Where’s the value in Crypto?

Headshot of Paul Foley, CTEX Markets CEO

Stewart: Where is the value in cryptocurrency? I'm Stewart Foley, this is the Insurance AUM Journal podcast, and I am a crypto skeptic, I think, to start it off. We are joined by an expert in this field, who's got a great last name, his name is Paul Foley. Paul, welcome.

Paul: Hi, Stewart, thanks for having me.

Stewart: We are thrilled to have you on. And so, I have a lot of friends that are into crypto and really like it, and some in the insurance asset management industry, some outside of it, and I was fascinated to have you on, because we started talking about this and I started being a skeptic and you weren't really ruffled by it, and I'm like, "You'll be a great podcast guest to walk our audience through this, what seems to be the wild West to me." So, can we start off with, what constitutes value and can you give me some examples?

Paul: Sure, okay. So, when we consider the value of an asset, we consider a number of key characteristics, say five. And to illustrate it, I'll explain in terms of fiat and gold, because they're assets that everybody knows and understands. So, the first characteristic is scarcity, so there should be a limited amount of the asset. The second characteristic is durability. Can an asset be destroyed? The third is safety. Can an asset be copied, faked or devalued in any way? The fourth is utility, so an asset should have some kind of use. And obviously, the final one is portability. It should be possible to transfer ownership or part of an asset. So, these are the five characteristics which determine value.

Paul: So, let's look at those in a little bit more detail. So, first of all, scarcity or demand. So, both cash and gold, USD for example, have a limited supply. Gold, because it has to be mined and refined and fiat, obviously, because it has to be issued by the government. And obviously, if you find a lot more gold or issue a lot more fiat, it's instantly devalued, because there's more available. Now, in terms of durability, we know that gold being a precious metal is pretty hard to destroy, cash on the other hand is not hard to destroy, but both of these items or both of these assets have value until they're destroyed. And obviously with fiat, banks can guarantee them to a certain extent, so you're even insured against the risk of destruction.

Paul: That takes us on to safety. So, for cash, people try to counterfeit bank notes, it's not easy, but it is possible. The complexity of bank notes increases and it makes it harder to counterfeit. So fiat, although it can also be devalued by inflation, is relatively safe. We then come onto one of the really defining characteristics and that's utility. A stored value should have a purpose. In the case of gold, it's typically purely as a stored value and way to protect yourself against currency fluctuations and to protect wealth, whereas for fiat currencies, the utility is specifically related to the ability to perform trades, to buy and sell services or goods.

Paul: And that takes us on to portability. So, in order for gold or fiat to have any value, they must be perceived as being of value by other people. And also, other people must be able to take ownership of them. So, we take cash for granted. You walk around, it's portable, because you go to a store, you pay for something and you hand over the cash. So, these are the five sort of characteristics that in my book constitute what is behind value and it's these characteristics that help us to establish the value of an asset. So, when we talk about fiat, there are other underlying reasons why $1 is worth X in another currency, but for now, these are the characteristics that I believe are important.

Paul: So, now that we've talked about the characteristics of traditional assets that we're all familiar about, let's consider digital assets. And for demonstration purposes, let's specifically consider Bitcoin, because Bitcoin is the one that most people are familiar with or have traded themselves. If we look at the market activity, we see that this is potentially the number one traded coin. Today for instance, there was $59 billion worth of Bitcoin traded, so people must think it has some kind of value.

Paul: So, let's go back to those five characteristics. So in terms of scarcity, there should only ever be 21 million Bitcoins in circulation. In terms of durability, Bitcoin can't be destroyed. You can lose access to it, but it can't be destroyed. In terms of safety, it can't be counterfeited. It can be devalued, but it can't be actually copied. And in terms of utility, Bitcoin is currently a store of value like gold, but it's starting to be used as a currency. And in terms of portability, it is possible to transfer BTC to anyone, anywhere in the world, as long as they've got a Bitcoin wallet.

Paul: So for me, that would illustrate why it is that Bitcoin has value, because it does embody those five characteristics of value. And we see that, as demand increases, also the value on the market increases. So, the question where's the value, is exactly the same as asking the question about USD or GBP. Does that make it a bit clearer?

Stewart: Yeah and no, I got more questions. First, let me ask you this question. So, you are the CEO and founder of CTEX Markets. First of all, we have no financial relationship whatsoever either way, so let's just get that out there, but what does CTEX markets do?

Paul: Actually, we fulfill a role which people take for granted in the traditional market spaces. So, in the traditional asset manager, portfolio manager world, when institutionals wants to trade between venues, they typically have a direct relationship with their bank and the bank acts as a liquidity provider. Behind the scenes, the bank is going to anywhere from five to 20 other sources, so that when you place an order for say dollars or shares in IBM, they can go to one of these providers, get the best bid and ask price and present you as the client with the best bid and ask price.

Paul: Now, in the digital asset world, this is really missing at the moment and my background is real time trading systems, mostly currencies, both institutional and retail. So, it was instantly apparent that this was missing from the market, so that means that typically in the digital asset space, one client is trading with one venue, so the best bid, best ask is just what happens to be available right now. So, what CTEX Markets does is, we fill the gap of the liquidity provider. So, we bring together all of the different venues that you could be trading at, so that you, as a trader, are capable of getting the best bid, best ask across the market. We do a lot of other things as well, but we're primarily a liquidity gateway.

Stewart: Interesting stuff. So there are, and we're going to talk about this more, I think, as we go, but there are a litany, everybody knows about Bitcoin or has heard of Bitcoin, I think, but do you have a sense of... I mean, there was just another digital currency just got launched. I did a Google search and this is nothing new. This stuff happens all the time. Do you have a sense of the order of magnitude of the different Bitcoin or digital asset alternatives that are out there?

Paul: So, when we look at the other coins out there, we have to consider their utility. So, there are two real other use cases out there at the moment besides store or value, and that is stable coins and government coins. So, stable coins are typically backed by a physical asset and they basically represent a real world value. So, perhaps one of the most famous of these is USDC. And the beauty of USDC is for every USDC token that exists, there exists one physical dollar and people that are on the USDC network, which are typically regulated entities, when they take custody of a physical dollar, they're allowed to mint or create one USDC. And likewise, when they get rid of one USD, they're then able to burn or destroy one USDC. So, that means that one USDC is always equal to between 99 cents and $1 and a cent, so it's called a stable coin.

Paul: So, its value is being a representation of the fiat currency. It has a number of benefits. So, one for example is, if you imagine when we do a typical trade, it's measured in terms of T plus something. So transaction date plus one or two days. When we do a transaction in USDC, the transaction date and settlement date are the same thing, because obviously the transaction or the settlement transaction takes potentially minutes or maybe an hour in the worst case scenario. So, rather than incurring fees to send from HSBC to JP Morgan around the world, you send it out on the network, incur a lot less fees and your transaction is complete a lot quicker.

Paul: So, the second type of coin is government's coins. Imagine you've bought shares in IBM, Swisscom, Credit Suisse, every year they have an annual general meeting and you as a shareholder get to go along to that general meeting and vote on certain things. This is essentially what governance tokens are recreating but in a digital world. Now, you might wonder what's the purpose in that? Well, there's a lot of sites out there in the DeFi or decentralized finance arena that will onboard other crypto assets based on the feedback of the community. So, anyone who's got the coins of that community is allowed to vote. This means that if you've created your own coin today and you wanted it listing on a number of DeFi sites, all you'd have to do is either convince people to vote for you or if you couldn't be bothered, just go and buy the coins, either the governance corns and vote for it yourself. So, that's what governance tokens are for. It's all really part of the DeFi movement at the moment, though.

Stewart: That is an interesting... I mean, I guess where I go, is back to kind of my economics education underpinning and the idea that a fiat currency is, in the United States, US Government says, "These pieces of paper," and that's what they are, they're pieces of paper, right? "These pieces of paper have value." And they assign a value and then they create the stuff, they take it out and they have control over that, right? And part of that control is monetary policy.

Stewart: There's this currency tied to a nation state and a central bank and so on and so forth, and that sort of thing doesn't exist in crypto land, right? And where my mind goes at that point is, you had mentioned, this can't be replicated or can't be counterfeited, and the skeptic in me goes, "Man, there's a lot of smart computer folks out there, are you sure?"

Paul: Yes, and the reason that it can't be replicated or more accurately, can't be duplicated, is because the basic premise behind digital assets is that it's held on a distributed ledger. So, that means everybody that is maintaining this distributed ledger has a copy of every transaction. And if you look back at all of the transactions, say you held in your hand or in your wallet today, one Bitcoin, you would be able to look back by doing chain analysis, to see where your coin had come from, who had touched it, where it have been and trace the history, if you like, of your Bitcoin all the way back to the point at which the network was turned on.

Paul: And the complexity of the mathematics behind this and effectively the elliptical security model around it, means in order to fake or create a duplicate BTC, you would have to convince, I think it's half or 60% of the nodes in the platform, that you've done something correct. So you can't just hack one node, you'd have to hack literally hundreds of thousands of them, so this is why I think it's actually safer than physical paper currency.

Stewart: Interesting. Interesting stuff.

Paul: There was another point you mentioned, you mentioned that based on economics theory, paper money has a value, because a government says it has got a value.

Stewart: Right, fiat currency by definition, right?

Paul: Yeah. Now, the skeptic in me, especially when we look at the US economy, would say, "What is behind that notion of value? What is it that tells me as an investor, that if I hold $1, it is actually worth anything more than a piece of paper that I just picked up off the floor?"

Stewart: What I always tell my students is, it's because everybody else does. I mean, that's really, the US Government says, "This is what we're going to use." And then we all agree to that, right? And I guess in crypto land, there's a certain amount of that as well. I mean, there's got to be some community buy-in that there's value. I mean, sometimes I feel like I'm completely out on a ledge someplace. I don't know, maybe I'm wrong, Paul. Drag me back, drag me back into the boat.

Paul: My point actually was, it's exactly the same. If you imagine a room full of politicians, I mean, let's not get into the details of that, but a room full of politicians, it's effectively a small community. And I guess at their heart, they believe that they are representing a wider community.

Paul: If we then compare that to, say, the Bitcoin community, again, it's a group of people that at their heart believe they represent a larger community. Admittedly, they think they represent a larger community than the politicians, but still, it equates to the same thing. So, my argument is, why would you distinguish between fiat and digital assets? Unless of course your only constraint was, it must be geopolitically backed.

Stewart: Absolutely, and I guess that leads me to the next thing, which is, do you see or do you think that central banks are threatened by the proliferation of all this crypto?

Paul: Well, actually, that's a potentially very dark question that you're alluding to, because obviously the next question is, what's wrong with central government issuing their own digital currency? And to be honest, this is a very, very dark subject when you think about it, because it raises the question of complete and utter state control and oversight. Because if you imagine Bitcoin, it's not geopolitically motivated, it's a community endeavor, which is maintained by the likes of you and me.

Paul: When we consider a digital currency that's owned by China, for example, then it is a means of control, because with a digital currency, you can restrict who has access to it, where it's possible to spend it, what is possible to spend it on. And when you consider that in the context of other factors such as an individual's social worth, then suddenly we're looking at something the likes of which the planet has never seen before, which could turn very bad, very quickly. So, I believe governments do see it potentially as a risk, but typically, from a taxation perspective. Whereas we as individuals should see digital currency issued by a state as a significant risk to our freedom and wellbeing.

Stewart: I think that's an amazing angle and a very interesting perspective, interesting lens through which to look at this. Given that the tax issues and the lack of central government control, does the use of crypto for transactions lend itself to unsavory activities paid for by Bitcoin or some other crypto? Is that a reality or is that just something that is not a real thing?

Paul: So, I think, perhaps a few years ago, maybe that was the case, but now with just a little bit of regulation, it's not. And there's also the advancement of technology around chain analysis. Now, remember earlier I mentioned that you could trace your Bitcoin back to the start of a network. Well, there's something called chain analysis. So, if we imagine your one Bitcoin that you've bought, previously it belonged to 10 different people, at 0.1 Bitcoin each. Three of them were terrorists, one was a drug dealer and six of them were just normal people like us. Now, with chain analysis, what is possible to do is for the receiver of the Bitcoin to have a look back to see where that currency came from and to say, "Oh, 40% of this came from sources that I'm not happy with." So, the bank or institution that's handling your transaction can actually, from a compliance perspective, refuse to accept the transaction or refuse to allow you to further spend it.

Paul: So, as time proceeds and people like the FBI and the different intelligence services and financial services companies around the world become more familiar with the blockchain, they are linking people and institutions to wallets. I mean, this also touches on the legend, if you like, that the blockchain is anonymous. For some coins it is, but for most coins, it isn't. So, once the owner of a wallet is known, it's known and it's out there in the public. So, it might be that someone doesn't know exactly who you are, but they can see who you've been dealing with and who else has been dealing with you and link you in directly to that. And I think the other way in which we're moving away from the wild wild West is when we consider things like the travel rule.

Paul: So, at the moment, if I send you one Bitcoin from one institution to another, with me and you as being the end customers, the institutions that are sending and receiving are obliged to check who is sending the coin and who is receiving the coin. So if you're a politically exposed person, my institution should not engage in a transaction to start with. And your institution, if they see that I'm a politically exposed person or worse, they shouldn't engage in a transaction either. So, by adding a little bit of regulation, reducing the overall anonymity for most digital assets, we are ensuring that the market becomes cleaner and cleaner. And, dare I say it, more likely to be in a state that could be of interest to the Tier 1, Tier 2 banks and other high level institutional investors.

Stewart: I'm learning so much. I always say this in every podcast. I learn more than anybody else on these things, because I'm really fascinated by that idea, but let me take you back to the point you raised a minute ago about state control. So, the fact that more people can know who I am, does that raise anybody's antennas to say, "Gee, I'm subject to more state control at that point." Does that make sense or am I... I am learning, Paul, but it's slow.

Paul: In the Western world, do you care if people know that you're spending money? When you take your credit card out of your pocket?

Stewart: No. No, no.

Paul: Because obviously, in a typical transaction, you go to a store, you take your credit card out, whatever you spend, the credit reference agencies know about it inside of a few hours or a few days.

Stewart: Absolutely.

Paul: And that's a really big market and they resell that data to anyone and everyone. So, you've already lost control of your financial data, you probably just didn't do it consciously. Now, with Bitcoin as an example, if you're behaving properly, do you mind who knows that you own some Bitcoin?

Stewart: No, and it makes me feel better about who else owns it.

Paul: Exactly.

Stewart: I want to know that, and I'll give you an example. So, the shot heard around the world in the insurance business was when MassMutual made a big allocation to crypto. And I think it raised a lot of people's attention, right? So, you're beginning to see, I think, one of the things that's happening with crypto, and you mentioned about Tier 1 and Tier 2 banks, is the acceptance by large, well-known institutions with great reputations and so forth. So, it does seem to me that the acceptance is moving quickly into the more mainstream idea and the five points that you brought up earlier in this podcast is a powerful argument to me.

Stewart: I really think that is really helpful, particularly for people, I know there's people in this audience that aren't... They don't know crypto, like I don't. That sort of explanation is really helpful. I just saw recently, I learned about NFTs and that a PDF file, I know I'm over simplifying this, Paul, this is why I throw out the outrageous stuff and you straighten it out, a PDF file just sold for 66 million bucks. And I'm like, "I'm in the wrong business. I got to get in the business of making PDF files." But that's not what it is, right? It is different than that. What are some other digital assets that have value, but differ from the utility in Bitcoin, for example?

Paul: You mean in terms of NFTs, non-fungible tokens?

Stewart: Any of it. Yeah, I mean, if you want to talk about NFTs, that's great. If you want to talk about something else, that's great too.

Paul: Okay. So, the reason that the NFT market is of interest at the moment is because people have just realized that they can effectively tokenize physical world assets, such as art or sports cars. Now, when people tokenize these assets, it's not a case of the person with the most tokens gets the sports car sitting in their driveway. It is a case of, they just own part of an asset. So, if we consider the Mona Lisa, for example, you wouldn't actually own the Mona Lisa, you just own a portion of. I mean, it's kind of comparable to buying shares in IBM.

Stewart: Yeah, or in the securitized market, I mean, we've been securitizing cash flows from credit cards and automobiles and home loans and commercial mortgages and everything else has been securitized and the idea of that is very familiar to our audience and tokenizing is a different word for the same thing, basically.

Paul: I guess the other interesting thing about the NFT market, especially when we looked at art or collectibles, is when you own the NFT, you own the right to use that image. So you're effectively also purchasing, for lack of a better example, the copyright to use it, not actually the ownership of the item, but the rights to its image.

Stewart: Interesting stuff. So, at the end of this deal, and we're a little long on time, but I want to talk about this. You had mentioned to me when we first talked about ways that investors can be involved in this market, other than just making a direct allocation to a cryptocurrency. Can you just talk about ways that investors can get involved?

Paul: Well, there are the sort of traditional routes that we think of. I mean, when you think of asset management, you obviously go the route of managing people's money and typically that involves the investor depositing funds with the asset manager. Well, crypto, because it's intangible in that it's digital, facilitates the option to trade on the client's venue. So, one of the real benefits of the sort of asset management arena with digital is that you, as the client, don't necessarily have to deposit funds with anybody else, so your funds stay safe on the venues where you have it, and you then allow the trader access to your venues in order to trade on your behalf. And obviously, for smaller investors like you or I, potentially not that much of a big deal, but for institutionals where we're talking about hundreds of thousands or millions, then it becomes more of a risk awareness issue.

Paul: The other options are around the DeFi movement, but to be perfectly honest, that's a couple of hours all on its own, because that gets really interesting, but really complicated. And for people that are in the traditional asset management or portfolio management space, the traditional ways of managing money are possible with crypto. So, it's not really a big jump. I mean, comparably speaking, this is the same as someone approaching an existing asset manager and saying, "Hey, there's a new share coming out tomorrow, there's a new company that's just been listed. Do you want to invest in it? Where do you want to invest in it?" It's actually a lot more simple than you would imagine.

Stewart: That's really cool. I've loved this and we've got to have you back. I would love to talk about the DeFi market. I'm fascinated by that too. But, one thing on the way out the door, and we always ask our guests this question, this is the ask me anything portion of the program, Paul, which you probably weren't aware of was coming, but here it goes.

Stewart: So, I teach, I have friends that teach, I'm involved with a lot of college students, right? And so, I want to take you back to your graduation from your undergraduate institution, okay? Graduation day. Now, regardless of what festivities happened the evening before, you are bright eyed and bushy tailed and looking fantastic in your cap and gown, and you're getting ready to walk across the stage to get your diploma. So you wait, wait, wait, but you don't have to wait too long, because your name's Foley and it starts with an F and you're up there and you go across, everybody's happy, they call your name, crowd goes crazy. Quick photo op down the stairs and at the bottom of the stairs, you run into Paul Foley today. What do you tell your 21-year-old self?

Paul: That's an interesting one. I put my hand on his shoulder and I let him know that the effort will be worth it. The corporate turnaround projects are worth it, the travel across Europe to different clients will end up with him having a beautiful wife and family, so stick it out. And the final thing that I'd leave him with, just before letting him walk away, looking all confused and puzzled was, "Oh, and by the way, there's going to be this thing called Bitcoin in a few years time, buy it. Buy as much as you can stuff your pockets with."

Stewart: Buy it with both hands. I love it. I love it. Paul Foley, it has been a pleasure, my friend. Thank you very much for being on.

Paul: It's been my pleasure. Thank you.

Stewart: We'd like to thank you all for listening today. If you like us, please follow us on all the major platforms. If you have ideas for podcasts, please email us at podcast@insuranceaum.com. My name's Stuart Foley, and this is the Insurance AUM Journal podcast.

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