Client Spotlight: Arca
This month, we had a talk with Jeff Dorman, Chief Investment Officer of Arca, an asset management firm with a number of products that target the crypto space.
We chat about his experience and how he views crypto investing. But more importantly, he emphasizes that there is much more to the digital asset space than what you hear in the news about Bitcoin, Ethereum, and Dogecoin.
If you didn’t know that already, you’ll certainly see what a big world digital assets really is after this interview. Enjoy!
MM: As so many people in crypto do, you have a long-running traditional finance background, with Lehman Brothers, Merrill Lynch, and Citadel. But you also have experience in fintech with Harvest Exchange. How do you take experiences from both of those fields into crypto? How did it lead you to bitcoin, or digital assets in general, and how does it influence the way you view the digital asset market?
JD: I left the hedge fund world in 2014, and went to work for Harvest Exchange. Harvest Exchange was a fintech company that was building services for financial institutions. I left because I just no longer thought my traditional fundamental analysis skills mattered in the traditional debt and equity markets, because all we were doing was waiting every six weeks to see what the Fed said. And it was either “risk-on” or “risk-off.” It was really kind of a boring market, post-2012. So, I left and went into the fintech world.
It was then that I started to get a little less myopic in my kind of debt and equity investing style. It really opened my eyes to how much more there was out there. And on top of it, because we were a tech company, we had 10 full-stack developers that were all using GitHub every day and raving about open source code, and a lot of them were mining for Bitcoin or Ethereum. So, I started to have more of an appreciation for where we were headed from a technology standpoint.
In 2016, I made my first investment. It definitely resonated with me more from a macro-financial lens than it did from a technology lens. Just this idea of inflation protection and sound money, but I never thought much of Bitcoin other than just a passive holding.
When I met Rayne Steinberg and Phil Liu, co-founders of Arca, that was the first time that I recognized that there was more to this space than just Bitcoin. There were other people with a finance background, who actually understood how tokens could reshape capital formation and customer bootstrapping, and how different versions of digital assets could exist. That’s sort of how I view the digital asset world, which is, Bitcoin proved the concept of a blockchain-based digital asset. And now there’s gonna be all these different versions. That’s what’s most exciting to me — that this is now a full-fledged asset class with different sectors and different value drivers.
MM: How do traditional valuations methods translate into the crypto world, which may be valued differently?
JD: It’s not that different! I think the only difference is Bitcoin and Dogecoin are known by 90% of the world, even though they actually represent very little with regard to what is happening in the digital asset space. Bitcoin can’t be valued. Dogecoin can’t be valued. Those are true cryptocurrencies. They are worth something relative to something else, and that’s it.
Every other digital asset is effectively just a company combining loyalty rewards with quasi-equity. It’d be the equivalent of if Amazon Prime and Amazon shares were the same thing. You get the benefit of Amazon Prime, but you also get the equity benefits of being a shareholder. That’s effectively what every other digital asset is. It’s some form of hybrid equity and rewards program. It can be valued; you can use traditional cash flow analysis for the revenues, you can look at dividend yield models for the yields that are being spit out here. It’s not functionally that different from traditional debt and equity.
What’s the biggest difference? Graham and Dodd, in the equity world, their valuation techniques came out in the 1920s or 1930s. Frank Fabozzi’s Fixed Income Bible came out in the 60s or 70s. All of those were new concepts when they came out. But now, because everyone has agreed upon those frameworks, it’s become commonplace. Where we are in digital assets is that we’re making slight tweaks to some of these valuation models, and they just isn’t an agreed-upon consensus in terms of what’s right.
That means there’s actual alpha. There’s no real alpha in debt and equity markets anymore because everyone’s using the same techniques. There is alpha in this market because you’re layering on these traditional cash flow analyses, with new analyses. You’re introducing new variations, but it’s built upon the same fundamental framework that we’ve used forever.
MM: That’s interesting, this idea of financial value plus benefits rewards. How does [the benefits rewards aspect] affect your valuation when you invest?
JD: It basically comes down to confidence in your analysis. And again, if you were an equity analyst, you would confidently put together a DCF framework or some other comp model. And if somebody saw your inputs, they might disagree with your inputs, but based on your inputs, they would agree with your outputs, because it’s the same analysis that 10,000 people are doing.
Here, even if somebody knows all the inputs we put into our model, they might disagree with our output, they might disagree with how we’re valuing the supply sink, or how we’re valuing the velocity of the tokens, or how we’re thinking about what percentage of tokens are going to be locked up. Even little things like in defi, there’s basically a senior-sub relationship. Instead of a specific senior bond and a specific subordinated bond that had different covenants and different yields and different claims in terms of a waterfall structure, now you have one token. But, it can be utilized in either a senior or sub fashion.
The interesting dynamic there is it’s still just the same token. If you decide that you want to stake it, but I don’t, it’s the same token. You are just going to get more value out of it than I will for performing a service, right? So these different dynamics create different valuation techniques that just haven’t become mainstream. It’s not that they’re wrong, they’re just new. And it takes time for consensus to build upon these different frameworks.
MM: So, Bitcoin and Doge are obviously the “mainstream” coins that everyone hears about, but there’s so much more to the digital asset market. How do you feel like that might have misled or confused people who are looking at these as the face of digital assets? What are some things that people should know more about?
JD: Yeah, it’s incredibly misleading! I think Bitcoin is a great asset, but it’s an incredibly boring asset that doesn’t do a whole lot. And I think two years ago, almost everybody who would call us about our funds would say, “tell me about these other Bitcoins.” They just assumed everything was a version of Bitcoin.
You’re not getting any attention from these other assets that are providing a lot more return, a lot more value, or are a lot easier to understand. And it’s starting to seep through; we have phone calls now with clients who, instead of asking about the “different bitcoins,” now go immediately to defi and sports and gaming, and quite frankly, they understand it. You can talk about bitcoin for ten hours with someone, and they might smile and nod a little bit, but they don’t really understand it just like I don’t really understand. There’s a lot of nuances.
But when you talk about a cash flow producing defi protocol or a gaming token, they get it right away. Because it’s a real business, with a real CEO, a real cash flow, a real yield, and they understand it more. So, it’s not shocking to me at all that you’re seeing investors come directly into different assets for the first time.
MM: So, if these other elements of the digital asset market were more well known to institutional investors, crypto could get more flow. Would you agree with that? If so, what would be one of the first steps to get those other aspects in front of the right people?
JD: Yeah, 100%. If you’re going to say Bitcoin is digital gold…how many people actually care about gold?
I think these other tokens will start to get more traction when a few things happen. One is the educational process, you have to have more and more companies talking about it. I mean, look at Robinhood. I think they said they have 12 million crypto customers. And they make almost half of their revenue on it. But they only list seven tokens, imagine if they listed all the tokens.
So first, we need a lot of regulatory clarity to allow the exchanges and the broker-dealers to actually be able to offer these. Two is, you need investment bankers to actually start pitching this. You need investment bankers who are willing to pitch tokens in a company’s capital structure. Then you also need workflows to improve. We have huge funds that are talking to us that are always like, “well, we don’t need you, we’ll just go do it ourselves.” And then a year later, they come back and say, “we tried, we couldn’t figure it out.” There’s a huge operational and workflow lift that comes with investing in digital assets.
So what are they doing? They’re going to inferior products that are passive, high-fee vehicles because they don’t have a choice. Or they’re setting up SMAs with funds like us to get their exposure. Well, that’s not going to last forever. Eventually, they’re going to figure out the infrastructure and the workflows, and they’re going to be buying and purchasing these tokens themselves. All of those things have to fall in place: you have to get the regulatory clarity, the investment bankers, and the fund workflows to kind of come together at the same time. And when that happens, this is going to be the biggest asset class on the planet.
MM: What are some of the other things that you think are on the rise? I know, you guys invest on a thematic basis, so what are some themes that you’re excited about?
JD: Yeah, everything we do at Arca starts with a top-down theme. And then we look bottom up for the individual companies, projects, tokens that will help us express their pain. So, we were still a big believer in the idea of digital money. We think that Bitcoin, over time, will eventually do well as the only legit cryptocurrency and then we also think there’s gonna be massive growth in stablecoins.
We’re still really big in NFT’s and gaming, we think this is the most natural use case for digital assets. And then I think beyond maybe the next six months, I think there’s going to be a real big rise in governance; we actually put out a white paper recently called “GSC, not ESG.” So instead of focusing on Bitcoin’s destruction of the environment and the big “E,” why aren’t people talking about the “S” which is how socially coordinated all of these digital assets are, and how they really help with wealth inequality by allowing early stage users and regular retail investors to benefit instead of just the venture firms. And the “G,” the governance aspect. Digital assets were built for governance, this idea of global coordination, and decentralization. We think anything ESG related is going to be a big driver of digital assets going forward, once people really understand how these different types of assets work.
From a governance standpoint, we also think there’s gonna be a huge push from traditional funds and investors into passive income and yield-based services. Arca coincidentally, or maybe not so coincidentally, just launched the Arca Digital Assets Yield Fund, which is an actively managed fund, helping investors get access to the 10 and 15% yields that exist in this market that are impossible to get in the traditional markets right now. So, we think you’ll continue to see growth in structured products, and staking and yield-based instruments.
MM: Right, so you have the digital yield fund. What are some other ways that Arca is trying to implement these themes or take these themes into account? What are some exciting things you are looking to do in the future?
JD: So at its core, what Arca is trying to do is offer different products for different investors–who have different risk-reward profiles and different return goals–to get access to this asset class. So part of our business is taking this new digital asset ecosystem and wrapping it to offer traditional products. So that’s where our Arca Labs side comes in. We have the first-ever BTF, or blockchain transferred fund, called ArCoin. The shares trade has blockchain transfer funds that are peer to peer. So these are debt funds, these are equity funds, they could be commodity funds, the shares actually trade as peer to peer blockchain instruments.
On the other side, we are taking traditional structures, like hedge funds and venture capital structures, and we’re actually investing in digital assets. So that’s where our actively managed hedge funds come in. We have the Digital Assets Fund, which is a long-biased research based fund, we have the new digital yield fund, we have a private venture fund that’s launching. So we’re offering different types of vehicles for different types of investors, depending on what they’re looking for. Ultimately, we’re looking to be the PIMCO of digital assets, where you know, as PIMCO, is synonymous with fixed income, Arca is synonymous with digital assets, but we have tons of different products for different types of investors.
MM: Nice. To wrap up, what is any last advice that you would have for potential investors or people who are looking to get into the space that might be a little bit hesitant?
JD: I think everybody should dip their toes in, in some way, shape, or form, because you learn a lot more when you have skin in the game than you do when you’re just passively observing. So whether that’s a $10 Bitcoin purchase or an investment into a fund, you definitely need to get some exposure to this space, so you can start learning.
Beyond that, I would say, everyone just needs to have a pretty open mind. It’s very hard to change preconceived notions and preconceived workflows, which is why some of this space is so foreign to new investors. They’re trying to fit it into a box that they already invest out of. Once you open your mind a little bit and realize that for every Dogecoin out there–that has no real rhyme or reason as to why it’s working–there are 20 other real companies and projects that do have a real reason. They’re growing because of real revenues, or real cash flows or real user growth, etc. So once you peel back the onion a little bit and get deeper into what this asset class really is, you would be really hard-pressed for anyone to dismiss the growth and the long-term viability of this asset class.
