they already have capital deployed.

Pomp: Absolutely. No, it was fascinating. As you started to talk to these more institutional investors, where are they today? Are they interested? Are they learning? Are they, “Get out of my office?” What, where are they?

Michael: If we were having this conversation even, I’d say, 12 to 18 months ago, I would be telling you that I’d go to a given major city, meet with a multi-billion dollar hedge fund or an endowment or whatever it may be, and I was still spending 30 to 45 minutes doing Bitcoin 101 and 201. We were talking about the way mining works, the way that proof of stake works, things like that. Today those meetings have no part of the conversation going into those types of topics.

Michael: The investors are coming into the meetings having done their homework. These are folks that are looking at the plethora of resources out there on the Internet. People have written books, etc. There are so many great resources for people to get educated about digital assets. That’s been super validating, to be able to go to a meeting and have people be super informed, so that’s been a major change.

Michael: I think now, though, most investors are asking us for our opinions around how this asset class affects areas that they have exposure to. The truth is that it’s too early to tell. I think you’ll agree that there are some really interesting projects going in, and the space has a ton of momentum, but at the moment, is there any one killer use case that we have identified for Bitcoin or for really any digital asset? No, because it’s still so early. And so, I can’t tell you how many funds I’ve talked to that say, “We’ve been a decade-long investor in payment company X or in credit card company Y. What does Bitcoin do to our long theses?” I’ll say, “I don’t know, but I’ll bet your bottom dollar that payment company or credit card company is either deploying human capital into looking at blockchain technology or digital assets and/or has already made investments in digital currency-related businesses because they know that they have to pay attention to it.

Pomp: Absolutely. Do you think that these people are buying into the qualitative argument, right, of, “Bitcoin is a store of value, a medium of exchange. It could one day be the global reserve currency. It’s a hedge against inflation or economic chaos,” etc., or do you think they’re looking at it more from a quantitative standpoint in, “If I add 1% of my assets into digital assets, here’s the impact it could have on my portfolio?”

Michael: I think it’s a little bit different with each investor. The notion of Bitcoin being digital gold, a digital store of value, a gold 2.0, a superior form of gold, that narrative has certainly been sticking with investors as we talk to them. And so, we definitely are seeing some investors rotate some of their exposure to things like gold and other inflationary hedging assets into things like Bitcoin. There is no question that people get that. We have to be a little careful, though, sometimes because there are some people who are gold buys and really do believe in things like gold and other things that have been these time-tested areas to go to as a safe haven. That has certainly stuck.]

Michael: I think, though, if people are building diversified portfolios and are always looking for new areas to generate alpha, they cannot probably find other assets that have the same risk reward profile that something like Bitcoin or digital assets in general do. And so, when sized appropriately as part of a diversified portfolio, we’re definitely seeing investors putting on 10, 20, 30, all the way up to maybe 200 basis points of exposure because if digital assets like Bitcoin do some of the amazing things that we think they can do, well, then, that 10, 20, 30, up to 200 basis points actually becomes a really meaningful driver of returns. In the event that it doesn’t do that, well, it’s a small enough position that it’s not going to kill their performance, and it’s not going to be that material to their overall strategy.

Pomp: Absolutely. What’s the absolute worst reaction you’ve had in an investment meeting?

Michael: It’s been a while, but I’d probably say it was probably about two to three years ago when people were much more focused and the popular press wasn’t doing that good a job of explaining what Bitcoin and digital currencies were in general. We had this very heated argument around the anonymity of Bitcoin and the fact that it was being used for money laundering and drug trafficking and things of that nature, when in fact, and I know you certainly agree with this, that this is probably the worst mechanism possible for conducting anything at all nefarious, right? We are investors now in companies like Chainalysis and Elliptic, who are doing fantastic work on blockchain surveillance and monitoring. They’re working with law enforcement and government agencies. They love this, right, because they catch bad people doing bad things very, very easily. Bitcoin and digital currencies leave a “digital breadcrumb” on every single transaction. People are always able to be caught compared to the physical world when you cash. It’s quite hard to trace those types of transactions.

Pomp: Absolutely. How many of these people do you think that are investing aren’t yet ready to invest with the institutional capital that they oversee, but they’re personally invested? Are there situations where they’re saying, “Look, I actually personally believe, but from an institutional fiduciary standpoint, I’m not yet ready to deploy capital?”

Michael: Well, so the traders at a lot of shops have been involved for a while, right

Pomp: I can only imagine why.

Michael: Well, there’s a couple of actually pretty good reasons why that’s the case, right? Number one, these are typically folks whose personal trading activities are very closely monitored. They have all kinds of restricted lists that they have to adhere to, etc., but Bitcoin and digital currencies aren’t things that generally fell onto that list the way maybe Coca-Cola or some other public stock did.

Pomp: Yeah. Just so people understand, what you’re describing is if you’re a trader, and for a whole host of reasons your company may be involved or have information, etc., so you can’t trade certain securities for a set period of time. What you’re saying is basically these people want to go trade cryptocurrencies because those cryptocurrencies are almost never on the no trade list.

Michael: Exactly, exactly. And so, I’d say probably when we started talking to hedge funds, call it 18, 20 months ago, it wouldn’t be uncommon to start seeing some of the portfolio managers or head PMs, founders, etc., want to deploy some capital personally. They got the thesis. They have a high risk tolerance. Those are folks that have been doing so for a while. Again, because that taboo nature has been shrugged off, there is no reason that LP money is not being deployed into digital currency now.

Michael: The LPs are talking about it, asking for it, and it’s not crazy when the quarterly newsletter goes out to all the LPs, and the PM wrote that we’re now investing in digital currencies. In fact, I think a lot of LPs value the fact that these funds are now thinking about new and opportunistic-

Michael: …you. The fact that these funds are now thinking about new and opportunistic way to generate returns.

Pomp: For sure. What do you think in terms of … you and the Grayscale team manage a billion and a half plus dollars. How do you guys think about bitcoin as this economic hedge in the way that it could play out if there were some of these crisis or chaotic events that occur?

Michael: My colleague Matt Beck wrote a really great paper about this very topic. So if you go to the Grayscale website, greyscale.co, you can take a look at it on our insights page. We looked at a couple of global macro shocks. Things like Brexit, or Grexit or the Chinese devaluation of the Renminbi, and when you look at how traditional assets reacted in the wake of those types of shocks, bitcoin actually holds up quite a bit better. And so I think in our view, that’ll probably continue to be the case. We look at what’s going on globally and we’re amidst a currency crisis. We’re looking at places like Venezuela and Argentina and capital controls in China, etc. The promise of a decentralized, non government, non central bank backed currency is a very, very powerful thing.

Michael: When half the world’s adult population does not have access to financial services, the ability to store value or have your money in pretty much anything other than your local currency, that’s a pretty powerful concept. We think it’s actually almost even more powerful than the proliferation of the communication space and cell phones coming along. That was a big one and we think this is potentially even bigger. We think that this is the springboard to financial inclusion.

Pomp: Yeah. I mean look we talk a lot about this idea of beginning to trust math and software over humans. So if you think of all the central banks led currency, there’s humans making decisions, but really when you go to a transparency conversation … I tweeted the other day and I said “Bitcoin is more transparent than the federal reserve.”

Michael: It’s true.

Pomp: You understand how the system’s designed. You understand every single transaction from the beginning of time til today. You can go look at it. You understand what’s going on right now. You can actually look at the real time data. And then you know what is supposed to happen in the future.

Michael: Absolutely.

Pomp: Right. And I don’t know if you can say that about a lot of [inaudible 00:38:26] currencies.

Michael: Yeah. You won’t know how much is being printed or how much is being retracted or what inflation rates are going to be or what may happen the next time we have a economic crisis. So, it’s a powerful concept. There’s no question about it and we take the view that the genie’s out of the bottle. We’re excited to see more regulatory clarity come into the space. We’re excited to see more institutional capital flowing to the space and for a lot of our portfolio companies to continue building out. Everything from order management to custodial solutions to trading venues and different things that can support the under payings of this ecosystem. But again, the genie’s out of the bottle.

Pomp: Absolutely, no I completely agree. Alright, let’s go into some rapid fire questions and then at the end I’ll let you ask me some questions. Actually you only get to ask one, because we got a couple people who have tried to ask too many. What do you think, other than a DCG company, is the most important company in the crypto space?

Michael: Ooh, that’s a tough one. We’ve definitely, I think, been really good about being involved in some of the best and brightest entrepreneurs. One company that recently has come out, which DCG is not involved in, is look at [inaudible 00:39:46], which is the new future’s based exchange that ISIS is deploying. That’s important. The proliferation of future’s, on CME, CBOE, has been great. It’s brought a lot more folks into the space, given folks hedging instruments, etc. Really excited to see what [inaudible 00:40:06] is gonna do as well and how the market’s gonna receive that.

Pomp: Absolutely. No, I think that that is a very interesting one. Alright, what is your most controversial belief? What do you believe that you think the highest degree of other people would disagree with?

Michael: I don’t know if it’s as controversial as it once was, but I think when we meaningfully got behind the thorium classic, a lot of people thought that we were nuts.

Pomp: Alright, hold on. We gotta talk about this. So, let’s walk through the difference [inaudible 00:40:36] Ethereum and why you guys stuck with a Ethereum classic over a Ethereum.

Michael: Sure. So, we have long been believers in the idea of a Ethereum as a technology. Looking at a decentralized global computer that can give rise to smart contracts and all other kinds of really interesting digital applications. We thought that the Ethereum community, the developer community around it was really robust, really strong, but had a difficult time finding either companies to invest in or reasons to start buying the Ethereum currency, or the ether currency itself. And after the DOW and seeing the split between Ethereum and Ethereum classic, well very quickly in the Ethereum classic community, some of the developers instituted some really positive governance and economic principles into it that, for us, were pretty closely mimicking what had and what continues to make bitcoin pretty successful, and that was to cap the supply on Ethereum classic. To have a decentralized governance model where you now have different teams of developers working on the protocol and not necessarily coming to consensus around things and both challenging the status quo, which we though was super important.

Michael: And when you start looking at things like that, we said “Wow, well Ethereum classic is kind of being left for dead”, and I think a lot of people are overlooking some of these new and really novel attributes around it. And I think we probably started getting involved in Ethereum classic when it was probably sub a dollar. Maybe fifty cents. And I think a lot of people thought we were nuts. And when you look at how far that ecosystem has come along today, it didn’t die, it attracted a lot of developers, and that ecosystem is thriving. So, I think that today people think we’re a little less nuts than maybe we once were, but again that was pretty controversial when we staked ourselves around ETC.

Pomp: I think that the counter argument that people would have, so all the people on Twitter who are gonna listen to this and go nuts, what they, I think, would say … “Yes, but if you compare it to what has happened with Ethereum, when you compare it to all the developer activity and the attention that what is now known as Ethereum has gotten, did you make a mistake?”

Michael: Well, I would say that Ethereum classic is certainly the David to the Ethereum Goliath. There’s certainly been more developer work or more corporates throwing money at Ethereum, or perhaps more resources being thrown on ethereum, but I think what people often overlook is that ethereum and ethereum classic are the same technology. And ethereum classic trades for, I don’t know, 1/20 or 1/25 the price of ethereum. And so, if you have the belief in ethereum as a technology, generally, then maybe there’s no harm in owning both ethereum and ethereum classic. So, certainly too early to say if one will win or what not, but I also think that ethereum over the last year has also really been utilized and it’s price depreciation has most been associated with ICOs, which has not really been a use case or any kind of utility around ethereum classic. It’s kind of stayed away from that.

Pomp: Yeah, and I think that also we’re still pretty early. So to your point, anything can happen. This is crypto, literally anything can happen.

Michael: For sure.

Pomp: Okay. So, let’s say you’ve got a magic wand. You can wave it and change any one regulation in the United States. What regulation do you think should be changed?

Michael: That is a difficult one. I don’t know.

Pomp: Or improved. It doesn’t even have to be changed necessarily, just improved.

Michael: Improved… um

Pomp: Something that you guys deal with on a daily basis or maybe it’s even just the ETF of application process.

Michael: No. I mean I gotta hand it to our regulators. I mean I think some people may end up throwing some shade at me for this, but I think by and large they’ve done a pretty good job so far. I mean you and I spend 24/7 in this ecosystem and you and I can barely keep up with it, so it’s hard to expect regulators that have a score of other asset classes and instruments that they have to be looking at and regulating, that they’re keeping up with this. So, I think the fact that in the five years I’ve been in the space that we’ve gotten clarity from the IRS on taxation, we’ve seen statements on the SCC around bitcoin and ethereum and we’ve had some of the bit license and some of the other things that have come through. I think we’ve actually made quite a bit of progress in the space, and I think it’s good to see them starting to crack down on some ICOs and some of these other illegal asset raising schemes. So, more of that to come, but I don’t think there’s much that I would change.

Pomp: Got it. Okay, that’s fascinating. Alright, so let’s talk about aliens real quick. So, we’re just gonna settle on aliens exist somewhere in the world and do you think they have pets?

Michael: Do aliens have pets.

Pomp: Every time you think of an alien, it is in a human like comparison. There’s aliens that are human like, but we never talk about the animals. Are there alien animals? Alien pets?

Michael: I mean if you think that the dog is mans best friend, then one maybe has to assume that there’s something else that’s aliens best friend. So, why not.

Pomp: I always imagine them getting off of the space ship and they’re got their dogs and all their different pets and stuff and they’re just coming to hang out with us.

Pomp: Alright, so you can ask me any one question. What do you got?

Michael: Okay, so what is the protocol or the application that gets you most excited about what’s taking place in this ecosystem right now?

Pomp: Yeah. So, it’s a boring answer. It’s bitcoin.

Michael: Okay.

Pomp: But, for probably a different reason. So, I think everyone knows, very bullish on the economic argument around a censorship resistant deflationary economic model. So, I think that’s table stakes at this point.

Michael: Well and a tangential question is, has the 2018 bare market made you more of a bitcoin Maximalist?

Pomp: Okay, so I’ll answer that one in a second. I think the reason why I’m probably most excited about bitcoin is I think we get very attracted to innovation and this thought process that we need to test new things and try new things, etc. I think bitcoin is the core value [inaudible 00:47:30] is the security of the network. So if you draw a spectrum on the far left side you have security, on the far right side you have innovation. Bitcoin is, I guess, far to the left as you can get because it prioritizes that security. And I think what we’ve seen is more and more people push the envelope going to the right of the spectrum, and they’re trying to innovate and do all these things, and bitcoin is actually in a position of power. They can allow people to do that with different projects, different chains, etc. and they’re picking the things that work, that are valuable, that people seem to adopt, and then they can incorporate it into the bitcoin chain.

Pomp: And so I think that it’s one of these things where … there’s a quote that I really like, it’s “Be the first, be the best, or be forgotten.” And I think, not only with bitcoin first, but I think it’s the best, in terms of today. And so if you can be the first and the best, it’s a really powerful position to be in. Now, in terms of this bear market, I think regardless of market cycles everyone has to go through this cycle of “Okay, I found out about bitcoin, bitcoin’s awesome, I love bitcoin”, and then they go through the innovation cycles. What else can you do? “Oh, there’s this ICOs thing, that’s interesting. Oh, there’s this other thing”, and you keep going through all of these different application of a block chain. The enterprise block chain, [inaudible 00:48:44] securities, literally all the way around. And you come back and you realize the strength of the bitcoin network is the security and all of those things are possible, where obviously people are showing that they’re possible, but if they can be built on a highly secured chain then you get the best of both worlds.

Pomp: And so, I think that …

Michael: But don’t you hate when people are like “Is bitcoin the Myspace to the eventual Facebook, and what am I missing here?”

Pomp: Yeah. So, two things. I hear this all the time. “How many companies were the first in the space that ended up existing?” There’s two components that are really important to this. So, the first being that bitcoin’s not a company. It’s not like somebody else is just gonna come along and built a company with a better business model. Actually a couple things. So, the second thing is the network effect. Bitcoin has the strongest network effect and network effect is a very hard mote to defeat.

Michael: Totally. People overlook the switching cost. If everyone’s about to say “Oh, there’s this other thing coming along”, well look at how much has been built and invested in bitcoin and what the cost would be to switch from bitcoin to what that other thing was. And they overlook the open source nature of bitcoin.

Pomp: Absolutely. And this is an important … the fact that you bring up Myspace and Facebook is really important because one of the things that people forget about Myspace is Myspace did not have the newsfeed like applications that Facebook had. So, really what Myspace was, was a database. I could come and I could look at your profile and I could do all the stuff, and so it was a very loose definition of a network, but Facebook actually locked people in the network. You could go to the newsfeed and then you could see all this content and there’s one central location and people weren’t tied in. And so it’s not good enough to just have adoption and have all of the different nodes, you have to lock the nodes in. And that’s what Facebook did a fantastic job of doing that. They also had real identity, a bunch of reasons why they won.

Pomp: I think what bitcoin did was, through the incentive mechanism, the block reward, the proof of work, all these different aspects, they locked people in the network. And so when they do that it’s really, really painful for people to leave. And then also, every new entrant is more likely to join the longest standing chain with the greatest network lock in. And so I think that’s what we’re seeing. The bear market, I think, definitely helps people go toward bitcoin and gravitate that way. But one thing that I’m really interested to see if how many new entrant go to bitcoin versus a different digital asset during a time of economic crisis.

Pomp: So, if the thought process around bitcoin is, it is a hedge. It is some sort of safe have asset, etc., well a lot of people talk about bitcoin specifically, but there’s a whole host of digital assets now. There’s 1900, 2000, whatever it is. If all of a sudden we have a huge recession in the united states again, there’s higher inflation, all of the ingredients to a bad situation, to people run to bitcoin. Do they run to bitcoin and ethereum? Bitcoin ethereum, ethereum classic?

Pomp: Or maybe they go to some completely different asset that’s not bitcoin.

Michael: It’s a good question. I mean I think that’s one of the reasons why we’ve seen so many index like products being launched. It’s one of the reasons Grayscale launched the digital large cap fund. We started hearing from a lot of folks “I think I missed bitcoin”, or “I think I missed ethereum”, or “I wanna put money to work in the space, but I don’t think I know enough to pick winner and avoid losers.” And so, this idea of getting broad market exposure actually kinda makes a lot of sense. That’s why there’s things like the SPY ETF, and you get exposure to the s&p 500 companies. And so we’ve had a lot of success there, as have a lot of other businesses launching index like products. And maybe those are good things. Maybe those give people the diversification benefits within digital currency as well as having the digital currency exposure on within the context of a diversified portfolio.

Pomp: Absolutely, no I think it makes complete sense and I mean look, I love the fact that you started your career out in banking. And so it’s long bitcoin, short the bankers.

Michael: Sure. I’ll take that one. I like that one.

Pomp: Alright man, thanks so much for coming, this was super fun. I really appreciate it.

Michael: Of course, thanks for having me.


You can find the recording here: Off The Chain Podcast: Anthony Pompliano and Michael Sonnenshein

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