Preliminary notes:

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Upgrading capital markets for digital asset trading

Brian Kelly - Moderator

Juthica Chou, LedgerX

Bobby Lee, BTCC

Michael More, Genesis

Barry Silbert, Digital Currency Group

Please welcome Brian Kelly, Juthica Chou, Bobby Lee, Michael More, and Barry Silbert.

BK: Alright. Welcome everyone to the upgrading capital markets panel. You have the introductions of who these people are. Just one thing before we start, does anyone want to announce they are Satoshi? Well, what I want to focus on is that we have some of the premiere people in the bitcoin industry interms of the financial asset side of it. I would like to dig into what the trends are and where they think this could all go. I would start with the one question which I want to know. We have seen ethereum kind of to me showed us there might be room for more than one digital currency out there. Are we seeing the birth of a new asset class for investors and wall street to trade?

JC: I think it's fundamentally a new asset class. We get asked a lot by regulators and financial institutions. Is bitcoin a technology? Payment? Currency? It has elements of all of those. None of those are sufficient to distinguish or describe it.

BK: Bobby?

BL: I think it's a digital asset class. Before that, we had virtual assets like virtual points. For the first time now, we have a truly digital asset class that people all around the world can hold in paper wallets or digital wallets. It's something new for regulators to get around. I flew in from Shanghai yesterday and they asked me to declare currencies that I was holding. But they didn't ask about bitcoin. That's something interesting to settle later. Did I move it when I went into the country?

Michael: For a long time I was trying to figure out if within a few years, is it a commodity and try to figure out, to Juthica's point, which one it trades like. As it goes on, it trades like itself. It will have quality of other investments. The unique characteristics as a digital currency lends itself to be its own digital asset class. Bobby touched on this for regulators; I think investors are going to come around too and they wont be able to paint it as jus ta commodity.

BS: Do you disagree? I think there's a more fundamental change happening. Evolution, revolution, call it what you will-- the digitization of money. It's interesting. In our office, all the 30 year old and youngers, they don't carry cash around anymore. It blows my mind. I can't see the audience, but please put your hand up if you don't carry cash around. I think you are all crazy, but it's also the future. We are excited about digital currency. Not only is this a new asset class, separate but distinct commodities and fiat currencies, I think we're going to see a trillion dollars move into this asset class over the next decade. It won't just be into bitcoin and ethereum foundation, but also central banks are getting involved. Within the next few years, those efforts will be launched and we will see, who knows what a trillion dollars will be worth in a few years, but hopefully we will see this flowing into XRB and Bitcoin as well.

BK: Where do you see this trillion dollars coming from? Is it institutional investors getting into bitcoin? Will it be central banks creating digital currencies?

BS: I think it will be central banks creating money. This will validate the idea that their money can take a digital form. Money has been rocks, salts, pelts, arguably gold but I don't think so much. During this transition to digital money, central banks are trying to figur eout right now how to stimulate their economies and eliminating banks from the money creation process and giving it out to the citizens directly might be in our future.

BK: Let me go to Bobby on this. You run one of the largest exchanges. Do you think we're looking at essentially a new form of currency market where we don't trade fiat but we don't trade digital dollars?

BL: In some sense, trading bitcoin is already like forex trading. Very few banks are acknowledging it. Bitcoin exchange is not considered a forex exchange. But it trades just like forex. When some currencies appreciate or depreciate sharply, like RMB's depreciation, and the bitcoin price was relative to RMB for a while. So people who were hedged against RMB by buying bitcoin were winning. So it's already trading like that.

BK: If it's trading like a fiat currency, then at what point, and I am asking everyone, at what point does bitcoin disrupt both? Does it disrupt both? Juthica?

JC: I think in the theoretical sense, bitcoin is probably strictly superior to gold which is used as a store of value. It's used for rainy days when people want a currency where the supply is not controlled by a single central bank. Gold is not good for transactions, not easy to divide, not easy to authenticate, not easy to transport over large geographic areas. Bitcoin is strictly superior in that regard. The bitcoin supply is fixed, like in a rainy day people can fall back on that. It also offers utility in a way that gold doesn't. I think the typical argument is that gold you can melt down and turn into jewelrery, but in rpactice the IMF and sovereign institutions are not holding gold to melt down into jewlery, but to hold it for the raining day....

BK: If it's superior to gold, then it should be more valuable to gold.

JC: In a practical sense, bitcoin's utility is always going to be constrained by its market cap.

BK: If there's a trillion dollars coming in, then the market cap will rise.

BS: On the IMF point, the $7 trillion of gold held in the world today, and a large percentage is held by central banks and IMF and it is their rainy day fund, it's how they are going ot support their currencies. When push comes to shove, the IMF and central banks are going to sell the gold before they sell their airports or air force. As soon as gold stops functioning like that, I think that $7 trillion is going to look a whole lot different.

BL: Even $1 trillion is small compared to $7 trillion in gold. Just like gold, bitcoin does not rust. It does not tarnish. We all use UPS or FedEx, but what if I told you that I would give you unlimited supply for any gold you keep at DHL express? You could send gold for free everywhere in the world forever, that's what bitcoin is. It's much lower transaction free. Anywhere in the world for the rest of eternity.

BK: It sounds like you would agree that bitcoin could be more valuable than gold?

BL: Yes, it is more valuable. It took 7 years for Bitcoin to reach $7 billion so maybe another few years to reach $1 trillion.

BK: So Michael, are your customers thinking of it as gold or a new asset class or are they speculating?

M: I think bitcoin does not have the track record of gold. I think gold has been around a much longer time. I think the people of the world have a much better understanding of gold. As an investment thesis, certainly, I think the counteprarties on the buy side, I think they believe that it should at least be a significant percent of the global market and a part of the long term plan to go beyond the gold market. I think all of this will play itself out, it just hasn't been enough time yet.

BS: I think there's an important demographic shift, which is that, there's $30 trillion of wealth that is going ot be handed down from the boomers to generation X and millineals. $30 trillion. I am turning 40 years in 2 weeks. I don't know anyone my age or younger who is excited about gold. Nobody owns it, nobody is figuring out ways to buy it. I think there's two reasons for this. Reason number one is that we did not grow up in a period of time where the US dollar was backed by gold. We don't have it engrained in our head that gold has mythical value properties. We have that problem. Plus we did not grow up into a period of time where we have to move money over night to feed our families. When we look at this-- I don't know how old everyone is, but this is the future of investment allocation decision making. I think it's likely that not only is that $7 trillion of gold at risk, but also that $30 trillion that is going to move into our hands over the next 20 years. Some of it is going to find its way into bitcoin. I do believe it's going to flow into it.

BK: I agree with you on that. This is the future of finance. Whether it's the concept of having a stock certificate, I think that's antiquated and so far from the new wave of investment coming in, that they are much more interested in bitcoin and trust bitcoin much more than the traditional legacy infrastructure. My question is, is there a place for something beyond bitcoin as gold? Can we have a digital asset itself? Even more than digital commodities like oil, could we have a digital let's say Google versus Apple stock certificate?

BL: I think so. I think that bitcoin can bring this. Today, bitcoin is the first real example of a digital asset class based on blockchain. It's a bearer instrument. If you lose your private key, you lose it. Nobody can redeem that for you. As you transition to digital property management, like stocks or real estate, we have to think about the notion of what happens when someone loses hte private keys. If I own title to the house in the form of private keys, and my hard drive gets trashed and I had no backups, well the house is still there. So the county has to have the right to reissue the title to myself or someone else. Do I really have the title if someone can reissue it at will? These are the issues you have to go over. Bitcoin is like, if you lose it, sorry. You hear stories about people tossing hard drives or finding old hard drives... well it's like the ocean, if you drop gold in the ocean there it goes, you might find it 100 years later. It's complex.

BK: That's probably the biggest issue right now. I think all of us early on is that we had bitcoin locked on the computer or something, maybe I am not the only guy in the room to lose bitcoin. Alright, so, I talked to Michael a little bit about the type of investors he's seeing buying spot. Juthica, you are in options business. You were talking with the CFTC about viewing this as an asset class, versus how you view it or who you expect your customers to be. Traditional options would be long only buyers, your long only mutual funds, versus your ... what's the.. is there a contrast? is the CFTC on the same page?

JC: I can't speak for the CFTC. They did assert jurisdiction over bitcoin as a commodity in September 2015 under the Commodity Exchange Act. There's many similarities to other products they regulat.e The similarities are not just in the properties of bitcoin but also the companies and ecosystem developing around it. One of the topics we have spoken with the CFTC about is that there are real companies providing services to merchants and consumers, performing real economic function and they face bitcoin volatility risk on the natural long side or natural short side, which is not dissimilar to other commodities like gold or oil. For our participants, it overlaps with what Michael is seeing about putting money into it, it's not correlated to the rest of the portfolio, it's a binary outcome play. The hedging part is interesting I think, it shows that it's a fundamentally new asset class, bringing in fundamentally new trading participants, like bitcoin businesses that need to hedge risk. On the options trading side, it's mostly the traders recognizing the opportunity.

BK: iIf anyone wants to create the next digital asset, with a million coin stake or something. What would they need to do? Do they need an ecosystem behind it? There are 700 digital currencies out there. Do we really need an ecosystem around each particular asset?

JC: I think that first, depending on what the asset is I am with Bobby Lee, I think it's early for assets tied to the physical world. I don't see how those transfers in the physical world would be authenticated. The bitcoin blockchain would have to authenticate it. As far as cryptocurrencies, from the perspective of LedgerX it's who controls it, what's the susceptibility to manipulation and the viability to the currency in that regard.

BK: That brings me back to Barry. You said that central banks are creating some digital currencies. Bitcoin was created as an anti-central bank type of thing. Why would central bank digital currency be accepted? And would central banks really want to do that if they can't control the money supply?

BS: This is going to be very important. A decentralized currency like bitcoin already has a monetary policy set in stone. Central banks aren't going to cap the supply. They aren't going to allow for the movement of that currency in a decentralized non-regulated way. I look at it in terms of, governments are going to look for ways to stimulate their economies. They are looking for ways to get money into the right hands. There has been criticism of the Fed in terms of navigating the 2008 crisis. The government is going to ultimately own the ledger and decide how the money gets distributed. There's this idea called helicopter money which people laughed about, and then they laughed about negative interest rate and well we have a large amount of sovereign debt trading at a negative rate. I think central banks will do it, I don't think it's better than bitcoin, but I do think it has utility and it will attract speculators and investors. It wont come out of other asset classes, I think it will be from one currency to another.

BK: We might be trading fedex coins?

BS: Sure.

BK: So if I trade fedex coins, that's where we're headed?

BL: You're thinking about it as a coin, right?

BK: The governments, ultimately if they want to give their citizens money, they can create fedex coin.

BL: About two months ago, the Central Bank of China talked about issuing digital currency for RMB. People have asked about this. It comes back to what Barry Silbert said. Are they limited or not? The central bank decides whether it's limited. What's the point from the central bank's perspective if it's limited currency? If they have control of the currency, it's not decentralized, it's not limited, then it doesn't look any different from the current RMB or digital RMB in bank accounts today. I'm still skeptical of whether central banks are going to get this right for a sovereign cryptocurrency.

BS: I think the central banks are going to do it. It will have to be fungible with other forms of fiat currency. Who maintains the ledger? With negative interest rates, the idea is that they are trying to get banks to get their customers to invest money and spend money and to borrow money. And it's just not working right now. So the only thing that is left is giving out money to people they want to see invest money and spend money, and they can't do that through the current banks. Enabling citizens to do their tax return in the form of a digital US dollar that the government issues through a wallet, I think that has an appeal.

BK: So it's helicopter money?

BS: It enables helicopter money.

BL: Will it be different from our credit card statements?

BS: It will have to be fungible. They won't limit the supply. It will look a lot different to bitcoin.

BL: Some people are worried about losing private keys. Can they go to a bank and claim the money back? Is there recourse on the digital currency?

BS: I think there will be tons of monitoring and government surveillance. This is only going to enhance the government's ability to see what people are doing.

BK: Bobby, question for you about recourse. Is that essential to a digital asset working?

BL: It's an essential question to ask. People often don't think about these complex questions regarding recourse. If it's decentralized, how do you do recourse? I think the answer is, it could go either way. You have to think through the system design. Is it a beast, is it a unicorn or just a fuzzy animal?

BK: I want to leave some time for questions too. We have a blank screen. Did nobody ask questions? Oh here we go. Alright.

BK: Here's a great one. What's the future of digital autonomous organizations? DAOs. I think this is great because, if this is a new asset class, if we have a DAO that issues its own currency, what's the future of business?

JC: I am not the right person for this.

BS: I am incredibly excited about the enthusiasm from the ethereum community. I am excited for them. But, I sense that there's a certain utopian view of society within that community. I just don't see it from a real world application perspective happening any time soon. No regulation, no lawyers, no contracts, no SEC rules, no CFTC rules, it may solve some problems but... the idea of a DAO is interesting, but my biggest concern and I guess where I am skeptical about ethereum smart contracts is that they are focused on gambling, ponzi schemes and apps. That's okay because that's an interesting way to experiment... but I don't think the world needs a decentralized Uber, which is one of the ethereum projects. I don't think the world needs decentralized airbnb. These DAOs are raising money from the masses, it's a blank check, a pool of capital that will be deployed in some voted way, I am skeptical because I don't know how in the capital formation process what's wrong with the current system? Philsophically I hope they are successful, but I don't know what problem it is solving.

BK: So you mentioned PBOC is watching....

BL: I don't think DAOs are going to happen in China.

BK: Here's a next question. What's ytour vision of decentralized markets for energy, manufacturing, logistics, and I would add, getting into supply chain? That seems like one of the holy grails for bitcoin to be part of the supply chain. Michael, do you have thoughts on how other let's call it energy, the enregy markets might evolve? We do a lot of fixed income, how would the fixed income markets evolve if they were based on bitcoin?

Michael: we don't trade most liquid fixed income bonds. We are on the really illiquid some of the products created that led up to the 2007-2008 assets crisis that are still destressed today. We agreed to buy bonds from a broker, the sell side broker couldn't find the bonds. It was in their database but they ewnt to their custodian and their custodian couldn't find it. The asset class is illiquid so you can't really do a like buying of a similar, it's not like buying apple stock, someone thought they had it then went out to the open market, well that doesn't work because there's a limited number of bonds. So we had to make our counterparty angry, so I think if fixed income bonds are on the blockchain, the possibility of not being able to locate it wont exist. So we would be able to do due diligence before executing the transaction. Just asset location is hugely important. Being able to get a handle on who holds what, I think it's a huge thing.

BL: If they lose the private key?

Michael: True but there's still a problem about finding them.

BL: There's also a problem about not being able to find bitcoin. Satoshi's 1 million BTC is there, but you can't find the private keys.

BS: Yeah that might require someone to arbitrate to recover that, probably with multisig. I think we will see incredible innovation in the capital markets as a result of bitcoin. I don't think it's DAOs. I think we're going to have a world in the not too distant future where you will have real-time accounting. You will know expenses real-time. This will create new securities and new ways to invest in businesses, like hybrid equity, revenue shares, creation of securities, real-time auditing, those securitieis will be able to be sold globally to anyone over the world with a bitcoin wallet that can participate in bond or securities issuances. It's going to trade, it will be sold, it will be cleared and settled through LedgerX, and it will be instantaneous. That's the future of finance. But it doesn't have to be done in a decentralized way.

BK: So the bitcoin protocol allows the creation of those assets?

BS: It enables the creation of a new type of security where you don't have to pay E&Y to provide auditing. You will know real-time auditing.

BK: Give me an example. Is this a new type of stock? Will I be able to buy a piece of a capital structure of a company?

BS: Hybrid equity debt, or revenue share, it just hasn't been done because you often don't trust a private company to recognize revenue. But if we moved to a world where the entire ledger is moved into the blockchain in a private way, with payments and expenses recorded, you could trust that what is being presented is accurate.

BK: Michael, if Barry is correct about this, sounds like you will be busy. Is this going to be a growth area for you?

Michael: If Barry's world comes true, we are all going to be busy. We will eventually move to a world where you're not waiting for quarterly financial statements. You get real-time feedback on company financial health, to get the most up to date information to make your investments.

BK: This seems like the most logical useful case.

Michael: This might take 30 years, but that's the future. Might not happen tomorrow.

BK: Hopefully I will be retired by then. But this is going to change the entire capital market, isn't it? It could change the structure of how a market functions today. We have one more question submitted, this one is for Juthica because you have been, you have spent time with the CFTC, do you expect non-financial blockchain markets to attract regulator scrutiny? When you are talking ot regulators, do you think the next step is to look at non-financial?

JC: I think that some of these things will pop up, as soon as a problem occurs it will attract regulators. The regulators want to protect consumers. If there's a house where the key is lost, or even a dispute, things like that will bring them into the space to protect people. I think non-financial assets on the blockchain, there will be cases where someone has to oversee it, which introduces a centralized party whether it's a regulator or an institution overseen by a regulator.

BK: Does anyone have a view where a blockchain application starts to become a financial application? I don't know the answer. I'm asking the experts.

BS: Any application that involves the use of a token, a decentralized token intended to represent some value, whether it's money value or asset value, is where I would draw the line.

BK: Okay. As soon as something trades and has value, it becomes a financial use case.

BS: Regulators are worried about fraud, they are worried about defaults, regulators don't care about a scribe recording ownership of digital content to the blockchain. But if you are holding customer funds, well...

BL: Your question is a billion dollar question. Countries are trying to get grips on how to properly regulate bitcoin and blockchain and digital currencies. If we had answers, then the word would be further along.

BK: I think we have time for at least one more. I am going ot go to Michael for fixed income. How can blockchain decentralize the existing lending markets? I guess the question in terms of, if Barry's world comes true, how is blockchain going to change the fixed income, and a lot of people are talking about mortgage bonds which might be one of the first places for the blockchain to be used.

Michael: I think in some ways, blockchain lending is almost a corollary of peer-to-peer lending. You get to the point where, if you get to a world where you have access to where the borrower income statement is on the blockchain and you get their W2s and so on, and you try to assess from a credit perspective to get comfortable with who is the borrower that you are lending money to? I think that's interesting. To Barry's point, at the corporate level, if you have these financial statements on the blockchain, I think the lending institutions- you can go directly to these companies. I think the banks, the underwriters can be cut out and someone can process this because we know the right companies to invest ultimately are.

BK: So it could reduce cost of capital then?

Michael: Yes.

BS: If you eliminate... and inaccessibility, and if you have access to foreign currencies, well you level the playing field for borrowing or lending. I doubt that anyone here knows what it costs to borrow money in Brazil or Kenya or China, but I would imagine you could know the return here in the United States. So if you have a platform to underwrite risk in these markets, historically you wouldn't have done this because you wouldn't have access to those currencies but now you can have access, whether that's bitcoin or through btcjam, and it's empowering for the borrower and it's great for a world like here in the U.S. where you are getting 0.05% on your savings account.

BK: That's maybe 10 years away?

BS: Nope, it's happening right now. We invested in btcjam. They are enabling the borrowing and lending of money cross-border by using bitcoin as the underlying currency. You can now borrow or lend cross-border without worrying about how to get the fiat currency. That is a, it's an early time for that business, but it's opened my eyes to the potential especially as I look at other platforms, there's essentially no lending market-- people want to borrow money but they are paying 40%. I don't know if that's the right number, but I assume it's not, I assume that by eliminating borders around currency, if it's 25% they would be more happy. I would love to get 25% return on my money.

BK: I think we have run most of our time. I want to thank the panelists. Great discussion. I think people can chew on all of these points. Thank you.