Podcast Summary
Understanding complex markets through a holistic perspective: In traditional markets and crypto, a comprehensive viewpoint is crucial to identify investing opportunities and navigate complexities, potentially leading to significant profits through arbitrage.
Markets, whether traditional like stocks or newer like crypto, come with their unique challenges and opportunities. Principal Asset Management, in the real estate sector, leverages a comprehensive perspective to identify investing opportunities, demonstrating the importance of a holistic viewpoint. Simultaneously, in the world of crypto, market structure is far from efficient, with numerous platforms, vast spreads, and regulatory differences. These complexities create potential for savvy traders, as seen in stories of significant profits from arbitrage. Sam Bankman Fried, CEO of FTX exchange and Alameda Research, brings valuable insights from his experience in both traditional market making and the crypto space, making him an ideal guest to discuss crypto market structure.
From Math to Finance to Crypto: A Career Path Driven by Curiosity and Impact: A background in math and a desire to make a positive impact led one individual to explore a career in finance, where they focused on buying low and selling high. Their curiosity and early recognition of crypto's potential motivated them to make a successful entry into the crypto market despite uncertainty.
The speaker's background in mathematics and a desire to make a positive impact on the world led him to explore a career in finance. During his time at Jane Street Capital, he focused on buying low and selling high. This experience, combined with his curiosity and an early recognition of the potential in cryptocurrencies, motivated him to explore opportunities in the crypto market. Despite the uncertainty and skepticism surrounding crypto at the time, he saw it as a promising area for significant returns. This mindset, shaped by his experiences and goals, allowed him to make an early and successful entry into the crypto market.
Understanding international ETF complexities: To trade international ETFs, analyze historical correlations and use them to estimate non-trading stocks' prices
Trading international ETFs involves intricate complexities due to the different kinds of exchanges and trading hours. These ETFs, which contain stocks that don't trade on the same exchange or during the same hours, require a deep understanding of their underlying assets and the mechanisms behind them. The speaker's team specialized in providing liquidity for these ETFs, even in the most challenging situations, by carefully analyzing price relationships and historical data. So, when trading international ETFs, the underlying stocks might not be trading during the ETF's trading hours. To estimate the price of these stocks during the ETF's trading hours, traders need to analyze historical correlations between different indices, such as the S&P and the KOSPI, and use this information to impute what the stocks would theoretically be doing during that time based on the trading of other equities. In simpler terms, the takeaway is that trading international ETFs requires a deep understanding of the underlying assets and their trading hours, as well as the ability to estimate the prices of non-trading stocks based on historical data and market correlations. It's not a simple task, but starting with the most straightforward and intuitive methods and building from there can lead to success.
Identifying new opportunities in crypto market: Successful professionals continuously seek new opportunities and adapt to changing markets. In 2017, crypto markets offered significant potential due to inefficiencies and high demand, with wider spreads than international ETFs. By 2021, the crypto market matured with institutional participation and better infrastructure, leading to narrower spreads.
Continuous improvement is key to success, even if you're already doing a better job than most. The speaker in this conversation, after a successful stint at Kingstree, felt the urge to make a bigger impact on the world and explore new opportunities. He identified the crypto market during the late 2017 boom as an area with significant potential due to its inefficiencies and high demand. At that time, crypto markets exhibited large price discrepancies and a lack of institutional liquidity, creating opportunities for profit. Compared to international ETF trading spreads, the speaker noted that crypto spreads in 2017 were much wider. However, the situation improved significantly by 2021, with more institutional participation and better infrastructure, resulting in narrower spreads. The speaker's experience in recognizing opportunities and his adaptability to new markets allowed him to transition from traditional finance to crypto successfully.
Opportunities in Crypto Market for Arbitrage Trades due to Extreme Spreads: In late 2017 and early 2018, the crypto market saw unprecedented spreads, reaching up to 50%, presenting opportunities for arbitrage trades. However, the limited ability to offload large amounts of crypto for non-crypto currencies made it challenging to execute these trades at scale.
High-frequency trading (HFT) in traditional markets operates on extremely thin margins, often measured in basis points, which is a fraction of a percent. Competition in this industry is intense, and traders often aim to make a profit of a few basis points per trade. However, the crypto market in late 2017 and early 2018 saw unprecedented spreads, reaching up to 50%, due to high demand in certain regions and restrictions on certain currencies. These massive spreads presented an opportunity for arbitrage trades, but the limited ability to offload large amounts of crypto for non-crypto currencies made it difficult to execute these trades on a large scale. The "kimchi premium" in the crypto market during this period is an example of such an extreme spread.
Crypto arbitrage: Complex and high-risk opportunity: Profit from price differences in crypto markets, but face complex regulations and practical challenges, including limited withdrawals, long verification processes, and money laundering risks.
Despite significant opportunities for profit through crypto arbitrage between different exchanges and currencies, the complex regulatory landscape and practical challenges make it a difficult and risky endeavor. The example given involved trading Bitcoin between US dollars and Japanese yen, where a substantial price difference existed. However, the process was fraught with obstacles such as limited withdrawal amounts, long verification processes, and the need for Japanese residency and bank accounts. These hurdles, along with the risk of being flagged for money laundering, make arbitrage a complex and high-risk proposition. Despite the potential for high returns, the complexity and risks involved limit the number of participants and make it an inefficient market.
The Paradox of High Demand and Limited Circulating Supply in Crypto: Despite high demand for crypto buying, a significant portion remains in long-term holdings, creating large market moves and the need for premiums in futures and other synthetic products to address the lack of traditional sell-side liquidity.
The crypto market, while bullish and dynamic, presents unique challenges compared to traditional financial assets. The HODL concept, where investors hold onto their crypto assets for long periods, coexists with the need for a liquid two-way market. This paradox is resolved by the fact that everyone in the crypto ecosystem is extremely bullish on crypto, leading to high demand for buying more. However, a significant portion of crypto is not circulating in the market, held by investors unwilling to sell. This creates a high trading volume relative to the effective liquidity, leading to large market moves. Additionally, the lack of traditional sell-side liquidity from market makers is addressed by the premiums in futures and other synthetic interest rate products that reflect the forward-looking bullish sentiment in crypto.
Decentralized exchanges present challenges for crypto traders due to inefficiencies, capital intensity, and counterparty risk.: Large amounts of capital are required at each exchange to capitalize on arbitrage opportunities in the decentralized crypto market, where counterparty risk can be minimized with market knowledge.
The cryptocurrency market, particularly in its decentralized exchanges, presents significant challenges due to inefficiencies, capital intensity, and counterparty risk. An interesting example is the acquisition of dumped Bitcoin on Binance, where the trader had to wait for Tether to arrive, highlighting the need for large amounts of capital at each exchange to capitalize on arbitrage opportunities. Counterparty risk, though often perceived as high due to the unregulated nature of these entities, can be minimized with a deep understanding of the market. However, the specter of counterparty risk limits liquidity and creates opportunities for those who can accurately assess the risk. As a major player in the market, the trader, known as a crypto whale, faces liquidity risk and manages it by carefully considering the market conditions and potential risks before making trades.
Understanding Exchange-Specific Liquidity Risk in Crypto Markets: Crypto market crashes can be caused by a ratio of liquidations to price movement, emphasizing the importance of managing exchange-specific liquidity risk in crypto markets.
In crypto markets, acting as a liquidity provider and maintaining a delta-neutral hedged position can help manage risk, but it's essential to consider exchange-specific liquidity risk due to the decentralized nature of crypto exchanges. The March 12th, 2020 market crash serves as a stark reminder of this risk. During the crash, massive liquidations occurred due to margin calls, causing a cascading effect of selling pressure and further liquidations. This ratio of liquidations to price movement can lead to exponentially increasing liquidations and market crashes. The global demand for liquidity during the crisis intersected with both crypto and traditional financial markets, highlighting the importance of understanding and managing crypto market risks.
The correlation between stocks and crypto is growing stronger: Investor perceptions of future inflation, crypto's upside potential and volatility, and the intertwining of equity and crypto markets are driving the positive correlation between stocks and crypto.
The correlation between traditional assets like stocks in the Nasdaq and cryptocurrencies like Bitcoin has become more robustly positive in recent times. This shift can be attributed to various factors, including investor perceptions of future inflation, the huge upside potential and volatility of crypto, and the increasing intertwining of equity markets and crypto markets. A notable example of this can be seen in the behavior of stocks like GameStop, which have seen dramatic price movements driven by social media hype and influencer involvement, rather than traditional financial analysis. Historically, the correlation between stocks and crypto was unclear, but recent events suggest a stronger positive relationship. This trend is likely to continue as more investors view crypto as a high-risk, high-reward asset in a risk-on market.
Stocks behaving like gambling tokens: Extreme market behavior of stocks can be linked to crypto tokens, driven by speculation and popular interest. Market's global liquidity can't fix extreme price divergences, and undervalued companies can be potential buys if their market cap crashes.
The market behavior of assets, like the extreme case of GameStop, can be compared to crypto tokens, where speculation and popular interest drive prices. The moment Robinhood banned buying of GameStop, it crashed, and investors shifted to Dogecoin, which saw a significant price surge. This highlights how stocks can function as gambling tokens. However, the lower bound of equity prices is determined by their discounted future cash flows, but there's no upper limit. The market's global liquidity buyers can't necessarily fix extreme price divergences. The discussion also hinted at the possibility of buying undervalued companies, like Apple, if their market cap crashes significantly, but the trade isn't straightforward. Overall, the conversation emphasizes the volatile and speculative nature of the equity markets.
Investing in crypto through tokenized equity: Principal Asset Management explores innovative methods to invest in crypto, such as tokenized equity trading, creating value through public and private equity and debt investments, and adapting to new market trends.
Principal Asset Management leverages a global perspective and local insights to deliver value in real estate through public and private equity and debt investments. They are actively seeking out opportunities for their clients, even in the crypto space like FTX, where tokenized equity trading allows for investment in companies not yet publicly listed, such as Coinbase. This involves creating cash-settled contracts or tokens that convert to actual shares once the company goes public. However, hedging these investments before listing presents a challenge, as there is no existing market to sell the shares. Potential solutions include owning the underlying equity and converting it to tokenized equity, or relying on the belief that a buyer will emerge once the company lists. This innovative approach to investing in the crypto space highlights Principal Asset Management's ability to adapt and uncover value in today's market.
Managing taxes in crypto market: Unanswered questions and complexities: Crypto taxes present unique challenges due to airdrops, staking, and other factors, requiring new thinking to effectively manage
Managing taxes in the crypto market is a complex issue with many unanswered questions. While it's relatively straightforward to treat gains and revenues from trading or exchange fees as income, the situation becomes more complicated with unique crypto assets and their associated tax implications. For instance, gaining tokens through airdrops or staking with lock-up periods presents challenges in determining taxable events and realizing gains. The world is not yet ready for these complexities, and new thinking is required to effectively manage taxes in the crypto market.
Historical significance and safety perception fuel Tether's market dominance: Tether's first-mover advantage and perception of safety in certain regions have contributed to its continued dominance in the stablecoin market, despite concerns about regulatory status and auditing practices.
Tether's persistent dominance in the stablecoin market can be attributed to its historical significance and the perception of safety in certain regions. When cryptocurrencies first gained popularity, exchanges needed a solution for customers to convert their cryptocurrencies to fiat currencies. Banks were reluctant to provide services to crypto businesses, leaving Tether as the go-to option. Additionally, in some regions like China, the perception of government regulation as a safety feature is the opposite of the reality. Tether's offshore status and lack of regulatory oversight make it an attractive option for some users, despite concerns about its regulatory status and auditing practices. Overall, Tether's first-mover advantage and the perception of safety in certain contexts have contributed to its continued dominance in the stablecoin market.
Crypto and Traditional Markets Converging: The crypto market is intertwining with traditional finance, enabling cross-asset trading and introducing new complexities and risks
The crypto market is becoming increasingly interconnected with traditional financial markets, with platforms like FTX enabling cross-asset trading between crypto, equities, and fiat currency. This intersection is leading to new market structures and trading opportunities, but also introducing new complexities and risks. For instance, the ability to use one asset as collateral for another can lead to significant leverage and potential linkages between seemingly unrelated markets. Additionally, the rise of tokens like FTX's own, which have substantial market caps, adds another layer of complexity to the traditional financial system. Overall, this melding of the crypto and traditional financial worlds is a notable trend that is only expected to grow in significance as time goes on.
Market turmoil tests Bitcoin's role as a safe haven asset: During market instability, Bitcoin's connections to other assets like stocks and bonds could strengthen, testing its safe haven potential as a diversification tool
During market turmoil, the connections between different assets, such as stocks, bonds, and Bitcoin, can become increasingly interlinked. In times of crisis, investors may sell off various assets to secure liquidity, leading to tighter linkages between them. The ultimate test of Bitcoin's thesis as a safe haven asset could come during a significant market sell-off caused by inflation shocks or scares. This would provide insight into Bitcoin's role as a diversification tool in times of market instability. The Odd Lots podcast discussed this topic with Sam Bankman-Fried, and they also mentioned the upcoming Money Stuff podcast, which will explore finance news and trends in-depth.
