The Inquisitive VC: Colleen Sullivan — CMT Digital

Colleen Sullivan is a Partner and CEO of CMT Digital. CMT Digital is a part of CMT Group, focused on crypto asset trading, blockchain technology investments, and legal/policy engagement in the crypto asset/blockchain technology industry. Prior to this Colleen worked as a lawyer and also founded her own startup in the fintech space.

We talk about her journey from law to crypto, the Chicago Defi Alliance, her thoughts on ETFs and institutional participation in crypto, Horizon Blockchain Games, and more!

NA: Hey Colleen, thanks so much for joining me. To start off with can you talk about your background and journey, you move from law to investment management to crypto?

CS: Great, yeah. I figured I’d give you the full background here. I started working at a brokerage firm called First Options, I was on the floor of the Chicago Board Options Exchange when I was a teenager. I spent every summer there from that time until I graduated from Law school. I worked in all kinds of different capacities. Like I was a runner on the floor, I was a clerk in the IBM pit, you name it I did it.

In my last summer there when I was in law school, I worked in their legal department. Basically through that work, I knew I wanted to be a lawyer in the derivatives space, but before I became a lawyer I became a founder. So, I had met a lot of traders obviously over the summers and decided to co-found a company with two of them called iOptions. From my time working on the floor I started to see that high net worth executives with employee stock options would hedge them on an over-the-counter basis with big investment banks like Goldman and Citi. They would then lay off that risk on the floor where I was working.

My co-founders and I thought that it made sense to go to non-high net worth employees and bring them directly to the listed options markets, so they could have access to those same hedging and monetisation strategies as the high net worth executives but on a more transparent and efficient basis.

We ended up raising some venture capital for the business and that’s actually how I met the CMT Group. The two founders Scott Casto and Jan-Dirk Lueders invested in that startup twenty years ago. The tricky part was, in order to make iOptions work we needed the Securities and Exchange Commission (SEC) to approve a rule change, that would let people with employee stock options use them as good collateral in these listed options hedging transactions.

We had great support. We had the New York Stock Exchange, the Chicago Board Options Exchange, the International Securities Exchange, which was later acquired by NASDAQ, they all supported the rule change. We went to meet with the SEC in 2000 to propose and it took the SEC nine years to approve it. So, basically that delay killed our startup.

It taught me a lot about building a business in an area of regulatory uncertainty. During that time I was waiting on the SEC I ended up joining Sidley Austin as a lawyer in their investment products and derivatives group. I stayed with them for four years until I decided to start a family and then I joined the CMT Group as a lawyer, became a partner there in 2013, which is the same year I started to become obsessed with Bitcoin.

So I had read the whitepaper and I was actually fascinated by the potential for this autonomous technology to potentially democratise money. I was very curious how regulators and our legal frameworks would work within that. My goal with iOptions was to democratise financial services, you know to bring these hedging strategies to non-high net worth people and similarly when I looked at Bitcoin thinking this could just open up a new financial system potentially.

At the time, my first act as a CMT partner was to suggest to the two founders that the firm invests in Bitcoin. CMT at this point is a 23-year-old proprietary trading and investment firm, had always traded in regulated products and regulated markets and of course in 2013 Bitcoin didn’t look anything like that. It had some reputational issues.

They encouraged me to get involved in the legal and regulatory side to really understand how this asset was going to be treated before they wanted to invest. So that how CMT Digital started. In a weird way, we started on the legal and regulatory side. That is how I got here.

NA: That is quite the journey. I really like the idea of your first startup, it seems very interesting. So you talked about how CMT Digital was formed. Once you did get the founders of CMT to sign up to the idea of investing in Bitcoin and formed CMT Digital, what was the initial thesis and how has it evolved since then?

CS: Yeah, so a little bit of background on the CMT Group. We’ve traded in the traditional equities and commodities markets all over the world. So the United States, Europe, South America, Asia, and I would say one thing CMT has always done, they are definitely innovators and adopters of nascent technologies. So, we actually started in Europe instead of the United States intentionally because we wanted to be trading in the electronic markets and not on the floor.

I guess the point is, CMT as a firm tends to run at change instead of fearing it. From that early legal work that then led to a pretty significant investment in Bitcoin. From there, we decided to launch a trading desk, which exists to this day.

We trade on a proprietary basis globally on crypto spot and derivatives exchanges. Then through the trading and the legal work, we started to just notice there were a lot of gaps in infrastructure that are going to need to be filled in order for this space to grow.

By that time, this is now the fall of 2017, we were big believers, that this was the most significant opportunity we would see in our lifetimes. We all really believed that, and I thought if we believed that then we should start investing in the space, not just trading. That is when we started our venture investing.

Fast forward to where we are today, what we have added on since that time is CMT Digital Labs, which we started in January of 2019. The purpose of that was really to test products and services in the space. As you know, stuff is changing daily if not by the second. We felt like we needed an intentional initiative to make sure that we were staying on top of things. That is what we launched the Chicago DeFi Alliance out of, just recently here.

NA: Glad you mentioned it, could you talk a bit more about the Chicago DeFi Alliance and what you are trying to achieve with it?

CS: So Jump, DV, CMT we were all sort of noticing the same things. First, we all believe in DeFi very much and think that there is a place for it in financial services. It is only going to grow, we are convinced of that.

As we were looking to either trade on the platforms, or potentially invest in them we were kind of running up against the same things. Many of the platforms, they are built by technologists who don’t necessarily have traditional trading, market structure, or financial regulatory backgrounds. So, we were seeing some gaps there where we thought we can mentor some of these projects and get involved early in the process. Maybe we can help just inform the build of the projects, where they are built in a way that firms like ours can go in and provide liquidity and also think through the regulatory aspects.

We will be announcing our first cohort in the next week or so, but we had over 75 companies apply. We were pretty surprised about how much interest there was in the program, so we are selecting six and it will be a six-week program. We are really going to focus on the trading side, attracting liquidity, automated market makers versus manual market makers, and then we are going to go into what are the things you need to think about from a legal, regulatory, accounting, tax standpoint. To help the group think through some of the issues they are going to face as they scale.

NA: Sounds like a very valuable program, I’ll be looking forward to the announcement. I saw on your website that you are invested in four funds. How do you evaluate fund managers and come to a decision to invest in a fund?

CS: Yeah, it’s an interesting question. So, we do have the four fund investments and they are actually with just two managers, Pantera and Polychain. We are invested in two Pantera funds and two Polychain funds. When we started investing in 2017, we were investing on a proprietary basis really with no thought of managing third-party capital.

We then had friends and family asking if they could co-invest with us and that then led to us starting a formal venture fund structure in the fall of 2018. The purpose of the venture fund was really to invest directly and not in other fund managers, but in order to avoid conflicts of interest, we wanted to move all of our venture investments plus those investments in Pantera and Polychain into the venture fund. So we actually ended up moving nine investments over, they were sort of warehoused until the third party vehicle was ready.

We have a significant amount of respect for Dan Morehead and Olaf Carlson. The work they have done in this space is just fantastic and we have co-invested with them on a number of deals. We haven’t invested with any third party funds since then and I think to answer your question in order for us to do that again, there would have to be a pretty compelling reason for that. Like, if the manager was seeing differentiated and attractive deal flow that we wouldn’t see ourselves. That would definitely be a reason, or there is some other strategic relationship that we would like to have with the manager.

NA: If I’m not wrong, when Olaf started Polychain, I think that was his first fund with no previous experience in the VC space, what satisfied you about Olaf and the fund that helped you make the investment?

CS: Yeah, you are so right. You know you can contrast Dan with Olaf, they are very different. Dan had been a macro hedge fund manager, tonnes of experience in traditional finance and Olaf, he started at Coinbase, and you’re right, I think it was in 2016 he launched his fund.

We met with Olaf when he still had his office in an apartment, which was kind of funny. We were pretty much just blown away at how he thought this space was going to evolve and the potential that he saw for it. It is just really remarkable to me the way that from that early meeting with him to where he is today, he has just executed on that vision.

Like with Polychain Labs and the remarkable work they do there supporting their portfolio companies, through being active stakers and validators. I view him as the cutting edge of this space, he sees projects really early, and if he has an idea and there is not a team out there doing that, he will find the team and they will implement the idea and Polychian will invest in it.

He just has a very unique perspective on this space. So you’re right, we are like this old-time firm and Polychian was new, but we are pretty big believers that you invest in people and Olaf just had the vision from day one and we really believed in him. Its been a good investment for us, we really appreciate his work in the space.

NA: That’s amazing, it’s great to hear how you were convinced to invest. There is always talk about institutional participation in crypto, when do you think we will see institutional capital begin to move into the space in a meaningful way or do you think we are already starting to see it?

CS: I think my answer would have been slightly different a week ago, but May 7th was a really big day for crypto. That is when Paul Tudor Jones (PTJ), the seventh highest-earning hedge fund manager of all time issued his market outlook, where he made the case for the allocation of a portion of his funds’ assets in Bitcoin through Bitcoin Futures as a hedge against inflation.

He also did an interview on CNBC where he said that he has between 1–2% of his personal assets in Bitcoin also. I think that is a really strong signal that institutional investors will pay attention to. He is a fiduciary for his fund and he clearly determined that Bitcoin Futures are suitable for third party investors to have exposure to from both a risk and regulatory standpoint.

I do think its interesting to note, for the fund at least based on what he wrote, the fund is not investing in spot Bitcoin, the fund is investing in Bitcoin Futures to get its exposure. My guess is that those Bitcoin Futures are not on BitMEX, they are going to be on the Chicago Mercantile Exchange, where they are cash-settled. So that takes away the custody issue.

We are doing much better with custody, but I do think we need to see further infrastructure build-out, again for institutions to really come in. Fidelity is certainly helping with that. For the most part, I think what we’ve seen in terms of institutional involvement, at least on the trading side, its mostly proprietary trading firms. I think the reason you see more prop trading firms versus funds trading right now crypto is because we can take that risk, it’s our own capital. So again, that’s kind of why this PTJ thing is such a big deal.

I do think we are going to need better infrastructure, it’s starting to evolve you know Bakkt, Fidelity, Square. I also think just practically we have a bit of a chicken and the egg problem, where on the trading side in order for larger institutions to come in the markets need to be bigger. You know right now the markets are just too small, they are too small for big institutions to really deploy their capital and their strategies. I think right now we are at an overall US$250B market cap, that’s like one fifth the size of Apple.

So, we need the growth there. That said, I’ve been doing a lot of thinking about the PTJ thing, and what we have been talking about internally is, well we are not technically in a recession yet, considering unemployment in the United States is at its worst since the Great Depression in 1933, we think that’s probably where we’re headed. Bitcoin is only 11 and half years old, it wasn’t alive during the Great Recession, from December ’07 till June ’09, so at that time investors didn’t have the option to shift any portion of their assets to an alternative, to a 24/7, 365, global digital asset financial system.

Another significant difference is the usage of social media today versus ’08. You have got three and a half billion people, 45% of the world’s population active on social media. We are also in a situation, you and I started off talking about it was only imaginable in a science fiction novel three months ago, where now we’ve got a third of the population of the world in some kind of lockdown.

You look at all those factors and I think that today we’ve got more information being more widely visible and transparently shared, and while sheltering in place people have more downtime to digest that information. Which should mean that people are more informed today then they would have been in ‘08.

So when you see one of Wall Streets most revered investors like PTJ, determined to take that information and shift a portion of his personal and business wealth into a new digital financial system, that was not available during any other downturn, I think it means investing in the infrastructure necessary to support this new financial system has probably never been more important.

Innovation gains traction in tough times and I think right now we are literally witnessing a new financial and monetary system being built right in front of us, which is just extraordinary. I think all of that makes the space hard for institutional investors to ignore for much longer, but it’s so hard to tell.

NA: You mentioned how we need to work a bit more on infrastructure, is there anything specific you are thinking about or it’s still mostly custody solutions?

CS: Yeah, it’s interesting. So for us, we look at custody in two ways. On the proprietory trading side, from a technology standpoint, we are pretty comfortable self-custodying. Custody has not been a major issue for us on the trading side.

On the venture fund side, if decided that we wanted to invest in tokens outside of Bitcoin and Ethereum, which are commodities in the United States, everything else by default is a security. Because we are regulated by the SEC we would need to hold those assets with a qualified custodian, and right now the regulatory status of Coinbase Custody, Fidelity Custody, I think you make a case that they fit that definition of a qualified custodian.

But say that you are investing in a new deal and it’s nascent, Fidelity is not going to be ready, Fidelity only custodys Bitcoin. There is a good chance that Coinbase isn’t ready for that asset either. So, there is an impediment there from a pure regulatory standpoint. By law, I have to have this qualified custodian and they may not custody this asset. So, there’s definitely some friction there. On the trading side, where we feel we really need better infrastructure is with prime services.

So, when we trade on the traditional side, we go through one or two prime brokers and those prime brokers they have our assets, they look at the trading we do across various exchanges, and they look at that trading on a net basis. Then they will loan us, we will get margin financing to trade based on the net position.

In crypto its nothing like that. So, we have to self-finance every single exchange that we trade on. Which is like a completely inefficient use of coin and capital, because there are no prime brokers. First, it’s very inefficient from a capital standpoint, second, it introduces tremendous counterparty risk into trading.

On the traditional side again, my counter-party risk is going to be to like Goldman on the crypto side my counterparty risk is going to HitBTC, Binance, BitMEX, it’s going to be to each of these various counterparties, and each of these counterparties or exchanges have different rules. Some have socialised losses, some don’t, some have insurance, some don’t, some you can’t even find the management team, some are WebSockets, some are rust APIs, it’s a free for all.

So, when I think about infrastructure I also think about things like prime services, and by no means at all am I an advocate for cutting and pasting traditional finance and slapping it on to crypto. I don’t think that makes sense at all, but I do think that some of these concepts need to be implemented in crypto in a crypto native way. Certainly, there are better ways to do things with smart contracts, and escrow and crypto I think can continue to stay more transparent and more efficient.

These kinds of structures need to be implemented just to make the use of capital and trading more efficient. That is something else I think that these traditional institutional investors will be looking for as they want to interact with that space. Sorry, that was quite a long answer.

NA: Not a problem, it was quite insightful. So, to just dig into that a bit more, there are a lot of parties trying to get a Bitcoin ETF launched, what are your thoughts on an ETF and how far it is?

CS: In terms of how far off I think it is, its a tough thing to say but I think it’s accurate, I don’t think we will see an ETF approved by the SEC until there is a new change in the Chairman. I think under Chairman Clayton it’s just unlikely that we would see that approved. If he leaves around the election, depending on who the new leader perhaps we will have more of a chance getting that approved.

If he stays through his term, which I believe goes through mid-next year, it will be delayed even more. I think that’s just practically where we are. In terms of an ETF being available for retail investors, I think it will be an obviously good thing. Retail investors will be able to access that through their regular TD Ameritrade or Etrade accounts, it just takes away some of that friction of needing to onboard at Coinbase, acquire spot Bitcoin and investors are familiar with ETFs. They understand what that structure is and how they work, and it should help with additional adoption.

NA: Yes, I agree I think it will definitely help with adoption. What is the latest publicly announced investment you have made and why?

CS: Our most recent investment is in a company called Horizon Blockchain Games. They are a blockchain infrastructure company that obviously focuses on gaming. Initialized Capital, Alexis Ohanian’s firm, they invested in the prior round and they led this round.

We have been looking for an investment in the crypto gaming space for a long time. I have got three teenagers we are all pretty avid gamers from Fortnite, to GTA to Pokemon Go, and its always kind of bugged me that we spend money in a game, whether it’s for like skins or we’re earning shiny Pokemon or whatever. With my son, he will get tired with one game and he wants to shift over to another, but then it’s not like he can move his assets of the platform and convert to fiat, or they are interoperable within the game that he decided he wants to play, they just die on that platform.

Obviously we think blockchain technology can really solve a lot of these problems, by allowing gamers to own their assets in their digital wallet and be able to monetize them.

So, when we got the beta for Horizon’s flagship game called Skyweaver, it was the night before we spoke with the team and I really didn’t expect much of it. I gave it to my 13-year-old son, “Why don’t you just test it and see what you think.” Five hours later he’s still playing and he’s like you have to try it.

We ended up talking with the team the next day and it was icing in the cake. They are just a phenomenal team of devs and gamers. They are based in Toronto, we love them and they are moving into open beta this summer. They have a very vibrant discord and twitch, its a great game, we love it.

NA: I did see that CMT invested when they announced the raise in March. I have also signed up to it earlier, so I am looking forward to it as well. I had a great time chatting Colleen, thanks for taking the time out to talk.

CA: Thank you, I really appreciate the opportunity. As you can see I love talking about this stuff so very grateful!

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