Asset Backed Specialty Finance Enhanced Through Blockchain Technology

November 15, 2022

In this episode of Engaging Alternatives Spotlight, Elana Margulies-Snyderman, Director, Publications, EisnerAmper, speaks with Kevin Miao, Head of Credit at BlockTower Capital, an institutional investment firm headquartered in Miami focused on cryptocurrency and blockchain technology. Kevin shares with us his outlook for asset-backed specialty finance enhanced through blockchain technology, including the greatest opportunities and challenges. He addresses how the firm integrates DEI.


Transcript

Elana Margulies-Snyderman:Hello, and welcome to the EisnerAmper podcast series. I'm your host, Elana Margulies-Snyderman. And with me today is Kevin Miao, Head of Credit at BlockTower Capital, an institutional investment firm headquartered in Miami, focused on cryptocurrency and blockchain technology.

Today, Kevin will share with us his outlook for asset backed specialty finance, enhanced through blockchain technology, including the greatest opportunities and challenges he faces. He will also address how the firm is integrating DEI.
Hi Kevin, thanks for being with me today.
Kevin Miao:Thanks, Elana. It's a pleasure to be here.

EMS:Absolutely. So Kevin, to kick off the conversation, tell us about the firm and how you got to where you are today.
KM:Yeah, absolutely. BlockTower was founded in 2017 by Matthew Goetz and Ari Paul, both of whom come from institutional traditional finance world. Matthew was an exec at GSAN, Ari Paul was leading risk and working at the University of Chicago Endowment. And their vision at the beginning was really around, how do you build the best in class asset manager for a new asset class. The KKRs already exist, the Apollos already exist, the Bridgewaters, and I think both of them shared this vision that digital assets was a place where they could really make an impact and build a market leader, which I really think that they've done since then.

For me, personally, I came from a very similar background. I was at Citigroup until 2021, where I was running a structured credit trading desk, primarily focused on providing flexible lending solutions to FinTech lenders, both in the private markets, trading public market ABS, as well as doing a bunch of really interesting things on the ABS, CDO, and SIV side of things. So really legacy credits from the financial crisis that were highly distressed coming out of the financial crisis, we would purchase and basically dissolve and restructure into better financial outcomes. So that was a really interesting experience.

Then I left in 2021 to become the Director of Operations at a FinTech lender called Capchase, focused on providing credit to early stage software as a service companies and really doing so in a purely automated API focused manner, kind of like a modern tech company. Really odd to me.

After that, I went to Harvard Business School, but dropped out after a semester because I was recruited to come here at BlockTower to launch a credit fund that is really unique within the crypto asset manager space, where we don't focus on investing in crypto or crypto adjacent companies, we invest in traditional structured credit assets, like what I've been doing and what my team has been doing our entire professional careers, but leveraging blockchain technology and D5 pools of capital to enhance returns for our investors.
EMS:Kevin, very interesting journey to how you got to where you are today. That segues nicely into the next question about the investment strategy you manage, and I'd love to hear your outlook for the space.
KM:A little bit about our strategy is, we back earlier stage FinTech lenders through senior secured facilities or forward flow agreements, very similar to the Victory Parks or the i80s of the world. i80 was actually our senior secured lender at Capchase, for example. And that is the core asset that we really go after.

Now, what we do with that after the fact is instead of going to a Citigroup or a Goldman Sachs in order to restructure this into or remake this into a new structure in which there's a senior and a junior note, we do that through blockchain technology. We securitize directly onto Ethereum blockchain through a partner called Centrifuge, the senior and the junior notes live as NFTs on the blockchain, which is really a lot. I'm sure a lot of people think about NFTs and think about JPEGs and monkey pictures, but we use them to denote senior and junior loans.

By virtue of them being on this ecosystem, they are able to be interoperable with all of the innovation that's happened within the DeFi ecosystem over the last two to three years. So that means being able to draw capital from a partner like MakerDAO, for example, where we have a credit line engaged and we basically use our senior tokens or these senior tranches to effectuate a credit transaction to borrow against it.

It's a really exciting kind of space, and I think really what the opportunity here is for structured credit funds or anyone in this space is the ability for this technology to massively streamline the operations that you have and disintermediate traditional counterparty.
For example, a traditional securitization in the world that we live in today probably has 14 different roles from a calculation agent, a paying agent, a trustee, an administrator, all the way down the list. Code reduces all of that to really two or three necessary counterparties. And what do you get from that? Well, effectively, instead of paying 45 basis points to run a securitization on an ongoing basis, you are going to be able to do that for two to five basis points. And that's a massive efficiency gain in this space. And of course there's a lot of other things that are really exciting about it, but I think for many of the investors listening to this podcast that's probably at the forefront.
EMS:That's very exciting. Kevin, are any other specific opportunities that you're really excited about, or did you want to address some of the hurdles that you come across in this very interesting strategy?
KM:Yeah, I mean, I think definitely a lot of other opportunities out there for this, as I alluded to earlier. For example, if you are a lender, someone like a LendingClub or a Quicken Loans, when you originate a loan, you are going to the capital markets, typically a bank or a bank like Citi, in order to have them purchase your asset, right? You've originated this loan, it might be generating 6-7% yield, but you don't want to hold that on your balance sheet, so you go and execute that in the capital markets.

Now, after you sell the loan as the originator, you never see it again. It's never a revenue generating opportunity for you again. And really what ends up happening is the Citis of the world, the desk that I used to run, we would profit from the secondary trading as the investor who initially purchased it wants to sell it to someone else. Well, we would broker the trade, take a spread. And what I think is really interesting about this technology, or one of the many things that I think is interesting, is if you think about how we denominate or denote our senior and junior tranches, which themselves are, in effect, loans on the blockchain, they're NFTs. And when NFTs, say a Bored Ape or one of these JPEGs that a lot of people make fun of, when they trade around, typically there are royalties associated with the creator of that NFT. So if you created that piece of art, per se, every secondary sale afterwards there might be a 1-10% royalty fee going to you.

Now, imagine that in the case of a Lending Club, where originally all of the secondary trading was part of the profit that Citi would extract from the transaction, that could actually be given back to Lending Club, and Lending Club now has this really interesting recurring revenue that they have by securitizing this asset on the blockchain as opposed to in the traditional system.

After running operations at a lender like Capchase, it's very clear that any type of recurring revenue that you can generate from this asset that you worked so hard to originate in the first place, to find the customer, to underwrite the customer, to make that initial sale, it's a really, really attractive opportunity that's really kind of unique to this ecosystem.

In terms of the challenges, I mean, there are many, it's still very, very early for the crypto ecosystem. I think one of the reasons that I was really attracted to launching BlockTower Credit here outside of, or out of BlockTower, was because they already have five, six years of institutional experience trading, custodying, managing the process, the unique process, of being a digital asset manager or transacting in digital assets today, that is getting easier and easier as the infrastructure is being built out to democratize this technology beyond the earliest adopters who are super fans of crypto.

But it's not quite there yet. It's probably a couple years away. And so today, that's an embedded advantage for us here at BlockTower, because we can do our jobs on the credit underwriting and the credit portfolio management side of things, but integrating with this technology, while we are super interested in crypto and love it ourselves, we're doing it out of an institution that already has all these capabilities built in house. And that's something that would be expensive and time consuming for others.
But at the same time, this technology really won't take off until there are 100 BlockTowers out there doing what we're doing, and we hope to light the way.
EMS:Absolutely, Kevin. Kevin, to shift topics a little bit, DEI is obviously top of mind for the industry, so I wanted to ask you how BlockTower is embedding it into its firm's investment raiment and culture?
KM:It's a great question, and honestly something that I've spent an inordinate amount of time thinking about here. Taking an honest look at, if you think about the pool of employees that are out there for exactly what BlockTower Credit specifically is trying to do, we need people who have both kind of a technical background, not from just a software engineering perspective, but also a deep understanding of structure credit and what those markets look like, as well as an interest in crypto or savviness in crypto.

Both of those ecosystems today are dominated by men, and the intersection of those two circles is even more narrow. And so what we've really realized here at BlockTower Credit is in order to unearth the right person at those intersections, it takes a lot of work.
That is something we have to dedicate ourselves to. We have to commit to doing that. I think it was really easy before coming into this position to say, of course we want to hire women. We want to be equitable. We want BlockTower Credit to reflect what society looks like and what we want society to look like and finance to look like and crypto to look like. But you just make that claim and then don't put in the consistent work to do it, and you realize that you're not going to unearth that person. You're probably going to sit taking the path of least resistance, and that is something we just can't afford to do.

Now, BlockTower as a whole is also, I think, and crypto as a whole, is also wrangling with this. One of our newest VC team members, Winnie Lao, co-hosted a Women in Web 3 dinner in New York City last week where BlockTower was one of the sponsors. Doing more and more things like that, where we can get ourselves out there as an institution, as a brand, that takes this really, really seriously and is looking to bring more women into this ecosystem, not just here at BlockTower, but in crypto in general, if we can help by making the right connections to the right people and however that might manifest.

I think that's what it really comes down to, is getting ourselves out there as loud advocates for more gender equality across the crypto ecosystem, and in particular here at BlockTower, by doing things like the Women in Web 3 dinner, but then also committing to really doing the consistent work necessary in order to find and convince the right talent to come here. Because it doesn't happen overnight, and I'm realizing that every day.
EMS:Absolutely. And kudos to everything you're trying to do to make this a more prominent issue at your firm and in the industry as a whole.
Kevin, we've covered a lot of extensive ground today, so I wanted to see if you have any final thoughts you would like to share with us.
KM:I think this might not be what people expected when they tuned in, because you start off, wait a second. BlockTower is this digital asset manager, and then we're talking about asset backed finance and specialty finance and all of these things. And we really do sit at this intersection of digital assets and crypto and traditional finance. In our case, private credit, that's the type of vehicle that we are.

But the really important thing for us here at BlockTower Credit is we're not investors in crypto. We have crypto exposure in our vehicles, which I don't need to get into here, but we are users of this technology. Crypto, and Bitcoin, Ethereum, Avalanche, Solana, all of these coins, they're highly speculative assets that... It's not in our purview, it's in the other funds of BlockTowers purview to really trade and invest in.

For us, we're users of the technology that enables these cryptocurrencies to exist. And there is a bifurcation that's happening with traditional investors today who are starting to realize that this technology has real implications for finance at large. There's a reason why JP Morgan has their own internal private blockchain. They have their own internal JPM coin. Apollo has been talking about securitization after hiring Christine Moy from JP Morgan. All of the big institutions are looking at this technology, and it's important for all of us to separate that from the crypto assets that dominate the headlines.
EMS:Kevin, absolutely. And I want to thank you so much for sharing your perspective with our listeners today. And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast, when we get down to business.

Transcribed by Rev.com

About 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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