Introduction

Patrick: [00:00:49] My guest this week is Chad Cascarilla, the CEO and co-founder of Paxos, which describes itself as a financial technology company "mobilizing assets at the speed of the internet". Thanks to more than 20 years of investing and financial services experience, Chad has a unique perspective on integrating blockchain tech with traditional systems. He also has one of my favorite Bitcoin origin stories, which we explore. Before Paxos, Chad co-founded the asset management complex Cedar Hill Capital Partners in 2005, and its blockchain-focused venture capital subsidiary Liberty City Ventures. Our conversation is less about cryptocurrencies, and more about the history, current state and potential future states of our financial system. Please enjoy.

From Traditional Finance to Bitcoin

Chad, we're going to go all over the place. I guess maybe the theme of this conversation will be blockchains, something I haven't talked about in a while, so I've got some renewed fresh energy to talk about this topic again, which will be fun. Since you've got such a unique origin story for coming into the bitcoin community to begin, and now the broader blockchain community. I'd love to begin with what you were doing prior to reading the white paper discovering bitcoin for the first time in the more traditional finance, hedge fund world.

Chad: [00:01:58] I spent really my whole career as an investor. I worked briefly on the sell-side doing research. Then I went to the buy-side, public company investor, long/short equity investing globally in financial services, and then over time started to add private equity vehicles, added a venture capital vehicle. That allowed us to invest in the whole lifecycle of companies from early-stage all the way to public companies, and also the entire capital structure, so trading everything from debt to preferreds to equity. You really got to see and understand financial services in a deep way.

There were a number of trends that I think we did a really good job of catching, and they ended up being very relevant to blockchain. The first was this big change in market structure, which was the move from exchanges as not-for-profit and floor-based institutions to being electronic and for-profit. We were investing around the world, in seats and shares in the U.S. and elsewhere. Another really important trend that we caught was subprime, and really commercial real estate as well and how that began to unravel.

We also ended up doing, I think, a good job of taking advantage in the crisis of investing in subprime too, so we were involved in both directions. The reason that was really important to our understanding of blockchain is, one, we saw how really transformative price discovery and market structure could be on the exchange side. Then secondly, because of subprime and really the whole financial crisis, running an asset manager at that time, we're able to really understand how the plumbing of the financial system worked, or in the case of prices didn't work, and in fact, exacerbated the crisis.

And so, when we came across bitcoin - this was basically May of 2010 when bitcoin was only at three or four cents - we were immediately intrigued by it. I have to admit I thought probably it was going to go to zero because I looked at it and thought, "Oh man, this is probably a penny stock. Penny stocks go to zero. Maybe it'll go to $10." I didn't know it was going to go to 8,000 and yet not be the ledger record, which is our original thesis. When we looked at it, we said, "Oh wow, blockchain is what makes Bitcoin interesting, because you could put anything on this public record keeper." In fact, Bitcoin is probably more of a store of value than the record keeper, and ethereum right now is the record keeper of blockchain. Maybe we can save that for later.

Patrick: [00:04:13] Sure.

Chad: [00:04:13] We were intrigued because we said, "Wow, this is a way of how you could solve the problem in the financial system around how assets move." You had all this innovation around how to figure out price discovery and exchanges but there's been almost no innovation in the back office and post-trade. It's still running on COBOL mainframes. For people who don't know what COBOL is, it's basically the equivalent of Latin in computer programming. They're still running on COBOL mainframes from the '70s, I mean, the '80s. It's ludicrous. And so you have this possibility with blockchain to now have a decentralized system. That's what really fascinated us, because it could be more resilient. It could be more open and accessible. It could be both cheaper and free up capital. It could really do everything that the financial system is doing now but better, and that would be a process to transform things.

But we caught and understood bitcoin and blockchain fairly early because of those experiences of understanding what happened with market structure and then what happened during the crisis.

Patrick: [00:05:11] I want to talk about those as foundational things, and talk through your experience, because what I found when talking to people that were successful at taking the other side of the subprime trade is that they mentioned the word 'plumbing'. They tended to be very deep in the weeds on the details of the securities and the structures of securities and the actual assets in them. Could you talk us through your experience during that time navigating it as an investor? You said that you were successful at both identifying, but then also you couldn't just identify, you had to structure the trade, which is hard to do. Just talk through that story in as much detail as you're able to because I just think it was a fascinating time in investing history.

Chad: [00:05:46] It really was fascinating because the subprime trade, I think everyone knows now, was premised on giving loans that shouldn't have been given for a whole number of different reasons. But even more importantly, it wasn't just that the loan shouldn't be given, but the loans themselves didn't follow a normal procedure because people were trying to ramp up the loan process and make it go as fast as possible, but it was very antiquated. The loans themselves were going into securitizations and into trust incorrectly, and so when you tried to figure out what exactly was in a trust that had supposedly subprime loans in it, you would find out maybe it had something in it but maybe it had nothing, depending on what the legal process was.

And when you have a position on - where you're short subprime or you're long subprime - the collateral has to be somewhere. When the crisis is going on, what is the cause of this crisis? Well, I think there are two causes. The first is you just had an over-levered system, and subprime was the most over-levered part of an over-levered system, and that started to come unglued. Then the second issue was that the way the plumbing worked was not well understood.

My analogy is it's like a 19th-century sewer system. It looks like it's fine. You have a storm, and the streets flood. That's exactly what was happening with the collateral, and so you would have positions on with counter-parties, and they would owe collateral to you. You'd be waiting to see if collateral would come into your account, and it wouldn't move or it moves slow. You have things called ISDA contracts, which are very long, complicated ways of agreeing to trades that don't trade on an exchange. It was so slow to move the collateral and when Lehman failed, what it exposed was, no one expected that a large dealer could fail.

So all of these over-the-counter trades that did not go on an exchange were in process. No one understood that there could be a complete daisy chain, where if one person failed, the whole system could lock up. That included the Fed, who didn't realize this. And it got so catastrophic because assets move so slowly through the system - because of how you would clear and settle trades - that even if there was enough collateral, even if everyone was in good shape, you couldn't possibly get the movement of those assets to happen in enough time to prevent other people from failing.

That was really the genesis of what blockchain could do to solve a lot of what caused the crisis. You could now move assets instantaneously, potentially. You can't do that today because the system is continuing to rely on larger and larger intermediaries each step along the way, and there's a whole chain of them. That hasn't changed because of the crisis. What you've done is add more regulation and more capital. You've made the largest intermediaries too big to fail, but you still have fundamentally the same problem of trying to understand where assets went.

That was really clear through this subprime crisis and then the broader crisis; you could have good positions on but you didn't know if you were actually making any money because the collateral might not show up on your account. There were days where we were doing really well. You would think that you had just made a profit. You had a paper profit, but you didn't know if you had a real profit, because the money might not show up, because your counter-party might not actually have the money.

There'd be days where it would be very slow payment to get money into your account, and you're like, "Wow, I think I actually lost money today, even though theoretically, I made money." There were a couple days where we were like, "Well, I think we're making too much money." I think that's a bad sign for the system, or making too much money because of how fast the securities are declining in value. Then, of course, the baby gets thrown out with the bathwater. And we built a system where we had like 100 terabytes of mortgage data. We had every mortgage in the country modeled out, and we quickly realized, "Wow, the market has now gone completely the opposite direction, misvaluing these securities," and we created a fund that was just buying these mortgages.

There were a couple days where we were like, "Well, I think we're making too much money." I think that's a bad sign for the system, or making too much money because of how fast the securities are declining in value. Then, of course, the baby gets thrown out with the bathwater.

Patrick: [00:09:29] Buying the orphaned pieces.

Chad: [00:09:31] Exactly, because there was no place for them to go because securities got downgraded once they're not triple-A anymore. A lot of funds have to sell them. There isn't enough buyers. The price goes down because of forced selling and you could step in and take advantage of really good opportunities.

That's a background of how we thought about the trade and how we were trying to really understand what those securities were worth on a fundamental basis, but then the difference between the fundamental value and what was actually sitting in your account is predicated on your counter-party being able to give you money.

Changing the Foundations of the Financial System

Patrick: [00:09:58] If you're looking at the financial services space today, just as an investor, so imagine you would start a new hedge fund or something. I'd be curious to hear how you would describe the levers that mattered, things that you were most curious about, looking at it maybe at the start of your career or pre-financial crisis versus today. If you're trying to earn a return as a financial services, hedge fund investor or something, how do you think that has changed and things like regulation, how do these play into that space as an opportunity center for earning good investment returns?

Chad: [00:10:26] There's a number of things that have happened since really '99 or 2000, as I was really starting to get involved. The first is you've had a significant change in interest rate levels. At the end of the day, financial services companies are tied to what interest they are able to earn and the net interest margin spread they're able to have. The second thing that's happened is you've had to hold much more capital in general as a financial institution. If you're earning less money, and you're holding more capital, your returns go down.

What's happened is you maybe had, broadly, what I would call financial services - that was 30% of the S&P back in like 2000. Now you're looking at it, and it's 15%, maybe even a little less. On a relative basis, it's been very hard to be an investor in financial services over the last 20 years. Now, there's ups and downs, and there's periods when it was good and bad. But on a general basis, financial services has shrunk significantly, at least from a market cap perspective as the S&P, and then that's been, I think, true globally as well.

Those headwinds are caused by a structural need for more capital, and a structural decline in interest rates. Then I think the last issue is; innovation in financial services is not really being driven by the incumbents. Where have you seen it? You've seen innovation in trading, and so you've seen that on the exchange side, and there's certainly been a lot of value created there. You've seen innovation on the payment side, Visa, MasterCard, all kinds of other companies, Venmo, wherever it might be, PayPal. There has been a lot of value created there.

There's been innovation that's happened on the loan creation side, P2P lending, LendingClub, and others. That's where you've seen it, but guess what, none of those happen to be banks or investment banks or even really insurance companies, and so those very large financial institutions are still the main intermediaries that you're relying on. You've now hit the most interesting period for financial services in a very, very long time for, I think, two reasons. The first is you have a closed financial system. Now, maybe not everyone realizes that, because it's so ubiquitous. For the everyday person, you might not even think, "Oh, the system is closed." It just seems like something you can go use, but the reality is if you don't have enough money to open a bank account, or if you are trying to access your own stocks or whatever it might be, you have to use some kind of intermediary. While the system is very big, the biggest network in the world is still a closed network. That's the first issue. You have a closed system.

The second is that it's based on obviously, fiat money. You've had interest rates. As they headed closer and closer towards zero, you've had more and more debt growth, so the system itself is unstable. You have an unstable closed system, and so what will happen over the next economic cycle is going to be really, really important. I think the trend is going to be - that's why we created Paxos - about having an open financial system because you have lower costs, you have network effects, everything that we've seen over the last 20 or 30 years has been about how you go from closed systems to open systems. Whether it was media content, whether it was the way people interact with the retailers, all of this has been about how you get more and more open. I think financial service has been able to hold off on that because it's so highly regulated, but the benefits of being open have now become almost an order of magnitude improvement in cost and capital, and so that will shift to an open system. Potentially, we'll see whether or not that shift is to some type of asset-backing that isn't reliant on fiat money.

Everything that we've seen over the last 20 or 30 years has been about how you go from closed systems to open systems. Whether it was media content, whether it was the way people interact with the retailers, all of this has been about how you get more and more open. I think financial service has been able to hold off on that because it's so highly regulated, but the benefits of being open have now become almost an order of magnitude improvement in cost and capital, and so that will shift to an open system.

I think it's going to be an open system based on fiat money, but that's where the real debate has happened - that's where you're talking about like, "What does something like bitcoin represent versus what does something like blockchain represent?" That big change in financial services is going to unleash a completely different way in which the products are delivered. I think you're going to go from financial services to financial products.

Patrick: [00:14:06] I want to make sure I understand exactly what you mean by open versus closed. I think I understand. The media example's maybe a useful example because everyone will understand what that means that you don't have to go through bottlenecks of control to get a message out. Let's say you could go direct-to-consumer or something like this. Just describe it in a little bit more detail what open versus closed means to you in a financial services context.

Chad: [00:14:29] There's a couple different versions of what open versus closed could be. The way it's closed today is all the money that's not in your pocket, so cash is not physical, actually sits at the New York Fed. It's just a COBOL mainframe that maintains the balances. The only firms that can access that COBOL mainframe are Federal Reserve members. You go back to the first principles of what is the banking system. It's actually, you can't access money unless you're a commercial bank. That means there's maybe a couple thousand Federal Reserve members, I think it's 3000 or something, whatever it is, 4,000 member banks, and that's it. They're the only ones that can access it.

So, effectively, banks are middleware between you and the Federal Reserve. They're not the most efficient middleware. I think maybe there's less than 10 banks that have APIs, so they're not very modern middleware. Partly, that's what Visa and MasterCard are able to do - banks aren't very efficient at talking to each other, and neither is the Federal Reserve, so you have Visa, MasterCard and other payment networks that basically sit on top of the banks moving money around. But fundamentally, at the end of the day, it's just a database that holds dollars.

Why is there so much cost to move these around? Why can it only move nine to five? Why does it take days to move it internationally? It's held up at each stop along the way, there are inefficient steps, and so that's one example of how it's closed. The other is all the stocks and bonds in the U.S. that trade all sit at the DTC, which is the Depository Trust Company. There they all sit on exactly the same thing - a COBOL mainframe - and you have to be a DTC member, which we are by the way, and there's maybe a couple hundred firms that can access the DTC ledger where all the stocks and bonds sit. You can't go hold your own stocks, unless it's a private company. You want to go get your shares at IBM, you have to go through it through a broker. So it's a closed system, you can't actually interact with the ledger...

Patrick: [00:16:10] The end thing.

Chad: [00:16:11] ... the end thing. By the way, it completely made sense to have a closed system, I think. Go back to the Federal Reserve system. You look at why it's set up this way. It solved a lot of problems to be set up this way but now the contradictions of the system that were a net benefit before are becoming a net hindrance now. That's when you have to think of new ways to do things. Every system eventually gets overwhelmed by the contradictions in it because everything continues to change. I think we're at that point where, while having a closed system like that doesn't make sense, what does an open system look like? Well, it could be a number of things. You could directly - why couldn't, for instance, the Federal Reserve allow anybody to have an account with them or even the Treasury? You don't even need a Federal Reserve to act as an intermediary. You could just go to the Treasury. Couldn't you open up a Treasury direct account to buy treasuries? Couldn't you just have an account at that Treasury, and the Treasury gives you dollars? Do you need a Federal Reserve, and then do you need the Federal Reserve Banks? I don't know. Those are questions.

I think Governor Brainard just gave a speech on this last week talking about, "Oh, maybe there are different ways to intermediate dollars than to go through the current system, but kind of left it all open." I think you could do something quite radical. That'd be called open banking. Anyone could have an account at the Fed or directly at the Treasury, and you would change the nature of what the Federal Reserve looks like. Maybe they don't need to be issuing money anymore. Maybe the Treasury does, and the Fed just acts as oversight or acts as a bank. It could be privatized.

Another possibility is you don't necessarily need to be using banks as your intermediary. People are doing that now with Venmo and others where you can change the need for money to just move from commercial bank to commercial bank. Someone else could have an account. Another institution could have an account at the Federal Reserve. Maybe it's not a person, individual consumer, but it could be a business. They have an account with the Federal Reserve, and you just interact directly with them, and they're not a bank.

There's all kinds of interesting ways you can create an open system, and then you could get to something that's truly radical. I don't think that is what would happen, but the way banking used to work before is - gold was a ledger. Gold could be a ledger, or you could say bitcoin is the ledger. What does that mean? Well, what do you mean when gold's a ledger? Well, I mean, you hold the gold. You can prove whether you own the value. As you hold a Bitcoin, you can say I hold the value. You don't need anybody else to maintain the ledger. Not the Federal Reserve, not anyone else. Anybody could participate in that ledger by virtue of holding it, so now you can have an open system, and the unit of account is open. Now, that starts to get really different than what we're used to, though that's historically how the world has worked.

Patrick: [00:18:41] Right up until 100 years ago or something.

Chad: [00:18:43] You could argue-

Patrick: [00:18:44] 1971 or something.

Chad: [00:18:45] Yeah, 1971. You could pick some time or Bretton Woods or whatever it was, but '44, it's not that long ago. The reason that might happen, by the way, is not because I think people would just want an open system. I think it's because the closed one might not work anymore. At the end of the day, the terminal value for all fiat currencies is zero historically. None have succeeded, because it's just too tempting to continue to print money, and so if you assume history repeats itself, because it always has, then you're going to end up at some need for a replacement.

The reason that might happen, by the way, is not because I think people would just want an open system. I think it's because the closed one might not work anymore. At the end of the day, the terminal value for all fiat currencies is zero historically. None have succeeded, because it's just too tempting to continue to print money.

Patrick: [00:19:15] I'm a bit out of my depth here. I'm not an economist, not a monetarist, but one criticism that you hear often would be, prior to this - we'll call it modern period - whether it's '44 or '71 to the present, we've had relative stability from a recessionary standpoint and the number of crises, the depth of those crises, et cetera. There's this notion of a lender of last resort that people always talk about as being an important function of more centralized control. How do you think about that in these open systems, so the fact that there has indeed been fewer and shallower crises in this kind of modern fiat, even with inflation, this modern fiat system, relative to say a gold standard where crises were common?

Chad: [00:19:56] I mean, everything's a double-edged sword here. This is a societal choice. If you look at the average growth rate since the financial crisis, it's easily the lowest growth rate over any 10-year period. Even when you had more recessions, you had a higher average growth rate. And our productivity rate, there's other contributing factors - this is not just a monetary system, by the way - but the total factor of productivity is easily the lowest it's ever been. I think there are some crucial things going on.

The first is the level of debt-to-GDP has never been this high before. In effect, what is debt? Debt is a decision to spend today rather than tomorrow, and so you've made a time preference choice. If you continue to accumulate more debt than the economy is growing, which is what we've been doing globally, you're inherently making a time-based decision that's now out of whack. Why is it out of whack? It's out of whack, because the interest rate is incentivizing you to spend today versus tomorrow.

Maybe what we've done is defer recessions by pulling forward spending from the future, and you hit a point of no return, which appears that we're at, where you can't allow the debt to get paid down, because the economy would slow too much, and so you're going to keep spending forward as much as you can, and you're going to reach the end conclusion of that. We're going to have a real tough day, because you've been essentially waking up every morning, and instead of having a hangover, you keep drinking more. I think that's what the debt represents.

I can tell you there's a lot of firsts that we've now had happen that have never happened before. I mean, never. The first is; we've never had debt-to-GDP globally, which is now approaching 300% debt-to-GDP, a completely crazy number, and no one has ever seen that before ever. Then the second thing is; you now have negative interest rates, which to me is a sign that the economy is having trouble using the capacity that's already been built by all of this debt. How could you have -1.2% 10-year German bond interest rates? I get minus 12% back in 10 years. That has never happened before. You're getting paid to take a mortgage in Denmark, or there's a junk bond issuer - I think it's Nokia - that has negative interest rates. It's a junk bond issuer and you are paying them. You give the money.

I don't think you can have capitalism exist with negative interest rates and these levels of debt, and so I think all of this - the effect of elongating out the economic cycle and incentivizing more debt accumulation to moderate the cycle - is now getting us to a point where we have real problems from a societal level. I think this is why people support Trump. This is why people are supporting socialism-

Patrick: [00:22:22] Brexit.

Chad: [00:22:23] ... Brexit, all these things. I think it's not intuitively understandable that, in fact, I think a lot of that issue is tied to the way we've created the financial system and how it allocates capital. I don't know what the per-se solution is but it's an unbelievably interesting time. I'm not sure that it's the best time to be a financial services investor. We'll see what exactly happens and how society tries to work this out. It's not a set of easy choices here, but it's going to be unbelievably fascinating to see because I think the choice of the financial system, the fact that it's closed and the fact that it's based on fiat money has allowed us to moderate the cycle, but the costs have not come due yet. They're going to come due in a way like we've never seen before.

Patrick: [00:23:06] How does that manifest? We've never seen before would make people think of maybe the financial crisis. We had never seen something specifically like that before, and it was obviously massively painful. I think people are always - to me, this feels like a really weird market, because we're so close to all time highs - and nobody I know is positive or constructive. It seems like the contrarian view would be to be really bullish. That's maybe just the bubble I'm in or who I'm surrounded by, but it does strike me as this weird combination of pretty expensive stuff - assets are expensive, and volatility is still not crazy, but you've got all these big problems. How do you think that might manifest in the world? What could or might precipitate an unwinding of 300% global debt-to-GDP?

Chad: [00:23:47] I think there are really three choices. One is you could have some debt jubilee deflation, where everyone's like, "You know what, we got to figure out a way to crunch this debt." That's one choice. The second one is, I think, inflation, which is probably the way you go because it's the one that at least amount of people understand. That's what we've been doing since the crisis. Our solution of the crisis was, "Let's build up a lot more government debt, and just keep doing that. Then I think the third choice, socialism, which is also a possibility - which is basically, "Let's figure out a way to stabilize the system. You put a lot of regulation in place. Let's grind everything a bit to a halt, and we'll just sit here and figure out if we can grow our way out of this or find some other way out." I think those are really the three options that exist. I don't know exactly which one we're going to go down. I suspect it's probably inflation because the system has a lot of antibodies against going full socialist, and it has a lot of antibodies against creating big time deflation.

The problem with deflation, which is why maybe you're right, the contrarian viewpoint is to be bullish here is because they can't stop printing. The Federal Reserve just started doing QE last week, and it looks like it's going to be $500 billion; half a trillion dollars of QE. They're not calling it QE for a variety of reasons. The system can't function without more money printing to keep the thing going, and so the Fed's not going to basically allow deflation to happen. That won't meet their mandate, which is 2% inflation as a goal, and because there's so much deflation built up in the system from so much debt, which is inherently deflationary.

Remember what I said debt was. Debt is spending tomorrow's production or tomorrow's money, today. And so you've inherently made a lot of investment decisions based on the level of spending today as a business, so all of that investment that is made with debt becomes a hole for tomorrow. An example is a flat-screen TV. Okay, a lot of people can get loans. They can go buy a lot more TVs. People build factories. You have all this flat-screen TV capacity, but guess what, in the future, unless there's more debt, how are you going-

Patrick: [00:25:43] You can't use the capacity.

Chad: [00:25:45] You can't use the capacity, so it's actually hugely deflationary. That's what's maybe not understood. All this debt has kept the system going but it's built up an enormous amount of deflation. That's what I think negative interest rates show. All this money printing is just to hold things together because there's so much deflation. I think they'll just keep doing it, keep printing to both incentivize the debt maintenance, but also because people are not capable of living through this deflation.

Then the last component, which is really why this is a very complicated, multi-variable equation is population growth is slowing or even turning negative, which is unbelievably deflationary too. You haven't really had examples aside from black death or something, or whatever Roman times; what do you do when populations actually decline on an absolute basis? Now, that's not going to happen globally for some time...

Patrick: [00:26:31] We won't really see it, but yeah...

Chad: [00:26:32] ... but nonetheless, already, you have the second-order effects just because you have less workers and more retirees...

Patrick: [00:26:41] The ratio is bizarre.

Chad: [00:26:41] Yeah, because you have retirees spending down capital compared to workers. You see that in China. You see that here. You see that, especially in Europe. I mean, Germany and Japan have absolute declines in their population, so that's unbelievably deflationary too. It's hard to disaggregate some of these things, but deflating population sizes, if you will, against huge amounts of debt makes perhaps the contrarian call to be long stocks, because what are they going to do in that situation? I think you're going to have to print money, and you might call it something else.

Patrick: [00:27:08] Before we spend really the lion's share of the rest of the conversation on Paxos and blockchain and stable coins, all these other interesting topics, I'm just curious if all that went away. If you weren't building this company, how you would think about this just with your investor hat on, so if you're just a family office trying to earn a return, where do you think you would focus? What would you gravitate towards today as areas of doing more work?

Chad: [00:27:28] I think it makes it a very difficult environment to invest. I think one thing is you need to own outside assets, meaning assets that aren't someone else's liabilities. That could be gold. That could be Bitcoin. That could be real estate. Now, a bunch of these things, even gold and real estate have a lot of leverage in them, so it's not exactly an outside asset. It'll be dictated by the constraints of the broader financial system and what happens to them, but I think that's one thing that you need to own, and that creates safety and frankly, even cash.

It makes it a very difficult environment to invest. I think, one thing is, you need to own outside assets - meaning assets that aren't someone else's liabilities...then on the other hand, I think you want to own what look like call options, which is investments in businesses that can be very transformative and grow.

Then on the other hand, I think you want to own what look like call options, which is investments in businesses that can be very transformative and grow. I think private businesses or whatever it might be, having a portfolio them tends to be a portfolio of call options, because eight out of 10 fail. I mean, early-stage businesses, they generally fail, but if you're invested in the right mix, it ends up creating a very good return profile. It's kind of having a barbelled approach in my opinion, which is try and own businesses, where they're taking advantage of all this new transformation that's happening with technology, where software is eating the world.

How are you taking advantage of that opportunity in your investment portfolio, and then how are you creating a lot of stability and downside protection? Then I think the broader markets are - it's hard to be too excited about it. You have 1.7% interest rates or 1 point, whatever, 6% on the 10-year. The 10-year probably goes to zero if they just keep printing money, and so you'll make some money there. Stocks can go up but it's hard to understand that risk/reward versus, I think, being on more a barbelled approach.

But clearly, the best thing you could be invested in over the last 10 years, since the crisis, was the S&P. I mean, you don't have a lot of great options. I think that's part of the outcome of the fact that you're compressing returns by dropping interest rates and printing money.

Patrick: [00:29:13] It's been a fascinating period, where I don't think anyone would have guessed that was the portfolio to build. It's gone straight up, and with no volatility.

Chad: [00:29:19] Exactly with no vol.

Bitcoin: Finding, Investing and Holding On

Patrick: [00:29:21] You've had one of the more interesting - I always love bitcoin origin stories, and yours is maybe one of my favorites. I'd love to just tell the audience how you first came across it, and the way in which you began to interact with it here in New York City.

Chad: [00:29:34] We mentioned a little bit how we came through the financial crisis, and then it was May of 2010, came across Bitcoin. It was just three or four cents at the time. Like I mentioned before, I thought it was just going to probably go to zero.

Patrick: [00:29:44] How did you come across it?

Chad: [00:29:45] There's a newsletter, Elliott Wave. Robert Prechter had it in his letter. I think it was the May issue of 2010. I remember the back of the issue was about bitcoin. It's always colorful to read the Elliot Wave Theorist, but it's outside the mainstream, so I guess it wouldn't be surprising that they would point out bitcoin. On the back of it, there was this maybe three-quarters of a page writeup about bitcoin and how it was really interesting. I remember giving it to my business partner, and we were like, "Wow, this is kind of cool. I guess we'll just put some bitcoin clients on some of the computers that we have, and see what it's like." We were like 20% or 25% of the mining capacity at the time, because there was nobody doing it. I mean, these are just CPU-based client miners.

There was this maybe three-quarters of a page writeup about bitcoin and how it was really interesting. I remember giving it to my business partner, and we were like, "Wow, this is kind of cool. I guess we'll just put some bitcoin clients on some of the computers that we have, and see what it's like." We were like 20% or 25% of the mining capacity at the time.

Patrick: [00:30:24] Just in an office building.

Chad: [00:30:25] Just in an office, and so we were subleasing office space, and electricity was included in part of the rent. We were just like, "All right, let's have some fun with it," and we eventually upgraded to some GPUs and some other more sophisticated mining tools.

Patrick: [00:30:36] This is at three cents of bitcoin.

Chad: [00:30:38] This is at three cents. I can tell you I remember it being at 99 cents, and I said, "I just don't think we should be involved anymore. What's the risk/reward here, zero or $10?" It's probably priced about right at 99 cents. Now, obviously, that wasn't right, but we were having a lot of fun with it, but it was based on a premise, which I mentioned before, which is that blockchain which is really the ledger for bitcoin.

Patrick: [00:30:59] A public ledger.

Chad: [00:31:00] It's a public ledger for bitcoin. It could be used for all kinds of different types of assets. I still think that holds but when I was trying to think of what could get you from three cents to 8,000, I thought it would be you're going to need to use this ledger for all kinds of things, not just as a store of value. That was just one use-case of it. Now, that's not to, by the way, take away from the store value premise of bitcoin. That's just clearly what has taken hold. There's other blockchains now that you would use as the ledger of record for a lot of good reasons, by the way. But when you're at three cents, and I'm not a technologist, not to say I could understand all the deep algorithms that are used to keep the blockchain-

Patrick: [00:31:38] The cryptography.

Chad: [00:31:38] ... cryptography, all that stuff, I mean, I understand it, but just a level to be dangerous. It wasn't really well understood that you could even disaggregate something like Bitcoin from the blockchain, and how you could create other blockchains in all kinds of different ways.

Patrick: [00:31:52] It sounds like you've always had a very measured view of this, maybe even characterized by being skeptical of it being worth what you own it at, and not a philosophical acolyte of the white paper and all these other things. Sort of in contrast to some of the other large early investors in Bitcoin. One of the things I'm always fascinated by is the psychology of holding an asset like that through the volatility that it's experienced. To get from three cents to 8,000 has required absolute face ripping destruction. I don't know how many times but a lot. Just talk me through how you felt emotionally during those periods of time and maybe ultimately, why you think you were able to hold on to an asset through that run.

Chad: [00:32:30] Well, I think a couple things, definitely unbelievable, gut wrenching moves all the time. I think there's a couple things you could look at fundamentally. One was how much was the network being used? Even while you had severe price pullbacks, you could understand if the fundamentals are still trending in the right direction. That's what could give you some conviction.

Patrick: [00:32:50] Just usage?

Chad: [00:32:50] Usage of it, how much unspent outputs are there, which is a way of tracking how much is going through the network, how much trading volume is happening, there's a lot of different vital signs, and the vital signs, they would pull back a little bit, but they would then continue to grow. That could give you conviction. While I would say my initial viewpoint of the Bitcoin blockchain was, "Hey, you can use this to put other assets on it," that's what makes this interesting. Over time, I certainly believe this now - it has a reasonable chance to be a store of value in the way that gold is. I don't know if that'll happen. I think even if you talk to some of the most diehard people, they'll say, "We're not sure either," but I think there are good reasons why that could happen.

In some ways, every day that Bitcoin exists and doesn't go to zero, doesn't have something catastrophic happen is a day it should go up. I think it has a very high discount rate, and so I don't know exactly what the right trend line is because it gyrates so much, but every day that asset is unwinding the very high discount rate and it should go higher.

It's now been, what, 10 years. In another 10 years, let's just pretend that happens. It'll be 20 years while bitcoin's existed that something hasn't gone wrong. Now, that's a long time from now. You could look at anyone who's 20 or 25 years old - they don't even know a world that doesn't include bitcoin. Just imagine what does that mean the price would be like. There's different ways of trying to figure that out. Now, the downside is bitcoin is still relatively young even at 10 years. It's still very highly technical.

The code, it still has a lot of development that needs to be done in it. You talk to a lot of the core developers. They'll say it's still in a beta phase. Something could come along that's even better as a store of value than Bitcoin. That means it's not guaranteed that it will go up, but I think probabilistically even at $8,000, wow, this really makes a lot of sense. And it's such a pro-cyclical asset that at $15,000, it probably has a better chance of succeeding than $8,000.

Patrick: [00:34:41] It's like its risk-adjusted return gets higher as it rises.

Chad: [00:34:42] It gets better. That's right. It's very unusual. The higher the price goes, I mean...

Patrick: [00:34:48] The lower the risk.

Chad: [00:34:48] Yeah, the lower the risk. That's why you could call it a bubble.

Patrick: [00:34:50] It sounds insane to say but...

Chad: [00:34:51] That's why I understand why people call it a bubble because it has those characteristics of a bubble as a result of that dynamic, but I always tell people money is a bubble that never pops. I'm not necessarily saying that bitcoin is money, but it's a store of value. I mean, why does gold have 8 trillion dollars of value to it? Only because we say it does. It's just a ledger. It's an open ledger, and it's not money. I mean, we call it money. I can understand why people believe that, but it really, at the end of the day, is just a ledger.

It's such a good ledger that we've given it 8 trillion dollars of imputable value. It's probably still a better ledger than bitcoin, because bitcoin's still new, but you can argue that something that is natively digital - maybe that's a better ledger over time than gold. That's the bull case, I think, for bitcoin. If you ended up with a financial system that was both open and wanted an open ledger of record, you could use gold. You could use Bitcoin. That's the bull case. When I hear people talk about where could Bitcoin go, what they're talking about is you end up with an open system based on an open ledger, and that could be backed by bitcoin, or it could be backed by gold.

Patrick: [00:35:56] I always love that if you're comfortable sharing, the idea that, I think it's Nassim Taleb, "Don't tell me what you think. Tell me what's in your portfolio." You mentioned at the beginning this barbell idea of open assets. What was the term you used for that?

Chad: [00:36:07] Outside assets.

Patrick: [00:36:08] How do you think about your own allocation - obviously, you're a large Bitcoin holder, but how do you think about other things like gold, like real estate as part of satisfying that one left side of the barbell?

Chad: [00:36:18] I mean, I would say on the one hand, maybe you call it conservative, which is cash, commodities and other real assets. And then on the other, what I would call a heavy exposure to emerging businesses, and then a very small allocation to effectively publicly traded assets, because those just seem like they're the most fairly priced. That's the way I try to construct it, which is to have what I think is mis-priced call options or mis-priced put options, so to speak. Then the middle part of the portfolio seems really fairly valued now, so I don't know how you get too many mis-priced public securities.

Patrick: [00:36:53] Maybe to ask it slightly a different way, something like gold, which I want to move towards now, such interesting history, and obviously Paxos has a lot to do with the world of gold. Do you own gold? Do you think that that's...

Chad: [00:37:04] Yes.

Patrick: [00:37:04] You do.

Chad: [00:37:05] Yes.

Patrick: [00:37:05] In a meaningful proportion relative to something like Bitcoin?

Chad: [00:37:08] I do. We could talk a little bit about one of the products we created, which is related to gold. I mean, I think that gold has held its store of value for a long time. It's not a cash producing asset. Depending on how exactly you hold it, it may even cost you - cost to carry. End of the day, you go back over a long period of time, it's been able to hold its store of value. What's it holding against? It's holding it against money on a real basis. If you're like, "I really want to be conservative," you could hold cash, or you could hold gold.

I look at gold as a more safe version of cash, especially as you have interest rates that are effectively at zero, so the differential in holding it isn't that much. That's how I treat it in my head, and the idea is that it'll give you spending power in the future when maybe asset prices change in a way that make them less highly valued. I don't know if they're overvalued, but they're definitely highly valued.

Re-Building the Infrastructure of Finance

Patrick: [00:37:55] We've set really nice groundwork for where you came from, how you think about the world, and now into this, I want to breathe this story of Paxos. You've got a unique perspective, that you have long history with the blockchain community having played with it earlier, just about as early as anybody, and been an investor there, but also a fairly traditional financial approach as an investor to this space. Tell me about how then Paxos emerges from those two ideas, and the specific problems that you think it exists to solve.

Chad: [00:38:23] Part of what we did in our asset management business was incubate businesses. I remember seeing bitcoin and then seeing the blockchain and saying, "Wow, this could really solve a lot of the problems that we saw that exacerbated the financial crisis." It can't solve the fact that there's too much debt in the system, but it can solve the fact that you don't know where your assets are. There's an example of; Lehman Brothers fails, Barclays buys some of Lehman Brothers assets and to this day, this was even a couple years ago - only one or two years ago - there are assets that people hold at Barclays - they think they have like a Sallie Mae bond, but they don't. They don't know where the bond is, which is crazy because all the bonds are sitting at the DTC, but yet they don't know where the exact bonds are.

What could blockchain solve? Well, where the assets are. Who owns what, when? That's what I think blockchains can really help in the financial system. Who owns what, when? That's not known right now. That's partly why we started Paxos. When we came to the crisis, we thought about blockchain. We thought about how this could change the system - the financial system - in terms of creating more resilience, creating more openness.

What could blockchain solve? Well, where the assets are. Who owns what, when? That's what I think blockchains can really help in the financial system. Who owns what, when? That's not known right now.

Our viewpoint was you could create modern financial market infrastructure, financial market infrastructure for an open financial system, and that was the genesis of Paxos. The first thing we did in thinking about how you could create market infrastructure is; look at how it's set up right now and it's generally set up as a trust company. A lot of people aren't familiar with the trust and trust companies, but they're basically like a bank except safer.

The reason it's safer is when you give money to a bank - this is sometimes abstracted away for people - when you give money to a bank, you're making a loan to a bank. They go out and make other loans, and they make a spread, and you have FDIC insurance, so you're kind-of safe but at the end of the day, you're a creditor to the bank. With a trust company, it's slightly different. You give your money to the trust company. They hold it. Segregate it in your name, bankruptcy proof, bankruptcy remote. It's a completely different way of holding people's money and assets.

The reason infrastructure is set up that way is because it's meant to be something that you can rely on, and it's not risk taking with your collateral on your assets, and so we went and created a trust company. We were the first company to do this in the blockchain and crypto space. This was May of 2015. We were approved by the New York Department of Financial Services. Ben Lawsky was the superintendent. That was a big day for us. I think it was a big day for the space, and it allowed us to start the journey of creating financial market infrastructure.

To me, that is a world where assets migrate from a centralized place of them being held. It might be a paper database. It might be a COBOL mainframe onto the blockchain world. There's $600 trillion of assets in the world. That's the big number right now. I think what happens is; over the next 20 years, maybe, I don't know, 25 years, you have $600 trillion of assets that move on to a blockchain, and that completely transforms how they move, who's able to interact with them, and the types of solutions you can create. It lowers the risk. It increases the ability for anybody to be able to be part of the financial system. It frees up capital, and that is a different way of building a system, and that's going to be the new system. That's going to be the new way people are able to use the financial markets.

Patrick: [00:41:33] Paxos itself, just talk through a little bit of the infrastructure. How is this actually happening, that Paxos is affecting? What drew me to Bitcoin at first was the security. I was just really fascinated by mining and hash power and encryption and all these things, because you're able to have this public ledger that can't be tampered with. For $600 trillion of assets to migrate onto one of these things, my very first question would be like, "This better be the most secure thing on the planet." Bitcoin, I think what's so interesting about it is, it makes the case that it is the most secure database on the planet, but it doesn't seem to be the place where we're going to be putting all of these assets. How do you think about the security of a public ledger as a key feature of this migration?

Chad: [00:42:15] This is a really key point. Bitcoin right now, it's still early stages. It's like $150 billion bug-bounty program in a way, and it's held up by the way. It's held up really, really well, but it's still early. I mean, you're 10 years in, and you're not about to put $600 trillion of assets on a public blockchain, even with 10 years of performance data. But on the other hand, I don't think this is something where you're like, "Let's put it all on today." It's going to be a journey over time.

By the way, when you say a blockchain, it doesn't always have to be a public blockchain, it can be a private blockchain. I think there are some logical evolutionary steps where you can show it on a public blockchain. You can show stuff on a private blockchain. It depends what exactly the problem is that you're trying to solve. But in general, being in a distributed system allows you to turn control over to the users and away from centralized intermediaries. That's the transformation that will happen.

There's a lot more that needs to happen before you would put - and you couldn't, by the way - right now put everything on like the ethereum blockchain. That is completely impossible. The system would grind to a halt. It's not capable of handling that. That's just really, by the way, I think an engineering problem, and that's one that'll be solved over time. It's one that will prove out its performance over time. Part of going from where we are today to this point in the future is understanding what would you put on a public blockchain now, and what might you do in the future.

There are certain assets that I think should be on there now because they create benefits, and then there are certain assets that shouldn't. No one's going to put a public U.S. stock - no one's going to put IBM on the ethereum blockchain, or frankly, all of U.S. stock, whatever it is, $30 trillion of U.S. stocks, no one's putting that on the ethereum blockchain anytime soon. You just couldn't possibly take that level of value, and put it on something that's untested but you could put it on a private blockchain, and you could create all kinds of ability for different types of intermediaries to now interact that couldn't before. That easily sets you up to migrate into the future. So it's going to be a process of getting there.

Patrick: [00:44:11] Talk about then the relative advantages of a private blockchain. I've spent very little time with guests talking about what that means relative to a public ledger, and why there might be advantages to a private blockchain.

Chad: [00:44:24] Well, a public blockchain just for everybody is basically one that anybody can access the database. Maybe we should define a blockchain here. To me, a blockchain is a database. That's not to diminish it. I mean, it's a really cool type of database. But at the end of the day, it's a database. What you're really determining is who has access to it. Public blockchain is exactly what the name says. It's a public database. Anyone can access that database. You access that database by purchasing some of it. In the case of ethereum, you buy some ether. You're now on the ethereum blockchain.

Patrick: [00:44:54] As a holder of record.

Chad: [00:44:55] You're a holder of record, or you have an asset that's residing on the ethereum blockchain, and you hold it. But anytime you want to send it around, you need to own some of the blockchain. Bitcoin is similar. A private blockchain is slightly different. Someone is deciding who is on that, so it is gated in that way. There's a gating factor which requires some central person, whoever, to determine some gating effect, but anybody who's on that blockchain is now still able to interact with anyone else on a peer-to-peer basis. I think that's still a fundamentally more resilient place than when each step requires a centralized intermediary.

You still have a central person for sure in a private blockchain. Once you're in it, it's P2P. Whereas today, there's no P2P type of intermediation in what is a centralized and private and closed financial system. How do you get to fully public, which I think would be truly the most elegant place to be? You're going to have to get there through a combination of changes in regulation and a change in the technological capacity to handle all these assets on one giant, broad blockchain, and we're not there yet.

Patrick: [00:45:58] Can you talk about gold specifically and PAX Gold and how that all plays in? I think that's just a really interesting example given everything we've talked about.

Chad: [00:46:07] One of the products that we've created, and maybe to even talk about what are we doing that's a little bit different at Paxos, we have this trust, we have a lot of other regulatory approvals that we've gotten, and it allows us to hold people's assets. We hold their assets, and we convince people to hold their assets with us, because you can tokenize those assets with us. You have dollars. We'll tokenize them. Gold, we can tokenize it. We're working on certain types of securities, where you can tokenize them.

Patrick: [00:46:30] Just, again, to make sure it's really understood even at a very simple level, you become a custodian, and then this problem of moving stuff around goes away, because you, the custodian, sit and hold the base, whatever it is, ton of gold or something, but then the tokens that are created on top of this by you can be traded between people much more freely.

Chad: [00:46:49] That's exactly right. You're giving us your assets to hold because you want them to be tokenized, so you can move them around at a different way, and also because we've created a ton of automation tools that allow you to very easily send your assets to us. Frankly, the way financial services works, most people wouldn't believe this, but as a general rule, almost all of it is manual; emails, PDFs, whatever, so we created automation so it's really easy for you to send your assets to us.

Let's talk about gold here. You send me $1,500 and what I do is give you one gold ounce that's been tokenized. Tokenized means that it's on the ethereum blockchain, which is a public blockchain. I think a public blockchain is the right type of blockchain, not a private blockchain, for gold because gold is already a public asset. It's a public ledger. You wouldn't want to stick it on a private one. I think you lose part of the whole point of the value is that it's yours, and so you send $1,500 to me. I send you a tokenized ounce.

That tokenized ounce relates to an ounce that's sitting in a Brinks vault in London, and it relates to the serial number of the bar, so you have actual beneficial ownership of a gold bar in London. You can now take that gold ounce, and you can send it to anybody. You could send it to your dad. You could send it to me or anyone else anywhere in the world. The beauty of this is it's sendable 24 hours a day, seven days a week, instantaneously...

Patrick: [00:48:06] Settles right away.

Chad: [00:48:07] ... settles immediately, and the fees are very low. You're sending it for a couple cents. I mean, what's the problem with gold? By the way, this is probably the problem for almost all commodities; there's a fundamental contradiction - you either own the underlying real assets, or you have something that's highly tradable, and it's a synthetic. Let's talk about gold more specifically, you are either trading in the future for a gold ETF - that's not really gold, it's synthetic gold, - or you have the gold bar, and it's in your backyard. Guess what? You want to go sell a little bit of it. You want to dig it up out of the ground or take it out of some safety deposit box. Someone doesn't just buy it from you. They got to test it. They might melt it. It depends on how much it is. It's not obvious that that is still gold, and so you don't have this capacity to have something that's highly tradable, but also easily divisible and fungible and be the real thing.

This is probably the problem for almost all commodities; there's a fundamental contradiction - you either own the underlying real assets, or you have something that's highly tradable, and it's a synthetic.

Patrick: [00:48:52] What are the ways in which the, say, a future's contract or ETF are insufficient? In what scenarios would that be not a way that you wanted to own something like gold?

Chad: [00:49:01] Well, we can think of a number. Let's talk about it from a number of perspectives. If you really want downside protection, because you think financial markets are going to have a problem, and that's why you want to own gold, well, you don't want to own gold that's a financial product, because the markets aren't working.

Patrick: [00:49:15] It's exposed to the financial system.

Chad: [00:49:16] Exactly. Now, let's take away, that's one real tail risk reason people own gold, but there are other issues too with owning financialized gold. It's only tradable on that exchange. The futures contract is only tradable on the futures markets. The gold ETF is only tradable on the stock exchange that it's listed on. That means you might only be available to trade seven hours a day when the market's open. If you want to turn it into real gold, you can't do that, unless you're a really large institution with an ETF, or you are a really large institution with a futures where you hold enough, and you can get delivery.

You don't actually really get access if you're an average person or even moderately sized institutions to the underlying gold of those products, and you're trapped on those particular markets. They do have a lot of liquidity, but it's not the real underlying asset. If you want to transfer your ownership to some other place, you can't really transfer. You have to basically sell it, turn it into cash and then send them cash, and they have to go buy gold somewhere else, so there's no way to be able to move gold around. You're just getting exposure to the price, which is okay, but there are limitations.

On top of that, you have fees. You have to trade, that costs. If you looked at, for example, PAX Gold here, there's no custody fee. You can hold it with us. They don't charge you at all for storage. You have to pay to get it converted into a token, but now once it's a token, it's yours. You can move it around to anybody in the world, again, 24 hours, 7 days a week immediately. That's just a completely different situation, and it's listed on a variety of different types of exchanges, where you can trade it. They're all crypto exchanges.

You can trade in any size. You want to buy fractions of a gold ounce, and it still relates to the bar. You want to own multiple ounces, hundreds of ounces, you can do that too. If you want to withdraw the gold bar, you can do that. You can actually get ownership of the real underlying asset, so not only do you have it legally through beneficial ownership, you can also redeem it for the gold bar. That's what makes blockchain so interesting for gold but also commodities in general - you're able to now take real ownership of the underlying assets, make it fungible, which means the one ounce you hold and the one ounce I hold, are equal. It's completely divisible down to eight decimal places if you want it to, but you have this ownership; you can put a lien on it, you can get a loan against it. It really changes the way it's used.

Part of, I think, the problem with gold and the reason it stopped being part of the monetary system is that it really - and there's probably a number of them, but I think one important one is - it wasn't able to keep up with the times. Physical metal sitting in a vault could not be mobilized, as inefficiently as the financial system works now, gold is absolutely far more inefficient. Are you going to fly pallets around, or you know what I mean? What are you going to do when you need to move large amounts of gold because there are balances that need to move in big transactions? It just wasn't going to work, but now it could start to work again in that way. We'll see if that's the case, but I think at the very least, this is a better way of owning it if you're just trying to own an outside asset, let alone if it could now become something that the system begins to use as the actual ledger.

Patrick: [00:52:13] Can you talk about a stable coin as well, in the same idea where PAX is like a digital dollar, and what that means and why that's interesting to people, why people should care?

Chad: [00:52:22] Well, if you look at the way the financial system works today, it's based on dollars. I think 80% of transactions have the dollar on one side of it. It's ubiquitous that people are using the dollar. Part of the problem with using dollars is that they can generally only move nine to five, five days a week. It takes days for it to move on international wires. It's costly, and so if you really want a financial system that can be real time, you need to have money move in real time.

Where you've seen this most explicitly is in traditional crypto trading, because those assets are moving in real time. Bitcoin moves 24 hours a day, 7 days a week, but how inefficient is that? I can send you crypto instantaneously, but if you want to send me dollars for that transaction, it could be days - who goes first?

Patrick: [00:53:06] I remember early on when I was playing around with bitcoin that that was the thing for me that was so interesting, that it was actually our friend Bill, who just said, "Okay, now you have this, and it's there, and you could go redeem it, and now send it back to me, and route it through someone in Europe, or do some crazy stuff with it." The feel of it is so interesting. I think that's what the stable coin idea's channeling the same thing.

Chad: [00:53:27] It is. It's similar to the gold product, and that you send me $1,000. I take that $1,000. It's either FDIC insured, or I put it in T-bills, as Paxos, put it in T bills. I send you $1,000 on the blockchain. You can now send it to anybody in the world, importantly, anybody who has an ethereum wallet address. They don't even need to have an account with Paxos. That means unbanked people can now have access to dollars. That's really cool. Anybody with an ethereum wallet has equivalent of a bank account. This is great for unbanked people, but it also just has much higher utility when it's on the blockchain.

Now, what is important is the network effects. There's only so many people who are using blockchain cash. That will grow over time. As that happens, it will grow outside of just the crypto world to be used in payments and FX and remittances, but things happen over time. There's adoption curves. The key part of the adoption curve right now for dollars that are put on a blockchain are for crypto trading, because those assets are already trading at that speed. As more and more assets end up on a blockchain, talking about this concept of $600 trillion of assets on a blockchain, public or private over time, all those dollars need to be on.

There's $5 billion of dollars that have been tokenized, so to speak, but there's $15 trillion of M2, which is the total available amount that could be tokenized maybe. That's a huge difference over time. How do you get from five billion to 15 trillion? It's not going to be because of just crypto trading. It's going to be because assets are on chains and able to be moved and need the cash to move against it. We're at agnostic really to; do people want to use gold, do people want to use Bitcoin, do people want to use dollars. We're trying to create a financial market infrastructure that allows assets to be tokenized and be on a blockchain.

We're at agnostic really to; do people want to use gold, do people want to use Bitcoin, do people want to use dollars. We're trying to create a financial market infrastructure that allows assets to be tokenized and be on a blockchain.

Patrick: [00:55:12] You're plumbing and a rails company.

Chad: [00:55:13] That's right. I think it's a crucial way we're trying to build the business because that doesn't exist right now in the blockchain world, in the crypto world. How can you create an open financial system without the infrastructure that is in place to facilitate an open financial system? That's what I think we're trying to really do differently, and what should hopefully enable this world to be able to exist, because it can't grow up from where it is now. Where it is now is $200 billion of crypto market cap. How do you grow up to a point where you're really changing the way everyone's lives are? I mean, that's the real promise is that you can have a completely different system, but you're not going to get there without having highly reliable institutional grade infrastructure that people can build businesses and solutions and products on.

Patrick: [00:55:59] What is the most interesting challenge that you guys are facing right now? What problem are you deep in learning, trying to solve something?

Chad: [00:56:06] I think, absolutely, it's trying to turn securities into tokenized assets. That doesn't mean necessarily on a public blockchain, though there are private securities that are trying to do that, but also taking public securities and putting them on a blockchain. The reason it's so interesting but also so complicated is there's so much more regulation. It's understandable why there's so much more regulation, because you're talking about one hundred trillion dollars plus of assets are publicly tradable securities, maybe even more. That's really, really exciting. It's really interesting. It's a big market.

Then the other one is real estate. Everyone spends a lot of time thinking about how could you tokenize real estate? Could that remove the liquidity problem in real estate? I think there's two problems in real estate. One is there's a process problem with lots of different middlemen involved, because you have old paper databases if you will.

Patrick: [00:56:51] High transaction costs.

Chad: [00:56:52] Yeah, high transaction costs, title insurance, whatever it is, but it's also trying to change liquidity in real estate. I think that takes time, because we have illiquid small-cap stocks now. I think real estate is like an illiquid small-cap stock. You can improve liquidity, but is it enough? I think you have to solve the process problems in real estate. Those are the two really big asset classes, real estate and public securities. I actually think public securities is more difficult to solve from a regulatory standpoint. I think real estate is probably more difficult to solve because of the process problems.

Thoughts on Cryptocurrency

Patrick: [00:57:22] What else in the cryptocurrency world do you think people should be paying attention to now or even for people that are new to this space? We've been through this quiet period now for, I don't know, I guess two years, and you just hear way less about it. But during that period of time, that chart you mentioned earlier about you can look at the price, or you can look at some of the "fundamentals" of usage or other things, so where do you think people should focus or think about or learn right now?

Chad: [00:57:48] Well, I think yes, so this quiet period, I think, was a nice way to say it.

Patrick: [00:57:52] Nice way to say it.

Chad: [00:57:52] The bitcoin winter here or the crypto winter, now, I've lived through - I think this is the fourth one...

Patrick: [00:57:55] For six of them.

Chad: [00:57:56] Yeah, exactly. I don't even remember how many. Usually, they were always called the bitcoin winter. This is a crypto winter, because things have changed so much. I think you had all these altcoins that were created. What's been interesting to watch is bitcoin predominance.

Patrick: [00:58:11] It's very high right now.

Chad: [00:58:12] It's now high. To define what that is for everyone, what percentage of the $200 billion of crypto market cap is related to bitcoin? It's like 67%, or I don't know how you calculate it - it depends on different ways, 69%, but the low was 25% or 30%. It's literally since January of 2018 till today you have gone from 25% or 30% to almost 70%. The result of that is essentially, bitcoin has gone up, but all these other assets have really gone down a lot. I think that was a really necessary and healthy thing, to be honest with you, because you had a million different protocols get created, and at the end of the day, Bitcoin actually pushed through that.

To me, that's a really interesting sign about bitcoin. You had all these other things get funded, and all these other possibilities get created, but really, nothing has shown itself to have a combination of qualities that makes it better than bitcoin. Maybe they might be better in any individual sense, but it really got tested. I mean, you had bitcoin cash, bitcoin gold, bitcoin SV. You had all kinds of other new things get created and pushed out. I think that's a really important trend - how much bitcoin dominance has gone up.

You had all these other things get funded, and all these other possibilities get created, but really, nothing has shown itself to have a combination of qualities that makes it better than bitcoin.

You can see this through a great fundamental metric. If you go to CoinDesk, and you can go to the research section, and it will show you social engagement, code commits, trading of every altcoin relative to Bitcoin. It's amazing how small everyone is compared to it.

Patrick: [00:59:39] You mentioned infrastructure earlier. I'm always interested in these bubbles that we see through history, a lot of which invite a lot of new capital into a space, and it ends up being too much and the financial returns stinks, but you lay rails or you lay canals, or you lay fiber or X, and then society, there's a consumer surplus - there's a benefit to society because of these new rails due to a lot of speculative investment. Do you think that's happened in this case? Meaning, if we look back on Jan. 1, 2018 through to today, even though the financial return has been garbage, do you think it's fair to say that outside of bitcoin, a lot of good infrastructure has been laid, and things have gotten better?

Chad: [01:00:15] I think things are an order of magnitude better in terms of the talent that's in the space, in terms of the companies that - you look at how many companies are doing custody, how many companies are creating wallet software, if you look at how many exchanges exist, you're significantly overbuilt for what the opportunity set is. You have large companies that come in like Fidelity. You have incumbents that have been in place, whether it's ourselves or Binance or whomever it might be, Coinbase, all these different incumbents that have been there, but it's only for a $200 billion asset class. I mean, it's crazy. In some ways, you have more innovation and more exciting things happening here, then in all these other very large asset classes that exist outside. I think that's because it's an open system, so it fosters a real competitive environment. You're out in the wild. This is not the zoo. This is not some very contained environment. All of that investment that's come through is actually creating a lot of this innovation that, I think, will feed and really hone the ability to create an open financial system.

I think it doesn't necessarily seem like that if you're sitting on the outside, but when you look at what's happening, you can imagine how if the rails end up being blockchains, private and public, who's going to be positioned for that? It's going to be the companies that have really been investing in the space learning all the hard lessons, understanding product market fit, understanding what customers want and what problems they have. It's not going to be a somewhat linear optimization of the current system.

I think that's laying the groundwork for the next Cambrian explosion, hopefully one that's maybe a little more productive than the last one two and a half years ago or something, where you had all these altcoin explosions. Largely, they proved to not be very valuable in their own right, but it laid the ability for us to now have, I think, a much stronger and bigger ecosystem, but it still has a long way to go. If you think about what kind of institutions are involved in the space now, still very few. I think that's actually one of the most bullish things going on is that it's still not that institutional. Just imagine when that happens. I think that would really change things.

Patrick: [01:02:11] One of the reasons I always like talking to you about this stuff is that you do straddle two worlds, and you have the hard fought experience of just being a traditional investor with the curiosity and early experience in this new world. With those two things in mind, two questions left, I'm curious, any other lessons that we haven't covered, either personal because you've been through such interesting things spanning these two worlds, or business that you would leave people with given a very unique career?

Chad: [01:02:37] I think one of the key lessons that I've learned is the difference between a financial service and a financial product. I think, to a large extent, the way the system has been set up, firms have been delivering services. What's really going to change - partly, this will be from blockchain, but partly just as a general trend that FinTech is creating, is how can you deliver products? If you have an open system, and you're creating financial products, I mean, it could drastically change the way the system looks. If you have a closed system, I think you'll still move towards products, but it can happen more slowly because access is so restricted that you're still moving around the edges.

I think that is a really big difference, and it comes down to how you actually organize your entire business, because solving problems from a service perspective is a lot different from how you would organize yourselves - what those problems are, how you organizationally think - than if you're solving for creating a product. I think it's not well understood. It's partly what's driving this change. It's really hard for me to understand how incumbents can change their business when they have 100,000, 200,000, 50,000 employees, and to reorganize themselves to take advantage of this new trend where you could suddenly deliver things an order of magnitude cheaper.

Patrick: [01:03:45] Is there a simple analogy example of a service and a product that you think people could use to think about what that difference means?

Chad: [01:03:51] I think a perfect example would be Amazon versus Walmart. I mean, you basically create a lot of leverage in how you interact with your customers versus having them necessarily come to the store. Another example would be you go into a bank branch versus using your Venmo or whatever it might be. I mean, you're using Robin Hood versus calling up your broker. I think there's lots of examples of that, where it's like, "Here's a product. You are able to use it. It's not about automating the work that a person is doing. It's actually creating a whole different way you're able to interact with the service or product that you had before."

Patrick: [01:04:21] Speed is maybe something to think about. How fast you can iterate on products versus human dependent services.

Chad: [01:04:28] It creates a huge amount of leverage, because you are now creating a software.

Patrick: [01:04:32] Software.

Chad: [01:04:32] It's just software. To be able to do that, you have to have a different way of approaching the problem because the way you're set up now is, at a lot of these large firms engineering is called IT, and they're like a chief administrative officer. You're never going to be able to innovate your way out, and really completely think about how to shift your businesses when you have that much weight of history.

Patrick: [01:04:52] My closing question for everybody is to ask what the kindest thing that anyone's ever done for you as...

Chad: [01:04:56] Let's define kind here. Let's say loving or something. I think I'd have to say my wife agreed to marry me. That's the kindest thing that ever happened.

Patrick: [01:05:03] Pretty good. Well, this has been awesome, really interesting dive back into a place I used to spend a lot of time on the podcast and haven't in a while, so a great update and a really interesting conversation. Thank you.

Chad: [01:05:13] Thanks a lot. I appreciate talking with you.

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