Blockchain Speculators Powering A ‘Quiet Revolution’

Does that mean we’re in a cryptocurrency bubble?

“Great bubbles occur around stories that are going to happen,” said Mike Novogratz, a former hedge fund manager at Fortress Investment Group and now a private investor in cryptocurrencies, speaking with Dominic Chu of CNBC at CB Insights’ Future of Fintech conference. “There’s a quiet revolution happening; it’s not the front of the TV, it’s the back of the TV.”

There are still plenty of questions within this space, though, especially regarding token launches and the market capitalization of decentralized applications, several of which have raised upwards of $100M.

Since a token’s value rises or falls depending on demand for the network, tokens incentivize powerful network effects where the users of the network are also its owners. Such a paradigm shift has given investors pause when determining which investment bucket to place this new type of asset into. “These things are not currencies,” Novogratz said. “They’re either digital equities, or commodities […] with immediate liquidity.”

And, while token launches allow for more money to enter the space and further blockchain development, Novogratz acknowledged that the funding mechanism might raise more questions than answers. “There’s a monster risk,” Novogratz acknowledged.

Still, top technologists and venture capitalists in the sector point out that speculation leads to innovation, and have implored regulatory bodies to act cautiously when writing regulations around this nascent space. “The fact that people are making money in the space means they’re digging in and learning about it,” said Novogratz. “There’s real intellectual heft and capital going into the building of this new system, [and] I’m excited.”

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Transcript

Dom: I’m very happy and honored to be sitting next to Mike Novogratz, who is probably one of the…I’m trying to think the best way to say this. Probably one of the most talented and visionary people on Wall Street. I’m not just saying that to butter you up. You’ve had a very storied career on Wall Street, most recently at Fortress, and now, kind of on your own doing a lot of very interesting things, namely with regard to the cryptocurrency space. So for all of you guys who did kind of catch the last part of our program here, we use that as a way to kind of tee up our next conversation right now with Mike Novogratz because he is a man who has got a lot of investing expertise and has now chosen…I saw, for the record, Mike, that you had 10% of your net worth in crypto. Is it fair to say that that 10% mark is still accurate for your involvement in cryptocurrencies?

Mike: You know, I made that comment about two months ago at a Harvard Business School seminar. And at that point, Ether was trading at about $60 and Bitcoin was about $1400. And so when Ether went up to $400 and Bitcoin went up to $2,800, $2,900, you know, my net worth grew. And to be honest, I’ve sold a bunch. I think the market had a spectacular run and, you know, trees don’t grow to the sky. And so I probably still have roughly 10% of my net worth in crypto.

Dom: But it’s been scaled back.

Mike: But it’s been scaled way back. I own a lot less coins, they’re just worth more. And, you know, I’m still positively constructive on this space overall. Listen, you know, Ethereum started the year at $8 and went on to $400. I look at these things less in the price and more in market cap, and I think one of the things that helped us make a lot of money and stay in them as long as we could, was looking at market cap and…

Dom: But how do you look at market cap? I mean, first of all, this space, the only…I mean, there’s tons of crypto…the list of cryptocurrencies out there and their market caps, is not like a Bible, but it’s pretty long. There’s a lot of them out there. We talk about Bitcoin because it’s the biggest, and Ether because it’s the second biggest. How do you compare…when you say that you used market cap as a gauge, for kind of understanding the size of market, and when to kind of get in or out, how did you benchmark that? Because there aren’t that many comparables, I guess, in that space?

Mike: Well, I think the right way to do this is…what makes it tricky is people call them currencies. These things are absolutely not currencies.

Dom: They’re definitely not currencies, right?

Mike: Right. They are either…you should think of them as, either, digital equities or quite frankly the digital commodities.

Dom: Commodities, yeah.

Mike: I was thinking digital equity because I was thinking, how does this translate in the VC space? You know, people get really, really wealthy in the VC space, because you put $500,000 or $200,000 into it around at a $3 million dollar valuation, or $8 million valuation, and it becomes Uber, and it’s worth $60 billion, and, “Oh my goodness, I’ve made a fortune.” Well, most of those people don’t have a chance of liquidity the whole way. So they just…you know, I remember when Peter Thiel who famously invested $500,000 in Facebook. He sold it as soon as the IPO came out, when there was liquidity. If he had held it, it’d have gone up a lot higher. It’s really hard to hold something that you have liquidity in.

Dom: Because it doesn’t come that often or because it came at one point that after such a long stretch of not having it?

Mike: Well, you’re forced, like your parents got wealthy because they bought a house. They couldn’t sell their house because they needed somewhere to live, and the house went from $40,000 to $400,000. If they had bought stock they wouldn’t have the courage to hold it the whole way. And so what’s been hard about the digital currency space is, these are really VC investments. But they’ve given you the chance to sell at 12. You know, you bought it 1, and it’s a 12. “I made 12 times my money I should sell some.” Or at 15, or at 20, or at 50, or at 100.

And so I know the Ethereum community very well. You’d be shocked at how many of the programmers, the guys that built Ethereum sold out all their Ether, because we got 1, and now it’s a 30. But by looking at it as a VC investor, not that I was such a great VC investor, I was a macro guy but I was putting a VC hat on, and saying, “All right, these are system change companies. You know, Ether is a platform company.” Uber had a $70 billion valuation. You know, Google had a $800 billion valuation, it’s kind of yardsticks.

Could Ether be Google? Yeah. In 15 or 20 years it could, if it really…the Blockchain revolution really happens, but not in three years. So you’re not going to that level right away. Could it get to Uber? Yeah, but it got pretty close at $45 billion and it’s not proven out yet. You know, and there’s competitors. Just like Uber might not keep its valuation. And so it’s a much easier bet at $3 billion dollars than it is at $40 billion. And so you should have less of a bet, is the way I’m thinking about it.

Dom: You’re a macro guy by trade. I mean, you’ve taken different views on bigger picture themes that develop here. As we talk about the price action and things like Bitcoin and Ether and other cryptos out there, how much of it is you putting on that macro hat and checking out the fundamental environment that these things operate in, the competitors in the space, the motes if they have any or the lack thereof. Or is it very much more about price action than it is anything else?

Mike: I think you have to understand the story. And what I think is so interesting about this Blockchain story is that it’s happening. We will use Blockchain more in two years than we use it today. We will use it more in six years than we’re using today. It will be prevalent. Most giant databases will be switched to some form of a Blockchain database. Every company, every industry has a lot of data. And so the Blockchain revolution is happening, like it or not. Bubbles, great bubbles happen around stories that are gonna happen. The Internet bubble in 1999 happened because you could sit down with anybody and explain what the Internet was gonna do to the world.

Listen, it did a lot more by 2017 than we ever dreamed it would in 1999. But price went way ahead because it was such a story that you could get your hands around. Blockchain is gonna be very similar. And what’s even more unique is, because you can access it through your cell phone or through your computer, you’ve got Korea and Taiwan and Japan and India, and China. And not just the wealthiest people in those places participating, but everybody in those places participating. So I sense that this Blockchain, Bitcoin, Ethereum, ICO revolution is gonna be the single greatest bubble of our lifetime.

Dom: That’s a big call for a guy who’s got 10% of his net worth in crypto.

Mike: And, you know, is it gonna be straight one-directional? No. It’s not. I think we might have put the highs in for the year in Ethereum, and you’re gonna slowly consolidate. I don’t know what the price would be, $150 to $250, as the technology continues to get built out, as applications continue to happen. And then you’ll take another run up. But I don’t think we’re even close to the end of this. Remember the Nasdaq capped out. I think it was around a four and a half or five trillion dollar market cap in 1999. The total market cap of all the digital currency space, when you throw it together, we’re maybe at $200 billion, you know, if you throw the value of the company in there as well. And so we’re still small.

Dom: So the cliché is you use the baseball analogy. So what inning is it then in crypto, second inning?

Mike: Third inning, the third inning. Well, listen, if you buy Ether at $400 and it goes to $200, I don’t care what inning you think it is, it feels really shitty.

Dom: Yeah, it does feel really shitty, yeah.

Mike: And so you’ve gotta be pretty careful when you enter, you know, these things. There are a ton of ICOs out there right now. I think there’s been $500 million raised since the last time I spoke, which was about six weeks ago. Some of these are real companies that are gonna do really neat things. Some of these are white papers run by one guy. And so I think you gotta do your homework on what ICO you’re participating in. They’re all at really high valuations. I think there’s a monster regulatory risk. People are gonna say, “These are securities offerings.” Well, no, they’re not. Yeah, it smells like, you know, that old joke when you were a kid, smells like, tastes like.

Dom: Yeah, it is.

Mike: You know. And so I think that’s the biggest risk to the space.

Dom: So there is at least one ETF that I kind of look at every once in a while, that tracks, you know, this basket of cryptocurrencies. And at one point I had a viewer Tweet direct message to me about how, “Hey, look at this thing.” This fund trades at like, you know, the NAV, it’s like this massive premium, like 80% premium to net asset value for these things. There is a danger beyond just the, you know, the prices that we see. It’s also the idea that there is kind of this retail demand, and that if they can’t find a way to get it or transact in the direct markets, they find a way through an exchange traded fund and those things traded, bubble issues valuations as well.

So how does that dynamic play and do you expect that the landscape to change if there are that many more participants who are gonna use it, not because you’re a seasoned crypto user, but because you can just get it through an exchange traded fund.

Mike: Yeah. I mean, listen, the people were praying that the Winklevoss Trust got approved because it would allow, you know, the equity investor an easy way in.

Dom: Because dollars would then be able to find their way too.

Mike: as opposed to having to set up a wallet on Coinbase and wire your money in. And I have lots of stories I told a bunch of my college friends at a Christmas dinner that they should buy Ethereum and it was about $8. And one guy called his broker and said, “Buy me $100,000 in Ethereum.” And the broker didn’t buy it because he didn’t know how to buy it. He didn’t call back and never did it and then they, of course, went up and the guy is screaming at him.

Dom: Firing his broker.

Mike: You know, access to this stuff is more difficult than most people buying a stock. That’s getting changed pretty quick.

Dom: Sure. Because of FinTech, yeah.

Mike: And, you know, I think there’s gonna be funds set up to arbitrage, these price discrepancies and those will go away pretty quick. But there is a big risk that, you know, when it was a small little market cap, the regulators don’t pay that much attention. When you’re now talking hundreds of billions of dollars, the moment consumers start losing lots of money because they foolishly go in and buy the hype and lose, that’s when the regulators come out and say, “Whoa, whoa, whoa, wait a minute here.” And so, you know, when I talk to the Blockchain community, I’m always pushing, I’m like, “Dude, A, pay your taxes.” Because nobody in that space pays taxes. It’s a bunch of libertarian, anti-government, and…

Dom: It’s a way to circumvent the government, that’s all they want, right?

Mike: And, listen, the IRS is gonna come after people, you know, people are making real money now. And so like the IRS isn’t stupid, we pay our taxes. But it’s also developed sound ethical business principles. Or, you know, Mr. Regulator is gonna come with his hammer. And that’s, I think, one of the bigger risks here because there’s a lot of fly by night. Now, the core people, I think there’s a beautiful spirit. The core developers, you meet Vitalik Buterin. He is a benign dictator in the Ethereum space. And I think there really is a very revolutionary spirit amongst the guys that are building the system.

Dom: You know, it’s funny you mentioned that because you talk about those people who are neck deep in some of these processes. The last Fireside Chat I did was not that long ago. Maybe like last month or a few weeks before that, and it was at the Security Traders of New York, The STANY Annual Conference. And my Fireside was with Blythe Masters, who is now running Digital Asset. She has now become…she has taken her expertise from basically being like you, one of the luminaries and visionaries at a young age on Wall Street. Taking her career from JPMorgan and then now running a Blockchain company in essence.

When we talk about from a media perspective, the top two stories on the CNBC website this morning guys, by the way, were both crypto and [inaudible 00:13:06]. The first one was about the Ethereum flash crash that went to 10 cents and some guys got hammered because they were either margin called or stop lost out, and that the exchange is gonna make up for it somehow. The second most popular story was that IBM, European banks partnering on Blockchain technology story. So, you know, Rabo, Deutsche, [inaudible 00:13:26] HSBC are all kind of getting together.

When we talk about crypto, we’ve spent a lot of time on the price aspect of it and, you know, the investing angle of it. How much of it is driven by the fundamental change that Blockchain and distributed ledger technology can provide for changing the entire way that we operate in terms of transactions of any type, versus, “Hey, check out what happened with Ethereum. It went up 4,000% at its high this year. I could have made a gazillion…” And what was it? A thousand dollars invested in Bitcoin seven years ago is worth $72 million now, that sort of thing. I mean, how… Well if you’re in this space, you’re neck deep in it. So what does that play out like?

Mike: When you make money in a space, you dig it and try to figure out more about it. And so the fact that people are making money in the space, people are digging in and learning a lot more. It’s not just a fad. You wouldn’t have… Listen, there are over 200,000 programmers out there. When consensus put up tools for developers, developer tools on their website for free. They had 100,000 developers around the world download those tools to program on the Ethereum Blockchain. There are 200,000, I look at these as free employees. Because these are working in either the Ethereum system or the Bitcoin system out there.

And so there’s real, real intellectual heft in capital going into building this new system. The real hype is coming because there’s a revolution happening. And it’s, you know, in some way it’s not that sexy because it’s the back of the TV. You know, like I like the front of the TV. I actually like being on TV.

Dom: It looks good on TV by the way, I mean.

Mike: But, you know, it’s the back of the TV. It’s at the bank how things settle. You know, you’re a customer of the bank you don’t really care. And so, you know, a lot of people are gonna lose their jobs because the way things settles, and they get a lot more efficient. And so in some ways, it’s a quiet revolution. There are some big picture ideas that could be very disruptive. I think the killer app of all Blockchain space is identity where you will get your identity back. Right now I sign up with Facebook and I give away my preferences in clicks and I sign up my healthcare, and I give away my preferences in clicks. And that could all come back, right? The Blockchain can determine you are who you are.

Dom: And just taking back ownership of your own identity.

Mike: And that, I think, could be very disruptive to the big companies like, you know, Facebook and Google. Surprising, I’m guessing the next move is you’re gonna see…and this is just speculation, but the Googles and the Facebooks start buying big chunks of the space up. And so when I think of price of both of the companies and of, you know, we’re not at a bubble yet because Fidelity hasn’t bought into this yet, my hedge fund friends haven’t bought into this yet.

Dom: Cabbies aren’t talking about Bitcoin, yeah.

Mike: Google hasn’t…cabby, but it’s getting there, you know. It’s kind of first-level frenzy, it’ll go down, and then it’ll be a second-level frenzy. The other thing that I think is very important is there’s real money pouring into these companies all of a sudden. You know, $500 million dollars raised in the last six weeks. That goes into building out infrastructure, building out companies. Some of these companies are gonna suck, just like pets.com sucked, and some are gonna be the next Googles. And so I do think this is a real revolution. You’re still early, and so we’re adding resources, we’re participating in the ICO world, we’re participating in the venture side of it, looking for great CEOs.

Dom: So from the ICO standpoint, we had broached it during our last discussion, and I think you caught the tail end of that one. How much more prevalent can ICOs become…I mean, the runways, I mean, I can imagine it. But is it gonna be as, are we gonna speak about them as kind of, you know, routinely as…

Mike: Could they… Listen, in the Blockchain space they are completely disrupting the traditional venture capital space. Like why would you go do a venture round if you could do the ICO and get money at a better valuation and not give up ownership? It’s a tricky line. I think the regulatory bodies are gonna really define how that system works. And I think we’re too early to really know where they come out.

You know, Blockchain Capital did a ICO on a fund which was courageous and pretty cool. You know, it was a small deal, they raised $10 million but it was the first one on a fund. Like in essence, creating a closed-end fund overnight. If that happens, that’s gonna completely… If that gained steam, it’ll completely change the way venture capital gets done and looked at. You know, you’re providing liquidity into an illiquid space. That gets me nervous always. I like liquidity where there’s underlying liquidity, so.

Dom: Because it should be there, right.

Mike: Because that’s kind of fake liquidity but so we’ll trade it, you know, when someone wants to sell it there’s a 40% down bid. But, you know, that’s a process that’s starting. And so I really do think you’ve got to watch the regulators. But it could really change the way people raise capital, not just in the Blockchain space but in the entire venture space.

Dom: My mother had asked me one time about Bitcoin. I mean, I always said that that’s the top, right? When my mom starts asking me about whether or not Bitcoin is a good investment. When we talk about this idea of Bitcoin being more accessible, what do you see as the next big avenue for…what’s the next big development, the next big chapter when it comes to, not Bitcoin, per se, but just cryptocurrencies and Blockchain technology, that next evolution?

We’ve talked a little bit about the broader, “Hey what could be in the eighth or ninth inning?” But what exactly could happen in the next maybe year or two that’s really gonna kind of put it on the map even more than it is already right now?

Mike: So I think there are Blockchain companies in almost every vertical you can think of. We just invested in a company called Funfair that is going to bring Blockchain to online gambling. And it’s gonna make gambling fair and transparent, and fun, hence the name FunFair.

Dom: FunFair.

Mike: Built by a CEO who is a brilliant guy that was, you know, selling games to Atari and Nintendo when he was 21 years old and became a knight of the round table of, you know, OBD, I guess, in Britain. You know, he’s a wealthy guy and a great entrepreneur, and this has been a dream of his. And like if that works and he executes well it changes the online gambling world. And as you see these companies, there’s Blockchain companies in the music space. There’s Blockchain companies in the Uber space, you know. Why do you need Uber if you could have a distributed trust version of Uber? As these companies, and some will work and catch on, that will change the story. That’ll give the story the second level of juice of saying, “Well, wait a minute. I value, you know, my own kind of back of the envelope way of valuing these things is, if I think of Ethereum space, and I think of Ether as fuel, I need a little bit of fuel for every transaction that happens on the Ethereum Blockchain.

And so if I absolutely knew how many transactions there would be over the next 40 years and the slope of that line, and I knew how much fuel I’d need, I’d multiply fuel times transaction, and there’s my market cap. And so as you see these companies build and work and people using them, more blocks on that Blockchain, that should drive valuation.

Dom: I’m gonna put you on the spot. We’re about a couple of minutes over right now. But if I was to say to you, and please as a journalist I wanna know, but feel no obligation to answer if you don’t want to. Is there a limit order that you have down there below right now for Bitcoin prices or Ether? I mean, you said you’ve been selling into some of the strength. I’m kind of curious, where is the pullback where you’d be interested in buying?

Mike: I think, you know, I’ll give us some ranges. I think if Bitcoin got back to 1,600 you’d be buying a lot of it. And I think Ether at $150 to $200 you’ll probably accumulate the stuff that you sold above $300. I don’t think, you know, again, a $20 billion market cap at Ether sounds about right for where we are. Again, do I know? No. I’m just guessing. Bitcoin’s an interesting one because I don’t think Bitcoin becomes the protocol that everything gets built around. But I think Bitcoin has a very interesting use case because it was first, that it becomes the digital gold to store value. And I don’t think it becomes a currency that people use. It might in some faraway places, but like our currency works pretty damn well. And currencies…

Dom: It is the reserve currency of the world.

Mike: And currencies, by definition, have to trade in a low volatility band, right? I can’t buy this flour one day for a dollar and it’s $3 the next day.

Dom: Or milk or bread, for that matter.

Mike: Or bread. But I do think Bitcoin has a digital store of wealth. That use case has happened. I don’t think it’s going away. And in lots of parts of the world, that feels really good to have your money there versus a banking system that you don’t trust. Like, for us in the U.S., we’re okay with our banking system. I don’t think Chase is gonna, like, steal my money. But in lots of parts of the world, people don’t feel as comfortable. And so I kinda see, you know, that Bitcoin-gold relationship is a pretty tight one, you know. And, you know, old people might wanna buy gold but I know my kids would rather buy Bitcoin than gold. And so I kinda think as the generation shifts, you’re gonna see that use case continue because I don’t think it’s an either/or. You know, we bet on almost all of these systems because, like, I’m not such a technical guy to understand which is gonna win.

Dom: All right. We’ve now put you guys back by four minutes. But anyway, thank you very much, Mike Novogratz, for taking us through the world of Bitcoin. And thank you guys very much for your time as well.