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Trends Watch: Digital Asset Transformation

Sep 2, 2021

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Jeff Dorman, Chief Investment Officer, Arca.

What is your outlook for crypto?

I believe we are in the early stages of a multi-decade secular shift towards digital assets, as the evolution from an analog to digital world has been transformed forever due to COVID-19.  But, unlike the early days of digital assets where Bitcoin was the only game in town, this asset class has now evolved far beyond cryptocurrencies.  There are new sectors that have much faster growth trajectories, like defi (decentralized finance), gaming, sports, NFTs and web 3.0, all of which have completely different factors and token attributes that contribute to their returns. We often compare digital assets to ETFs, in that the underlying structure (a token) is similar to the underlying vehicle (ETFs), but price performance is driven by what is inside the structure, not the structure itself.  Meaning, you’d never hear someone say: “ETFs are down this week,” because that wouldn’t make sense.  Were health care stock ETFs down?  Or were gold ETFs down?  Or were high yield bond ETFs down?  Each of these different types of ETFs are affected by different factors.  Digital assets are similar.  The factors affecting a smart-contract protocol like Ethereum (ETH) are different from those that affecting a cryptocurrency like Bitcoin (BTC) which are very different from those that affect sports tokens (i.e., CHZ), gaming/NFT tokens (i.e., AXS) and DeFi tokens (i.e., SUSHI). The only commonality is that they are all digital tokens which trade peer-to-peer via blockchain.  As more sophisticated investors enter this space, and begin to recognize that the majority of digital assets have real revenues, real cash flows, and real fundamental economic value, price multiples will expand and token prices will continue to rise, independent of what happens to Bitcoin.

What are the greatest opportunities you see and why?

I believe every company in the world will have a token in its capital structure in the next three-to-five years.  Most tokens are essentially hybrid securities -- part loyalty/member rewards program and part quasi-equity, in that a token has a utility within a company's ecosystem (rewards) and also has financial economic value as the company grows revenues (pass-through dividends).  All consumer-facing businesses will benefit from engaging their customers with a token -- from Starbucks, Delta Airlines, Netflix, and Disney to your small local companies like your barber, gym and corner restaurant.  We'll also begin to see the digitization of illiquid real-world assets, like your home equity, your car, and your jewelry.  Ultimately, when every asset becomes digitized and liquid, you'll never need to own cash ever again.  You'll be able to stay 100% invested at all times, borrow against your assets as needed, and pay for common goods using your investments rather than cash.  By bridging the gap between investment vehicle and payment vehicle, digital assets eliminate the need to own cash and bonds.

What are the greatest challenges you face and why?

Education.  Most investors still don't even know this growing asset class exists beyond Bitcoin and Dogecoin, let alone that there are ways to value these assets. Investors that do know this world exists need to challenge their views without assuming others are crazy.  In a recent memo, Howard Marks wrote: “The natural state for the value investor is one of skepticism. Our default reaction is to be deeply dubious when we hear “this time it’s different.”  However, in a world where so much innovation is happening at such a rapid pace, this mindset should be paired with a deep curiosity, openness to new ideas, and willingness to learn before forming a view. The nature of innovation generally is such that, in the beginning, only a few believe in something that seems absurd when compared to the deeply entrenched status quo. When innovations work, it’s only later that what first seemed crazy becomes consensus."  This is how digital asset adoption will continue to flourish.  Digital assets are a speculative asset class with opaque fundamental value, but opaque fundamental value does not mean no fundamental value. It means most market participants don't share the same valuation model for each asset.  This is one of the primary reasons why this asset class is so volatile, and why there's so much opportunity for alpha creation. Helping investors understand the difference between speculation and value is what we live for.  A booming asset class is the result of new investors not only investing their money, but also their time. As more investors learn about this space, they begin to recognize that it is not as intimidating as perhaps previously thought. Arca, for example, does not employ a single software developer amongst our 30+ employees. That’s not a source of pride per se, but rather a reality -- the technology skills once needed to invest in early stage protocol tokens in 2017 have simply become less relevant than the financial skills needed to invest in Bitcoin (macro/trading) and pass-through tokens of revenue generating companies and protocols (financial research/modeling). A tech background has taken a back seat to a finance background, especially pertaining to decentralized finance and other revenue-producing entities.

What keeps you up at night?

We are pro-regulation, and we are hopeful that a regulatory framework in the U.S. is eventually released.  In the meantime, however, this asset class continues to be held hostage by a cloud of uncertainty.  This regulatory overhang is a constant drag not only on returns, but on innovation and growth within the U.S.  It's embarrassing that the U.S. is mentioned on the same "Do not do business with" list as North Korea, Iran and Cuba, but that's where we stand right now until Congress and regulators get their act together.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.

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Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.

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