Adam Back (00:09:11):
Yeah. I mean, the other thing that I think some people were misunderstanding is they thought that this would be bad news for miners economically, that they would become less profitable immediately. And actually that’s not the case. They actually became slightly more profitable to mine. So they were sort of operating like trading based on an inputted understanding of reality.

Adam Back (00:09:34):
So, and the reason that is, is because it’s true that the amount of coins across the whole network, there’ll be less less blocks are left. Therefore, less coins per day, so less profit is going to minors. But for the people, the difficulty doesn’t adjust during the two week periods. So if you are mining with a X of hash role, try to hash some amounts, your expected points per day are the same because you’re expending the same work and the difficulty is the same. So you’ve got a lot of variance, but your expected blocks mine per day is unchanged. And then as we saw the fees went up.

Plan B (00:10:11):
Yeah. So the fees kind of kicked in.

Adam Back (00:10:14):
So it got a little bit more profitable because of the fees. And then as Plan B just said, within about two weeks, the difficulty will actually drop and then it will get even more profitable. I mean, the fees will probably normalize, but you will be expending less work per block. So you’ll get more Bitcoins per week as a minor and then presumably in the next period because they… If you listened to CoinDesk article, they were saying that we’re expecting that power station to be operational again within a couple of weeks and presumably the difficulty will come back up again and we’ll be back to where we were in a little bit later. But it really was almost nothing, and actually ironically is more profitable for us as minors. Our profit went up a little bit and will expect it to go up even more next week. And if there are really people selling in the market because they think that we’re making less profit, they’re not understanding that difficulty doesn’t change in real time, I guess, is the point, right?

Preston Pysh (00:11:11):
Adam, would you think that… I’m just looking at it and whenever I talk to somebody who has a lot of mining experience, who’s actually done it, they tend to look at this very differently than somebody who has never participated in the mining. And they’re just somebody who’s looking at the price action and trying to trade it because in my opinion, you’re somebody who actually kind of fundamentally understands what’s driving the price action. As long as we have more and more miners showing up and the hash power just keeps going higher, from a business standpoint it just tells you they’re showing up and they’re performing these actions because they’re making money, right? They wouldn’t be showing up and doing these things if there wasn’t a profit incentive there for them continue to do it. And so I’m assuming you see it the same way. What are some of the other things that you think that people miss that don’t have that background or have that experience from a mining perspective of looking at the holistic picture of what’s going?

Adam Back (00:12:08):
There has been a pattern going into the halving, where people will resurface the mining death spiral theory which never happens. And I think this debate is the halving priced in, which is a fascinating debate. But now at least the minus certainly know that the hash rate’s going to drop and the number of coins they get per block is going to change. And that’s going to push some miners out of profitability, and people are buying miners with a maybe three year planning horizon of how long they’ll operate it before they’ll upgrade it. So if they’re buying a year or two before the halving, they they’ve factored that in basically. And some miners are also not selling coins, so that’s what we tend to do and what we packaged into the Blockstream Mining Note instrument as well. It holds the coins for the period it’s pre-funded.

Preston Pysh (00:13:02):
So talk to us about that period of time right before the halving. Everyone had their opinion on whether it was priced in, whether it wasn’t. Clearly, it was not in my opinion. And so the halving happened and then as a person who’s running a mining operation, did you have to shut down rigs because of profitability at that point for, call it… Because we had the halving event in May. I think it was May 11th. So when we got into June and July, the price action for the most part was kind of going sideways there. As expected for the first quarter, were you half in the shutoff rigs? Or were you still profitable even through that period of time to keep all of your rigs online?

Adam Back (00:13:43):
Yeah, we were profitable. What tends to happen is the least efficient operators will turn off. But I think the other thing that probably surprises people is there’s a big kind of gap between you’re going to make a decision to invest and buy more equipment and put it online now. In order to be incentivized to do that, you’re going to want to see a certain period of projected return or a certain value of Bitcoin mine versus electrical cost in a ratio of that. And then if that gets to a good point, you’ll do the investment, but once you’ve made the investment, so some costs, and then there’s another threshold, which is when would you switch this equipment off? Temporarily or permanently? And that level is far, far lower. So you might say well, under these conditions, if we didn’t have these miners, we wouldn’t buy them right now. As you have them and they’re making more Bitcoins than electrical costs, your cost of mining Bitcoin is some discount to current price of Bitcoin.

Adam Back (00:14:42):
You’re obviously going to keep doing it to slowly recoup your original capital expense or reduce your paper loss. And I think the other thing is that… And this is why it’s, in my opinion, generally not a good idea to sell Bitcoins as you mine them to pay the electricity bill, that you will tend to mind more Bitcoins during a period like this where some people have turned off. So you’ll have a lower discount on the mined coins, but you’ll continue to mine coins. And so I suppose it is kind of like buying in a bear market. If you could do a cost averaging, you’d get more coins. So it’s a bit like that, right? So I think if you were selling coins to pay electricity bills, when you’re in that kind of bear market for mining period, you’re selling a bigger proportion of the coins for power.

Adam Back (00:15:29):
Obviously you want to… A Bitcoin is fungible at the end of the period when you look at how many Bitcoins will be mined, so it’s unfortunate to be selling a big ratio during periods you want the ratio to be flat, and you can control that by setting aside the capital to pay the electricity bill before you start. So if you’ve got a hundred thousand dollars to invest, don’t buy a hundred thousand dollars of miners and then be selling the coins each month to pay electricity bill, but buy $50,000 of miners and use the 50,000 to pay the electricity bill. And I would argue you’re actually going to make more money using that second approach because you’re going to able to keep all of the coins and not be selling them, not be forced to sell them at disadvantageous prices in this full-time market.

Preston Pysh (00:16:13):
Plan B, I’m kind of curious if you have any thoughts or questions you want to throw in on this particular topic.

Plan B (00:16:20):
Maybe about the Blockstream Mining Note because I think that’s a very interesting concept and very interesting structure. I’ve done a lot of structure finance in my twenty-five years career, setting up SPVs, putting assets in there, and then selling to bonds on those assets. The Mining Note, so the Note is such a structure. Actually, you can make structures of everything that has a cash flow. And in a way, just disregarding how it’s done actually, but strategically it’s an important step because we’ve seen this trend of miners going from CPUs to GPUs to ASIC chips. Right now, yeah, one of the things that maybe restricts the further growth of miners is the funding of these professional data centers, right? It’s a lot of money in involved in those professional mining centers and the way the Notes fund the mining operation is very clever. So you have to invest in the hardware. You have to invest in the electricity as well.

Plan B (00:17:27):
If you package those cash flows and put them in a Note that pays in Bitcoin, you have something that is very attractive for investors, but especially for Bitcoin investors, the investors that are already in Bitcoin like me. I will look at it like a Bitcoin investment. So the Note is $200,000, that would be like four Bitcoin right now investment and you get a return in Bitcoin as well. So you could see it as a physically settled derivatives contracts as well. It’s all Bitcoin. It’s Bitcoin then, Bitcoin now. So there’s Bitcoin price neutral in a way. I didn’t really do all the analysis, but if you do the rough calculations, you get, you get a certain percentage of the network power. I think it’s 0.0015%, something in that neighborhood of the network power. So you get around that percentage of the newly Bitcoins as well.

Plan B (00:18:25):
And it boils down to break even in about a year. And then at the third year, you earn more. You’re in your return. And it boils down to doubling the amount of Bitcoin in those three years, maybe a little less, maybe a little more, hash rate of course being a certain factor.

Preston Pysh (00:18:44):
But from a volatility standpoint, when you’re looking at those coupons that are accumulating, and I know the payout, the way at least Adam has his structured it, it comes at the end of the three years. That is a lot of stability in those coupon payments that you see sitting there and escrow, and you’re not seeing the wild volatility with returns that… I mean, based on the returns that we’re talking about is assuming that that all of this continues into the future, based on what we expect to see, I mean, those returns are astronomical compared to anything else out there.

Plan B (00:19:21):
That is a lot better than BlockFi. I mean, if you put four Bitcoins in, you get eight plus or minus one Bitcoins out in three years, and that’s more than the 6% Bitcoin to Bitcoin.

Preston Pysh (00:19:33):
But I don’t know that that’s an apples to apples comparison because with this, you would have to sell the Bitcoin in order to procure or purchase the Note, correct? It’s not like you’re able to avoid the tax burden that’s associated with your deposit through a borrowing and lending platform.

Plan B (00:19:53):
I don’t know that actually if you can buy with Bitcoin as well.

Preston Pysh (00:19:57):
You see what I’m getting at, Adam, is we’re comparing those two different ways to kind of employ your Bitcoin. One, you’re depositing them and you’re collecting interest on it, but you never have a tax burden for the sale. But how could something similarly be done through the procurement of the Note so that you don’t have a taxable event? Is something like that possible?

Adam Back (00:20:23):
Kind of general tax planning question. I guess you might be able to get a secured loan against Bitcoin, then you wouldn’t have sold it and then pay off the loan or something.

Preston Pysh (00:20:35):
Yeah. That’s true. You could do it that way. So you’d borrow against it. And then with the money that you borrowed, you could procure the note. And you know what would be really interesting? I’d be curious to know if the return that you would expect to get out of that over a three-year period of time based on the interest that you would be paying against, whether that would marry up against the risk-free trade that we’re seeing in the spot contango trade. You would have to run the numbers.

Adam Back (00:21:03):
On average, yes. Of course, everything is volatile in the Bitcoin space. Now I’d say that the Note is generally lower volatility. It has a lower Z-score because you have some kind of discount dollar cost averaging behavior that’s interpretive behavior just due to delivery of new equipment. If the price goes up too fast, that takes a while to backfill the equipment. And that’s the current state of the market. Shortage of miners, surge price compared to norm, difficulty to get new minors, so therefore higher profitability per joule, per kilowatt hour in. So I think the average over the period, it reduces the volatility as compared to buying. And it still has a pretty good upside participation like about 60% upside participation average. We did sort of back tested periods across every 36 month period for some years going back towards the early ASICs.

Adam Back (00:21:59):
And so that’s saying that as Bitcoin was generally gone up during that period, I would say that it has historically achieved a return that will exceed typical borrowing costs. And there are reasonably low cost ways to borrow against Bitcoin. If you, for example, put Bitcoin, in some kind of ETF products in Europe, you might be able to borrow against that because it’s then a financial instrument. And actually the BMN is a financial instrument too. I mean, it’s a European securitization vehicle. I think it’s the first one of its kind of that’s both a token like an STO liquid security token and a European security. So it has an ICEN. You have a bespoke brokerage. They can probably take deposit of it because it has an ICEN and maybe use it as collateral as well, so that’d be interesting.

Adam Back (00:22:48):
And if you could put the value of the Notes up as collateral, then it’s a little bit like you borrowed money and then you put the asset that you bought with the money back into the collateral pool. I mean, this kind of thing is possible with more sophisticated brokers account. It’s a kind of one level of recursion basically, right, that you’ve put. I mean, let’s say you’re doing it with bonds. You would have a hundred thousand euros, buy some bonds and then put the bonds back into the collateral, and now you’ve got a lower risk or you could borrow against it. Again, that kind of thing.

Preston Pysh (00:23:23):
Plan B, I want to go back to just kind of how we opened the conversation as far as this correction that we’re currently seeing because before we started recording, you and I were chatting just briefly about similarities to drawdowns that we saw in the previous bull run. The 2017 bull run. And just for a little bit of context for people, so during the 2017 run, we had the price action correct six times in excess of 29%. For this current bull market that we’re in, we’ve only seen the price correct 31%. And then this one right now is at 26%, so far different from the number of corrections that we’ve seen. One of the things that you brought up when we were just briefly talking about the current situation was the RSI. I know this is a really kind of a generic metric, but talk to people with what this metric is and then kind of how you’re using it right now just to kind of look at the market.

Plan B (00:24:23):
Yeah. So, so it is technical analysis. It’s an indicator. A moving average is an indicator or Bollinger Bands. So the RSI, the relative strength index, it tells you if a series is trending up or trending down, and it is a number between zero and a hundred. So everything above 50 is trending up and everything below 50 is trending down. And well as with all TA, right, all technical analysis, it’s not meant as a predictive thing. It’s meant as a measure that gives you some situational awareness that you can look it up and in the past similar situations, et cetera. It’s kind of a language. But well, everything-

Plan B (00:25:03):
Similar situations, et cetera. It’s kind of a language, but everything… If you look at Bitcoin, the RSI is very interesting because normally in RSI stock or currency, for example, would be between 30 and 70. So if the RSI is above 70, they say it’s overbought. And that would be a time where the trend could reverse into bear, and if the RSI is below 30, that would be to the moment that you buy where it’s oversold. But with Bitcoin, those bandwidths are slightly different, and it depends on what time frequency you look, if it’s daily, weekly, monthly RSI. But one thing I particularly follow is the weekly RSI. Don’t ask me why, but it shows a very distinct pattern if you look at last 10 years, and indeed we have been above 70 for almost five months, and that’s kind of unique, different than 2017 and 2013.

Plan B (00:26:02):
So I was kind of wondering myself, are we going to see an RSI of 60? So will it go down anytime soon? Because that’s what happened during the bull market in 2017 and even in 2013. And speaking of the devil, that’s exactly what we’re seeing right now. So the RSI, the weekly Bitcoin is a little bit below 60, 59 or something. Yeah, if history is any indication, we look up 2016, we might go a little deeper, but this would be around the levels that you normally go up again. And just the pattern and the difference with 2017 is remarkable to me.

Preston Pysh (00:26:51):
Do you find that there’s some resistance layer… I’ve heard a lot of people online talking about a resistance layer around 47,000. Do you buy that or do you see any merit in even discussing that?

Plan B (00:27:05):
No, actually I’m not much of a TA guy. I spent some time on a trading floor. There we talk about TA indicators all the time. And even in the institutions, the dealing rooms, we follow the indicators, but I don’t know resistance lines, et cetera. What I do find more interesting is the on-chain analytics that also show you where… It’s actually data from the flows. The selling of the buying of which coins are sold and et cetera, et cetera. So I weigh them. I give them more weight in my decisions than the TA. The TA is just… Well, not for fun, but anecdotally.

Preston Pysh (00:27:47):
So what are you seeing right now in that type of analysis, the on-chain data?

Plan B (00:27:52):
on-chain it’s very clear that a lot of the old coins are being sold. And that a lot of the action is still to come. So if we compare flows, coins and how they flowed in 2017, in 2013 to today, there are several measures actually, but they all point towards that we’re halfway into this bull market. Have a long way to go. Really 50% or something, and the other half still to come. So that’s a very bullish and optimistic view, of course, but I think it’s a undeniable. And Glassnode, now that people are tweeting about it, I’m looking at that as well. Well, there’s one measure I follow, but it’s proprietary, so I can’t say much about it, but I’m very optimistic about based on-chain stuff, and of course it’s very convenient that it aligns with the stock to flow stuff that also says we have some way to go yet.

Preston Pysh (00:28:54):
Adam, I’m going to throw it over to you. Do you have any comments or questions on this one?

Adam Back (00:28:58):
I think one of the interesting things is I think this is a Glassnode data, but other people have claimed the same, which is that the removal of coins from exchange. So it seems like large buyers are buying chunks of coins in any pullbacks and cold storing them, basically. So it seems like in terms of the comments we just heard about not as many deep pullbacks as in previous cycles, and not as deep, that these buying activities are probably making it more buoyant or recover more quickly, so you see less deep pullbacks, because there’s enormous amount of leverage trading and liquidation cascades, which are part of the market.

Adam Back (00:29:45):
The other thing I like is this graph, I’ll just send it to you, which is somebody put together a graph of the price during the previous two holding periods and then drew an average for the middle of it, so you’ve got a nice orange. So anyway, it shows us being about in the middle. So we’re about halfway between the price increase this far into post [inaudible 00:30:15] period. We’re right in the middle of it having been higher in one of those previous periods, and lower in the other period. So we’re tracking in the middle of it, to the extent that you could infer anything from that. I think that’s kind of interesting.

Plan B (00:30:29):
I like that chart as well.

Adam Back (00:30:31):
And I just tend to look at it in terms of people looking at the current market. I mean, I’m not remotely phased just buying some more and evening out the volatility. So people say, “Hey Adam, how comes you’re not all in? Where are you getting the money to buy coins from?” Well, I have a total allocation and I’m just profiting from people’s lack of confidence, lack of conviction. So if they panic sell some, I’ll buy them, and then when it’s back to around where it was before I’ll sell what I bought and keep the profit in Bitcoin and do it again. So I think if enough people do that, it provides a bit of price support as distributed market-making or something.

Adam Back (00:31:17):
And of course there’s neutral reflexivity. Different people having confidence for various reasons support each other. So now I’m going to be more confident because I have the impression that institutional buyers and high net worth individuals are taking opportunities of temporary pullbacks and buying, taking them off exchange. So then I’ll buy it going down, assume that they will too. So it’s a neutral cycle of people trading for a variety of compatible reasons.

Plan B (00:31:47):
Yeah, I think that’s one of the big differences between this cycle and the last cycle’s that the institutions are now stepping in, big buyers are there, you can see it in the price patterns. Once it goes down, it immediately gets sucked up by big buyers and they move it from the exchanges. So that’s one thing that changed. On the other hand, the thing that doesn’t change, of course, it’s human nature. People FOMO in, even the institutional buyers sometimes because those are people as well. And then at a certain point the fear sets in and they sell. So this volatility, if you will, the ups and downs, the bull markets and bear markets, I don’t know if that will ever change. And of course that’s the underlying thing and a big debate at the moment between the super cycle or not. So are we going to have another bear market after the all time high, maybe later this year, early next year.

Plan B (00:32:40):
After that, will it be a bear market or are things that different this time with institutional buyers that we will not have a bear market and a cycle anymore and go up, up, up, like Michael Sater likes to say, and I think, Preston, you are a super cycle man as well. So that’s the big question. I don’t have the answer, and it’s certainly different. And I also know why, well, people that are in tech investing and earned a lot of money with investments in Google and Amazon think that way, because if you look at the tech stocks, it’s always volatile in the beginning, when there’s a lot of risk about the technology, about the regulation, and then once all that is settled, then it goes up, up, up, and the volatility is gone. Is Bitcoin a new technology, and does it behave or will it behave like a technology stock like Google and Amazon, or is this a thing that will be influenced by greed and fear for at least the next 100 years? And I’m of that latter group, but there’s a whole debate that we could have about this super cycle.

Preston Pysh (00:33:54):
Where a person who would support the super cycle, and I’m just going to be completely agnostic to the conversation because do I think it could happen? Absolutely. Do I think that this could keep playing out for more years into the future? Of course. But for people that would be making the super cycle argument, they’re going to immediately go into a lot of this derivatives conversation that Adam and I were talking about last week that you clearly have highlighted probably earlier than anybody else, Plan B. Then you start looking at the stuff that Adam’s doing with his note where you’re… I mean, if you buy one of these notes, Adam’s escrowing all the Bitcoin he mines for the next three years before he pays it out, so that’s effectively a lockup of Bitcoin.

Preston Pysh (00:34:36):
It almost seems like a lot of the products and the financialization of Bitcoin that’s currently taking place involves an incentive structure that involves more locking up of coins and taking and clawing them off the market to be put to some form or some type of use that involves overcollateralization. So does that mean that we’re getting almost like a second halving event through all of this? Is that the reason why maybe this cycle right now is playing out a little faster as far as the price action is concerned than the cycle we saw in the past or the previous four year cycle? I don’t know. It kind of seems like that would support the narrative, but I’m opening it up to you guys to hear your thoughts.

Plan B (00:35:22):
I wouldn’t say it’s another halving, because those are existing coins that are locked up, like gold could be locked up in vaults. But I know what you mean. If the coins are off the market, if there’s no sellers, then yeah, that will have a price impact. And yes, I think those things, like miners funding their operations in a way that they don’t have to sell is huge. It’s a huge impact on the market. And also the derivatives markets are a huge impact on the market. But there’s more, of course. I used to say forget about adoption, it’s all about arbitrage. And that blends into this as well because the contango premium that we see on the futures markets right now, and that’s one of the reasons, of course, that people go do this, get cash and carry trade. They buy the Bitcoin and sell it in future, thereby locking up the collateral, the coins they bought for a year or half a year, or whatever.

Plan B (00:36:27):
That goes away when that premium goes away. So before the big liquidation last weekend of all the leverage longs, we saw the contango premium, the basis premium be 40%. And now it’s like 30, maybe it’s 25 at the moment. And it used to be 10 to 20%. And in the beginning, like in 2018, even parts of 2019, it was in backwardation even. So the future price was lower than the spot price. How will those coins be locked up and for how long, that would be the question, but I would certainly see that as long as the contango premium is there, and especially as large as it is right now, there’s more room to go up because what it essentially means is that there is two parties finding a natural equilibrium in risk return terms. On the one hand, it’s the leverage longs that use futures to leverage and to have a position that has 10X the Bitcoin returns, up and down. And against that group of leverage longs there’s the cash and carry people or maybe the institutionalized buyers that buy the Bitcoin and sell while they have the collateral at hand.

Plan B (00:37:48):
And they take a lesser return, but with much less risk. So it’s all a risk return game. The leverage longs take much more risk at Bitcoin and hope to get much more return, and the cash and carry traders are taking less return with almost zero risk. And those groups find each other, so it’s a very natural equilibrium. And as long as those groups are there, as long as there’s leverage longs, and as long as there’s institutional traditional buyers that are happy to take the 20, 30, 40% while Bitcoin neutral return, this accelerates the bull market and the Bitcoin price, in my opinion. And by the way, the leverage longs are not the only buyers in that corner of the world. Those are also the traditional investors that don’t want to hustle with keys and stuff, and want an icing code on the future so that they can administer it in their systems.

Plan B (00:38:47):
So those are also, I know that, funds, trackers that track the Bitcoin price, but do not want to buy the Bitcoin outright and hassle with custodian or keys themselves. So they just buy the derivative and they replicate the Bitcoin exposure with it. So that’s also a large group and it doesn’t go away. So in a way, as a long way of saying, I might agree with you that, especially the derivatives markets and the funding of miners in a novel way that Adam is talking about, could enhance this cycle and make it maybe into a super cycle.

Adam Back (00:39:28):
I’m fascinated by the fact that there’s some positive feedback loop between these different activities. I would say also, though, as well as the degenerate traders, the 10 times people who are often taking very short time positions, minutes, hours, days, but not very long, there are also longer term holders or people who will take a much lower leverage, like 50% leverage or two times leverage, so the liquidation level is maybe 25, $30,000. They feel comfortable with that. They put an allocation in. They end up paying a rate, but in a bull market that can pay off for them. So I wouldn’t encourage people to do it, because if it makes you nervous, then you’re going to make bad decisions, and it has risk if you don’t manage it properly. But there are people that will do that, who are more long-term, they’ll hold that position. People have been holding those positions since December, for example. They’re obviously giving away a fairly high premium to people that [inaudible 00:40:36] the dollars in effects, but they’re on the winning side of that balance of profit at the moment, until it changes. So I think the other thing that’s interesting is the feedback loop, because as Plan B said, the fact that people are having to lock up Bitcoins to do this cash and carry trade, so they’re going to buy physical Bitcoin and sell the future, they are having to hold Bitcoin and they are potentially completely Bitcoin neutral. So it will bring in people who are not yet in the Bitcoin ecosystem, and convicted by Bitcoin, but this is a way to earn an attractive return, and they’re providing liquidity to people that want to either short-term trade or hold a long position, a lower leverage long position for three or six months or something like that.

Adam Back (00:41:27):
So it’s just providing liquidity to them, and the combined things are both positive for price, so if the price is going up… Because one worry is what’s the feedback loop eventually… Not worry, but if you’re collecting yield, this would be a worry, is that eventually more players bring… They’re currently collecting 1, 2%, or zero or negative depending on term in the regular markets, and they will come into the system and there’ll be so much liquidity that that the premium will drop a lot. But I think the thing that makes it potentially perpetuating is that because both of those factors, locking up Bitcoins and people buying [inaudible 00:42:07] Bitcoins of exchanges are pushing up the price, a higher price, the Bitcoin ecosystem goes from a 1 trillion market cap to 2 trillion, it can absorb more money, because somebody who is 50% long or two times long is going to collect more capital doing that. They still have the same number of coins they’re doing it with.

Adam Back (00:42:26):
So that can absorb more US dollars and euros, and then it just keeps going and absorbs more and more money. So I’m interested to see how long that lasts. Of course these rates are basically calculate typically every eight hours or… Well, it depends on the type of platform. I think the CME thing is you’re buying a future, so you know the price, you know the premium, and it’s like a three month or whatever the term is. So you’ve got your trade locked in and just wait for the maturity. But some of the crypto exchange leverage platforms are calculating perpetual future funding rates and charging them every eight hours and paying them out every day. It varies a bit per platform. And those rates are highly variable and can get silly at times. In a very short period where there’s a rapid price movement, basically all the liquidity on the platform will get used up right down to half a percent a day rates, a crazy rate, not sustainable, but it averages out, so it will be lower.

Plan B (00:43:28):
If I may add two things. That argument, Adam, that you made about attracting more liquidity, that’s very true because if I look at the traditional investors, they might be scared a little bit about Bitcoin with its -80% drops once in a while, but they really recognize the cash and carry trade, because they’re familiar with it in other commodities and foreign exchange markets. So in the company that I used to work, this was the number one argument for them to look at the Bitcoin market. So they recognize the futures basis of 20, 30, sometimes 40% and thought that was, of course, much better than they’re used to, and that triggers them much more than the outright Bitcoin position.

Plan B (00:44:10):
And the second thing is, let me be very clear about derivatives markets, through the eyes of a traditional investor, that’s a very good thing. That’s also a thing, a mechanism to attract more liquidity. It attracts buyers that want to have Bitcoin exposure, but with less volatility, like to cash and carry traders, and it attracts people that want to have even more risk and return like the leverage longs, and thereby both groups, as long as both groups provide liquidity like they did last year, that’s a very good thing for Bitcoin, I would say, and it makes the market so much more mature.

Preston Pysh (00:44:54):
So when we’re looking at this trade where we’re seeing the largest spreads, it appears that it exists on exchanges that allow… That are immediately settled, that had all the aspects of tokenized fiat currency to it. So I’m talking like BitMEX, they allow 75X leverage or whatever. Those are the exchanges where you’re seeing these spreads be the largest. What I find interesting is you don’t have any of that happening in the United States right now. This is all outside of the United States that these exchanges exist that allow these types of activities, and it hasn’t been approved here yet for… Adam was talking about perps and how this is a new type of derivative that hasn’t existed anywhere else, because now that you have immediately settling security tokens, or I shouldn’t call them token… Now that you have immediately settling tokens, you now have this capability to enter these perpetuity type derivative products.

Preston Pysh (00:45:56):
So I find that, and I’m asking this more than stating this to you guys, are these products that, once they make their way into the US, which I suspect they will here probably in the coming year or two, when they arrive here, is this only going to further extensuate what we’re seeing with this cash and carry trade because now you’re going to see it actually arrive in the US? Because CME doesn’t work this way. The US derivatives markets don’t work this way. They don’t allow people to go 50X leverage on whatever position they think the direction of the market’s going to go, and if they’re wrong five minutes later, we’ll then they’re liquidated without the counterparty risk that you see in traditional derivatives markets. So I’m curious to hear your thoughts. If that’s a true statement, everything that I just stated, and it arrives in the US, does that market size that now is also participating in this activity, enhance things or amplify what we’re already seeing?

Plan B (00:47:00):
It is true what you said, the CME has lower spreads, because it’s not Bitcoin physically settled and it doesn’t have the leverage that a BitMEX or a Deribit, or all the other exchange, Binance, for example, give. That’s very fascinating to me as well. So there seems to be a very direct link between leverage and spreads on the cash and carry trade. So I know that US people cannot access those cash and carry trades and physical settled exchanges, which is very weird to me, but they’re not allowed, they’re blocked. US citizens cannot trade on a BitMEX, I think, [crosstalk 00:47:37]-

Preston Pysh (00:47:36):
No, we can’t. We cannot do this stuff. I’m curious if Adam knows the impetus of why.

Adam Back (00:47:43):
I guess the US is a more complicated… On a personal basis, I’m looking at it from a European point of view, so the same outlook as Plan B, and Blockstream is a Canadian parent company, but we do have subsidiary in the US so it is something that you see that basically, I think the exchanges defensively would sooner not have jurisdictions that have complicated financial regulations, and they don’t want to trip over the fine print of some rules. So the defensive thing is to just say it was somewhere… I mean, there are some which are US but not New York because New York introduced a BitLicense which was more [inaudible 00:48:30] than the general US rules. I think rates are higher as well on venues that let you use Bitcoin as collateral, and I think that may be what’s complicating the CME situation, because I think you have to put up quite lot of collateral, maybe 50%, if I recall, and that collateral can’t be the Bitcoin that you bought to the cash and carry because they don’t have a way to deposit Bitcoin on there. So you need to use some other collateral.

Adam Back (00:48:57):
Let’s say you’ve got a share portfolio and you can access CME through, I don’t know, let’s say Interactive Brokers. I’m not sure if they have it. So you have that and you have some stocks, you can use them or cash presumably as a collateral, but that’s going to limit what you can do because the Bitcoin that is actually collateralizing the trade is off balance sheet. It’s unrecognized. So that limits the access to that cash and carry trade, where the other platforms have effectively cheaper leverage and you can deposit the collateral into the platform itself. So of course they can safely do it. I think what CMA is doing is they will liquidate you if you go too close to that 50% line, but the other platforms can let you get within half a percent of the line, because as long as they can liquidate in time, it doesn’t impact the exchange. And of course, people doing these very high leverage things are… They’re taking a risk and typically-

Adam Back (00:50:03):
Green, they’re taking a risk, and typically they are putting stop-losses really close above and below, right? So, particularly below. If they are over 20 X long, then they probably got a stop not far below it, or they put a small position size on the will liquidate in isolation. So, it’s 20 times, there’s an implied 5% drop liquidation minus a bit of wiggle room because there’s a buffer between. There’s another 1/2% on top. So, something in that order. So, maybe 19.5%. The demand is coming from, I mean, some of them are just going for people that want to buy Bitcoin and have mostly Bitcoin, but obviously it’s risky and I wouldn’t necessarily recommend it.

Preston Pysh (00:50:47):
And I don’t think that that’s necessarily, my point is people doing this trade. I’m looking at it more from a mechanical standpoint of because this trade exists and because of the safety, like you’re describing Adam, is there because you can immediately settle. I mean, one could maybe even try to make the argument that it’s safer than the CME because of the time and the collateral that’s being used. The time to settle in the collateral is being used and all that kind of stuff is actually riskier than some of these exchanges that allow this insane amount of leverage that we’ve never seen before.

Preston Pysh (00:51:22):
My point is more on, I think this is why you’re seeing the spreads that you’re seeing between the spot and the future price is because of some of these exchanges that have this built into the, just how they systematically work, that you’re seeing these spreads develop. I’m just interested that if, and when, because I suspect it’s going to happen in the United States, just it’s a regulatory constraint at the moment. That may be, it just adds more fuel to this fire that’s burning that locks up more coins, that incentivizes the locking up of more coins through the derivatives market.

Plan B (00:52:03):
Yeah, I think the regulatory restriction, that wouldn’t surprise me if there would be a regulatory arbitrage in the future as well. These restrictions and these kinds of costs, what normally causes the contango spreads, right? In gold as well. There’s a 1% contango spread because you have to ensure to gold, you have to storage the gold, but I guess this, the fact that US citizens cannot do this trade will be arbitrage by setting up a fund that has this as a investment strategy and then setting the fund or are setting up a note or maybe sending up a coin. I don’t know how easy that would be on liquid or something. But yeah, I think if you have a coin that pays off the cash and carry, that could be very interesting and maybe something that is legal to buy in the US and it will for sure, open the flood gates and for sure this whole derivatives cash and carry, and also the covered call writing in the option department is a very important network effect in making Bitcoin a, well eventually a $100 trillion assets.

Preston Pysh (00:53:07):
Well, and you just think about how volatility only incentivizes this activity more. And so, before we started recording plan B, you and I were talking about where the price was at in the previous 2017 cycle about a year after the having event, and then how much more it had the run from there. If we just assume that we’re going to see a similar activity playing out in the next 180 days from where we’re at right now, that implies a lot more volatility in the price action. Which for me, when I’m looking at how’s that going to interact with the derivatives market, especially these ones that offer tons of leverage, to me, it seems like those spreads are going to continue to widen with each expansion and the price growth, and it’s just going to attract more and more people that are trying to capture that spread. So, I’m assuming you see it the same way. Do you see it differently?

Plan B (00:54:04):
Absolutely. It will go up and down and the spread, I don’t know how high it will go. I think 40% that we saw last week was quite high.

Preston Pysh (00:54:12):
Aggressive.

Plan B (00:54:14):
Very aggressive. I have never seen that before in my life, but even at 20 and 30, if you compare it to the normal returns that an institutional investor like a bank or an insurance company makes, or even a pension fund, that’s wild.

Preston Pysh (00:54:28):
It’s insane.

Plan B (00:54:28):
Yeah. Especially if you compare it to the risk, there are so little risk, maybe some credit risk on the exchange and stuff, but yeah. So, it will attract and I’ve seen that with my very eyes. It will attract traditional investors. By the way I am doing this trade. I’m in Europe, not restricted by any US laws. I’m doing the covered call writing. I’m doing the futures cash and carry for months now. And a lot of my friends do this maybe every week, somebody that starts to do this on a personal level. And those are all professional investors that take these thoughts and these little personal experience to their asset liability meetings and they talk about it. I know they talk about it because I was there, right? This is something that will happen. And it cannot be ignored if nothing looking at 4% return with a lot of risk. And then that comes a guy that says, “Oh, you can make 20 or 30% without any risk.” No, well, it’s a very interesting thing and I’ll be watching the spreads like a Hawk, because that tells me something about the future.

Adam Back (00:55:31):
Do you think it’s like the free market interest rate? Because people have been talking about real asset price inflation with all the money printing and the market rates are set by monetary and targeted by monetary policy commissioners, all setting the prime rate or the base rate is more free-market right? Because it’s just, they will pay what they want to pay. And I’m just curious because people have looked at different metrics like M to money supply inflation, how much of the US dollars in existence were printed in the last 12 months? And actually even the headline consumer price indexes are under control. People just empirically Michael Saylor posted rates of prices increases on 20 top commodities lumber in different things. And they’re all up double digit percentages. So, maybe people who are putting assets to work at 2% are actually losing 10 or 15%. And the people getting 20 to 30% on these yields strategies are making a real return above the actual inflation rate because you never know the actual inflation rate until the dust is settled afterwards really.

Preston Pysh (00:56:48):
Yeah. And I completely agree with you, Adam. I think that the more I’m looking at this and the more that I’m saying, okay, what is the inflation rate? What is the interest rate that should be constructed on top of said interest or inflation rate? All roads lead me to this market and this particular trade that we’re talking about representing that most accurately, at least for me. And I obviously have a bias towards Bitcoin, but I definitely don’t see it at 1.5% on the 10 year Treasury. That’s for dang sure.

Adam Back (00:57:17):
Right. Some sort of other thing you can look at for market direction, engage people’s future expectations is the auction market. So, for example, LedgerX, I just pulled it up. And now they introduced a $200,000 call option for the end of this year, a little bit ago, it used to top out a 100,000, but in essence, the price of Bitcoin is up. They’ve put 200,000 and there’s, it looks to be quite a lot of open interest for a 200,000 call option end of year with bid-ask spread between 3,200 and 4,000. I think a big part of that spread is actually the commission structure on the exchange. It’s like a 15% or something. But it says basically saying that if you have Bitcoin and you sort of conceptually be willing to sell at 200,000 at the end of this year, you can collect $4,000 now.

Adam Back (00:58:13):
And it’s kind of like writing a limit order and putting on the exchange and not being able to cancel it, right? And somebody’s going to pay you for that. So, now you get the 4,000 now. If Bitcoin never reaches 200,000 this year, you keep the 4,000. If it reaches 200,000, you’re forced to sell it and pay the upside above 200,000 to the person that bought the call option. But you’ve still got the 200,000. So, I do know people who have been selling these, but when I was looking at them and comparing it to that kind of Bitcoin yield strategies, I started to think it’s mispriced because, and that you should possibly be buying them, which is a curious phenomenon. Just because the… If the cost of the call option, so, let’s say it’s going to cost you $4, 000 to buy it.

Adam Back (00:59:01):
And that as a percentage of the current Bitcoin price, when Bitcoin is 60,000 or something, it’s six or something percent. And if you can achieve that return on Bitcoin yield, then interest is better. You still got the coins at the end, right? So, that means this option is cheap and you should buy it. And so, if that’s correct, but arguably is saying that 200,000 and if you’re… Is what the market’s saying, we don’t know what’s going to happen obviously, but the way the market’s pricing it, you could argue that’s under priced. So anyway, it’s interesting. And of course, then we’ve got the 400,000 at the end of December, 2022 the spread between 4,400s bids and 6,000 ask. So, it’s not that much more expensive, but it’s a loftier target.

Preston Pysh (00:59:54):
Yeah. That’s for sure.

Plan B (00:59:57):
Those are very interesting games you can play and we’re only discovering them, right? It’s for Bitcoin, the whole, the fact that those options have implied volatilities or around a 100%, it’s crazy. How do you price that? And of course, a part of the option price is the future price. So, all the basis, the contango spread, if you will, that we talked about is in there as well. There can be very nice arbitrage between the future market and the option market as well. And it all leads to more liquidity, more people buying, yeah. And I can tell you a little bit, like if you’re an institutional investor and you have to invest big sum, like a billion or 2 billion, 3 billion, whatever in asset. You want derivatives markets there, you want future markets, you want option markets because those are exits.

Plan B (01:00:53):
So, even if the spot market is closed, which can happen or gives you crazy prices, you have some other ways of getting out of your trade. You can short it, you can buy put options. And the fact that you can get out more easy is also a big part of the decision to get in, to invest in Bitcoin. So, yeah. I hope those option markets will grow as the future markets, because they’re relatively small right now.

Preston Pysh (01:01:21):
I think they’re perp contracts that obviously we don’t have here in the United States. Also offers a really interesting solution for people that don’t want to have to pay. If you want to get into a, let’s say you want to buy a put because you think the price is screaming high, and we’re going to go through another cycle or whatever it gives you kind of a unique way to not have a huge upfront cost, but you can still participate in that protection quote, unquote protection if you think that it’s going lower. So, I’m interested to see some of these newer derivative type things showing up here in the United States. I really hope it comes in the coming year too, because I think that it’s going to only add to the free and open market. And at the end of the day, I think we talk about all these really kind of complex trading strategies.

Preston Pysh (01:02:09):
And I think for most people, they are absolutely the wrong thing for them to even think about getting involved in based on maybe what they know or what they think they know. But I’m looking at it more from, and I want to be really clear about this. I’m looking at all of these conversations that we just had as a mechanism to understand why Bitcoin is so important moving forward and how everything that’s being engineered around it is supporting this idea of a real free and open market for the cost of capital and for conducting economic calculation for the value of everything on the planet. That’s why I think everything that we just talked about for the last half hour or 45 minutes or whatever is so important. Because I think it’s all the things that kind of support that to materialize out of all of the insanity that we’ve seen for the last, from the 2008, 2009 crisis.

Plan B (01:03:07):
Absolutely Preston. I couldn’t agree more because the… And in the US it’s not half as bad as in Europe, right? With a negative interest rates. And wait until that comes to the US, it’s this whole context of a crazy world with trillions and trillions of dollars in QE and negative interest rates that sets this whole thing on its head. And it’s as if there’s two worlds right now, a traditional world with QE and negative interest rates and well, zero interest on your money. Talking about usability, you cannot use money anymore. Money in your bank account is a liability in the Netherlands and in lots of, in Germany as well. It’s a liability. So, there’s one world with that. And there’s another world where you can make-

Preston Pysh (01:03:58):
40% interest rates.

Plan B (01:04:00):
… 40% interest rates. And it’s the same time. It’s like a quantum real world where you have those two things at the same times. And well, that must be a moment. And we can see that happening of course, that the people in those two worlds are talking. But it’s Kafkaesque, it’s weird. It’s sort of amazing to live in those two worlds at the same time and-

Preston Pysh (01:04:26):
And it’s even more amazing to see people that don’t get or see the other world, which there’s a lot.

Plan B (01:04:34):
Yeah, I know. And that are we so smart or are they so dumb? I don’t know. Maybe-

Preston Pysh (01:04:40):
Yeah, we’re going to find out.

Plan B (01:04:41):
Yeah.

Adam Back (01:04:44):
I think people would also look at high yields and ask is too good to be true question, like what’s going on for that to be the case. And so, my one thing that would deter them is exchange custody risk because a lot of the exchanges are effectively startups. What’s their solvency like? Will they become insolvent due to mess up or a rapid price movement? Which can happen with derivatives, right? Some something like they’re all side bets and they have an insurance fund. Sometimes the price moves too quickly for them to calculate things properly and they have to socialize it. So, they got a fund, insurance fund the techs at first. So, there is platform risk in some of these things and they start ups, they’re a mutual platform. So, they’re not necessarily the same grade as the New York Stock Exchange or CME or something like that.

Adam Back (01:05:37):
But it has a lot of rock solid trading platforms. And suddenly some of the exchanges that infamously crash on the [inaudible 01:05:44], which is very annoying. That’s a reason to switch exchanges, I would say. If you can’t trade, when it’s a key point, what’s the point of trading on that platform because it could burn you at the one time you want to trade. So, another question that some people asked, talking about custody risk is what’s do the three of us think about Bitcoin interest products. And I think that they typically involve custody risk and to generate a Bitcoin yield, I mean, if you look on platforms that have a, so trading a margin lending market for traders to use as collateral like Bitfinex, the lending rates on Bitcoin are extremely low below 1/2%. And so, when people are, there are a number of companies that are offering five and higher percent points on Bitcoin ma maybe with teaser rates, but there are people offering relatively high rates on Bitcoin.

Adam Back (01:06:45):
And certainly for people who are, most of their portfolio or net worth is in Bitcoin, then getting any kind of interest rate on Bitcoin, it’s attractive to them. So, I think really what’s going on though, is behind all these products that are generating interest, they have to do unsecured lending or nobody’s going to borrow off them. And, who were they lending to? If you listen to their pitches and there are a number of podcasts out there where they’ve explained approximately how they do it, they are trying to manage the risk by diversifying. In some cases they claim to stand between so that they will absorb the first loss. If they’ve got 20 different people that are lending to one of them becomes insolvent, they’ll cover that until they can’t. And of course they try to analyze like, know who they’re lending to. Is the credit rating goods on it?

Adam Back (01:07:33):
Maybe they don’t have a credit rating, ask around as a word on the street that these guys are experienced traders and they’re trustworthy. But of course diversification is better than no diversification and standing between is good until the lending platform becomes insolvent. So, I tend to not do that or to be careful about doing that or to do that with a smaller allocation. But I know there are people who are looking at the interest rates. Of course, there’s a little bit of a race to the bottom phenomenon where you can achieve. As a lending platform like this, you can achieve a higher rate behind it by being more aggressive lending to people with lower sort of credit risk and it was credit risk. And so, then you offer a higher rates and attract the users. So, if they’re sitting there kind of one-upping each other, the actual risk is creeping up and we might eventually see a Mt. Gox like incident where one of the lending platforms becomes insolvent because the hedge funds being probably small startups themselves, right?

Adam Back (01:08:36):
But our prop trading shops effectively gets too aggressive with their strategies. And of course there are perfectly valid ways for these funds to create a yield, for example, trading short-term options, for example, right? And if they have a 24 by seven trading shop and they’ve got experienced traders, they can probably make a yield above what they can or a Bitcoin for now, everything has risks.

Preston Pysh (01:09:03):
Adam, I think what you’re saying here is you’re calling out borrowing and lending platforms and telling them that the same thing that they’re holding their retail investors to as far as overcollateralization, they also need to hold their institutional depositers and borrowers to the same standard. Is that kind of the message?

Adam Back (01:09:24):
Well, I’m supposing they won’t have visibility into that because there’ll be lending to a fund and and the fund maybe to get an idea of the risk profile before they lend to the fund, they’ll ask them the track record of their traders and they’ll say, that this person was on the trading desk here or something like that and approximately what the strategy is. Now, they may not want to describe this strategy because it’s proprietary information, right? But so, that may be somewhat uncontrolled but diversified risk, but there are other lending platforms. And this kind of risk applies to some of the ways to generate your solar return too, which is, if you are providing margin lending, you’re exposed to a platform risk. If you are using the long short strategy, which is a variant of the future buy spot sell futures.

Adam Back (01:10:14):
So, very enough that you, if that platform has an impairment, you’re constantly at risk, even though you’re not Bitcoin exposed your dollar exposed to the platform, right? And so, there are other ways to kind of reduce that risk and maybe give up some of the… Reduce the default risk and give up potentially a little bit of the interest rate upside. And that the main one I see for that is Hodl Hodl, which is a way to lend dollars and it uses Bitcoin as collateral, but in a direct way. So, as the lender, the coins are held in a multisig and you have one of the keys and you can see that the collateral is not moving basically. And so, there’s no unsecured relending behind it or all getting a matched interest rate that’s coming from the borrower.

Adam Back (01:11:05):
And my impression is probably a lot of these borrowers are actually using it as margin to trade or turning around and collecting a slightly higher yield on the constructions that we were just talking about. So, if you’re interested in the yield, but you’re worried about the platform risk, go to Hodl Hodl, and then it’s market sense. So, you set your own interest rates and durations and see what rate will get bought. And this used to be in an excess of borrowers. So, the rates are fairly high as it is, but it’s a way to insulate a risk because there’s no platform default risks basically, right? So, there are people probably arbitrage in that who are borrowing on there and then relending, or using it as conventional leverage, but cheaper than the exchange leverage on exchanges that don’t have in, on platform leverage.

Preston Pysh (01:11:52):
So guys, real fast, I wanted to go into something that’s very different than what we’ve been talking about. And it involves the Lightning network and kind of the incentive structure that you guys see moving forward for the adoption of Lightning and the further pegging of Bitcoin into the Lightning network. When I look at this where it’s kind of becoming obvious to me, so you got Cash App, you have all these other Venmo, you got PayPal and others that are allowing on chain Bitcoin purchases. On Cash App, you’re able to send Bitcoin to your own wallet. And when I’m looking at the fees, especially on the network right now, people don’t want to have to pay 10, 20, $25 fees in order to send Bitcoin on chain to their own personal wallet. So, to me it seems like a natural next evolutional step is that I would want to convert that into Lightning, be able to send things to myself via Lightning.

Preston Pysh (01:12:51):
But when I think about what does that mean for the platforms that are allowing these transactions call it Cash App or Square or whatever you can name it, right? They don’t have much of an incentive to want to start enabling some of this stuff, because now you’re not using their network and they’re not able to keep track of the data and everything else that’s associated with using their network. Do you see this as a concern? Do you see this as just kind of a short term kind of concern because everyone’s going to have to remain competitive so they’re going to start opening these kinds of things up and the gen, just in general, your thoughts on Lightning and the incentive structure for further adoption.

Adam Back (01:13:31):
Yeah. So, we have some, a Lightning play. So, see Lightning Blockstream is one of the three [inaudible 01:13:38] are a couple more now, but one of the first three original. And I think that there is generally a bit of a lag in technology adoption in this space, not just with Lightning, but with, for example, the network upgrades. So, plan B mentioned a [inaudible 01:13:58] drama a few years ago, and that was about a network upgrade. Well, it probably wasn’t really about the SegWit feature, but some other kind of scale discussion, in fact. But in any case, the SegWit technology effectively increased the network capacity by two to three times, but only if you used it. So, for each person that opted in it would increase capacity, but even today, the SegWit adoption rates are not a 100%, maybe 60+%.

Adam Back (01:14:32):
And that is because there are popular wallets, like Blockchain info is claims and those appear to have a quite high percentage of transactions. You could tell because the site went down and then the SegWit ratio show up for a while, and then they came back online. So, we believe it. And they’ve recently announced that they’re finally in 2021 and bouncy start rolling now across the different wallet architectures. And they’re not alone, right? They were many platforms that-

Adam Back (01:15:03):
yes. And, you know they’re not alone, right? There were many, many platforms that took a year or two to integrate Segway, and it’s extremely simple thing to do. I think that a developer with the right skillset could get it done, presumably in a maximum of a week or something. So, you might wonder why have they not incentivized to reduce the transaction fees. And, the answer is not… It’s typically, there’s two sets of problems. One is that the customer pays the fees, they don’t, so not their problem. And secondly, at least for the exchange trading part of it, I know you were talking about retail payments there, we will comeback to that, but for the exchange trading part, the exchanges make most of their money from the bigger traders. So, if they have to pay a 10 cent transaction fee, or a $1, or $10, that doesn’t really change their trade because they’re maybe paying 10 or 20 basis points on the trade, and that’s far more money than the deposit and the traders are also impatient.

Adam Back (01:16:04):
So, they want to… When they want to take a trade, they want to take a trade. So, they’ll look at what the current fee rates are and they’ll double it just to be sure. They’ll tend to push the fees up, so I think most of the high fees are due to traders and there are multiple things that platforms can do about it, but they tend to be a year or two behind the curve in upgrading it. Eventually they get there, and you’re starting to see more exchanges integrate Lightning as well now, which is cool. I was actually more excited about exchange Lightning integration for retail broker exchanges, where I just buy the coin now, kind of user experience, because it would give you a way to top up the Lightning wallet, which would make it into more of a circular economy.

Adam Back (01:16:49):
So, when the merchant… I mean, generally speaking, the users are buying things. So, they’re either paying each other, which will work fine, or they’re buying things from merchants. And if the merchants… So all the money is going to pile up on the merchant end of door channel, and then they’re going to close it. And so if the merchant goes to the exchange and sells, the exchange can basically pay them to send the money back to the user on average, and then you get a nice circular economy. So, it’s been a bit of an uptake and exchange is doing that, but they’re busy with other stuff, so when the market gets crazy, they’re focused on scaling the trading engine, adding more support staff to bring in more users, or adding Altcoins and defied products and things like that.

Adam Back (01:17:36):
If you log on to many of these exchanges, or get an email update every week or so, and there’ll be half a dozen new coins. So, that is consuming engineering resources. Regardless of your views about the investability of non-Bitcoin coins, they are for the exchanges. It’s actually… They make money, but it’s a competitive ecosystem, if you don’t stay at the top of your game, you’ll start to lose liquidity to other exchanges. And that’s not good if you’re an exchange. So, chasing new coins is a way to get it a little increment of extra liquidity. Most of the liquidity is in Bitcoin, most [inaudible 01:18:15] is in Bitcoin, so it’s only an increment. And, they also give updates, less prominently, about deal listings because they pull out favor after a bit and they don’t want thousands of them, there being something like 9,000 coins at the moment.

Adam Back (01:18:29):
So, I think it’s technology inertia is the problem. But, you mentioned another one, which was the cash app. So, basically retail wallet-like experience, where the coins are in custody typically, but you can take them out and they are able then to pay user-to-user in platform. And some of the exchanges do that too, or withdraw the coin. So, obviously it would be nice if more platforms like that use Lightning and in a way that’s kind of what Lightning can do very well, is it can give you the same kind of scalability almost as a platform like that, while having less trust. So you’re… You can net people out in fairly real time or net between platforms too. You kind of [inaudible 01:19:15]. So, you don’t even need a credit line, some people had credit lines between exchanges and things like that.

Adam Back (01:19:20):
So, if you have a Lightning channel, you can… You don’t even need the credit, you can just net it out as the balance moves during the day. If users net pay a wallet user on one platform or the other. So, I think people in the technology sector world tend to… Not your keys, not your coins. And obviously I think that’s a very good advice because there is custody risk in this space and it has been people, it’s not all in the past as the Mt. Gox, but it was used in Turkey just this week. That was the exchange seems to have gone offline and funds are not withdrawable. So, it happens. I think that it will be good to see more Lightning.

Adam Back (01:20:02):
It’s the same kind of thing with liquid as well, because that is, a technology that is a layer two or different kind of layer two that can hold, not just Bitcoin, but also stable coins like TBA and other instruments, like the BMN, the bloodstream money note, we were talking about, that’s a liquid asset.

Adam Back (01:20:24):
So, users can use it as a wallet, as a way to transact, pitch pair, even do like OTC swaps, peer-to-peer store the assets in a hardware wallet. So, it has a Bitcoin-like experience, but it also is faster for exchange to go from cold wallet to exchange and be ready to trade within a couple of minutes, and that can be important with volatility that you need to add more collateral if you have a margin position to avoid liquidation. By the way, the price is back at 50,000, I see. So, that’s… And you also get confidentiality because liquid has confidential transactions by default. So, you don’t get the kind of open source intelligence that drives the whale calls, or you see tweets about some large number of coins being deposited on an exchange, which some people will try to use as part of their open source intelligence for trading.

Preston Pysh (01:21:18):
Is there any question that you guys have for each other?

Plan B (01:21:22):
Adam, I’m… I always say… This is a question I’ve been researching and nobody can tell me the answer and if there’s anybody who can, maybe Adam, it’s you. Because we all believe, I think, in the halfing cycles, so there’s a four year period in Bitcoin, the price sort of moves around that, but why is there a four year period? Why not a three-year, why not a five-year, why not a daily adjustment of the number of coins that’s being mined? Why this non-linearity in there?

Adam Back (01:21:55):
Yeah, I don’t know. I mean, it certainly could have been continuous. And some people were even arguing that it should be changed to be continuous. And it appears that you could even design such a change as a soft fork if you really wanted to.

Adam Back (01:22:14):
But, I think that obviously there would be resistance to that because people don’t want to see any fundamentals about Bitcoin change, so there’s that. But, I’m also finding that the halving is quite an interesting economic effect and maybe positive in sort of being a heartbeat for market cycles or something. So, it seems to have a market effect. If it was continuous, you wouldn’t have this effect. So, I’m thinking it’s nice, but it’s not clear, it seems like as you say, it could have as easily been continuous or a different period. I presume a lot of the numbers in Bitcoin are round numbers or whole numbers, it looks like for tidiness. And even the 21 million coins is suspected to be to do with the size of the maximum sized integer that fits in a unsigned 32 bit CPU instruction. So, programming, formatting, a derived number.

Adam Back (01:23:17):
And then like [inaudible 01:23:19] is three, probably because it’s easier and tidier to program power of two. So, it would be like two, or four, or eight, but you know why that and not continuous? I don’t know. I think some of the parameters probably wouldn’t matter. So if there had been exactly half as many coins, they would just be worth twice as much. And so a lot of numbers could be different and have the same effects, but the sort of supply inflation rate is interesting, because it could have been different and worse and it seems to be very nice. I don’t know how Satoshi picked that, but it seems to work great.

Preston Pysh (01:24:05):
I have an opinion on it. I think that it has to do with gaining entrenchment. I think that if you had it as a fixed rate of difficulty, I’m calling it difficulty, but the having, if you just had it as a nice linear curve, like Adam was describing, you would have the price action, not take these breaks where it would just kind of just keep going, going, going. And it would, in my opinion, it wouldn’t have given you the decade that you’ve had in order for the engineers to continue to build without interruption from regulatory pressure. So, it almost seems like every time that we’ve reached a fever pitch in the price… I know in 2017, near the end of 2017, it was coming up in white house, press briefings that this was a, “Hey, what’s going on with the Bitcoin price, it’s like $15,000 and is up whatever thousands of percent in the last year and a half?” It was becoming a topic.

Preston Pysh (01:25:02):
And then, as the price calmed down, it just literally went away. No one talked about it for two years and you would have never had that if you didn’t have this four year quantum leap that takes place. Another reason that I think four years was selected, and this is all obviously Preston Pysh’s opinions on whatever, I think four years was selected because when you look at Moore’s law, you have the processing power is doubled every two years. So, when you think in just that rule of thumb, you want to enable miners to the new miners that are coming into the fold to have an advantage over the old miners so that they can carry the burden of the supply shock that occurs with mining half as much. So, by waiting out a certain period of time, whether that would have been two years or four years or six years or whatever, I think four years was just kind of a spit ball of, “Hey, that’s going to have four times as much processing power than people who were buying mining rigs at the previous having event.

Preston Pysh (01:26:13):
And they’ll be able to weather that supply shock and be profitable in order to continue to carry the torch as you go through that shock. So, I think it was just like a look at Moore’s law and saying that every two years it doubles, so we’ll be a Forex improvement in processing power and that’ll assist in carrying that burden as the system and the network feels that that shock.

Plan B (01:26:38):
Surely it worked perfectly.

Preston Pysh (01:26:40):
Oh my God, it’s working pretty darn well, that’s for sure. Adam, did you have anything or Plan B did you have another question?

Adam Back (01:26:48):
So, I heard some people talking about other forms of the yield extraction using options. So, I was curious how that works if you… If it’s not a kind of proprietary thing that you’d know how to explain.

Plan B (01:27:04):
Oh no, no. So, that would be the covered call writing, and that would be like having a Bitcoin, buying a Bitcoin, and then writing a call option. So, selling a call option. What that gives you is basically a higher premium than the futures premium. Let’s say the futures premium with the cash and carry trade is like 20% right now at 25, the call writing strategy would give you like 40% premium upfront, so you don’t have to wait for it, you have it upfront. And that caps your upside to 40%. So if the Bitcoin price goes up, you will lose your Bitcoin, but you will have sold it for 140%.

Plan B (01:27:51):
So 40% profit, if it goes down, the buyer of your call option will not call the option and you will keep your Bitcoin, you will keep your 40% premium, but of course you will have the loss on your Bitcoin. So, that could be 10%, 20%, maybe even 80%, if that happens again. But in that way, the call option writing strategy also works as [inaudible 01:28:16] because if the price would drop 80%, you would have your premium of 40% of the call option, you would have your Bitcoin and you would have your loss, but your loss would not be 80%, it would be 80% minus that 40%. It would be… Basically you have a higher premium upfront even, but you have a small downside risk. You keep that small downside risk and of course your cap. You cap your upside risk to the premium that you receive.

Plan B (01:28:45):
So, there are some non-linearity, it’s not a future it’s… So some of the losses are for you, and that’s how you do it. But, you basically get the futures premiums plus the volatility premium, you should see the trade and every option trade as a volatility trade. So, you should write an option, should you do the covered call writing when the implied volatility spikes. At the moment there’s a spike, you should deploy that strategy and then write all the volatility down and then buy it back or write it out. It’s a very nice strategy, especially since the implied volatilities are 80, 90, 100%, which is crazy.

Preston Pysh (01:29:28):
Adam, I’ve got a question for you. So, it was brought up recently on a podcast I was listening on Peter McCormick, where he was interviewing Bill, who runs his own borrowing and lending platform. And he was bringing up the concern of fungibility, and from what I understand, I was talking with Jimmy Song about this, as far as the taproot upgrade, potentially providing a solution to the fungibility concern that some have, that governments could potentially create on the fungibility of Bitcoin. What are some of your thoughts on that?

Adam Back (01:30:01):
I think there have been typically some form of privacy or fungibility improvement in new versions of Bitcoin as they come out, either at network level or in a protocol and taproot and the channel signatures that come with it are both helping that way. And, it’s not a silver bullet, but it does incrementally improve fungibility because it reduces some wallet or use case fingerprinting. So, part of what the open source intelligence is doing is it’s trying to correlate coins as belonging to the same wallets or belonging to the same user like fat and with Bitcoins generally, there’s a tiny, smart contracts attached to them, and the contracts will be different depending on the type of wallet or type of use case. So, if it’s a Lightning channel establishment, you’ll see it because it’s a different contract when it’s closed.

Adam Back (01:31:01):
And, the contract is revealed when a channel is closed and, the green wallet has a multisig, which is two or two multisig on a time lock, and that’s visible too. If you were using that wallet and, I pay somebody who is a single-sig wallet, it will be obvious. So there’s change, and the person looking at it from the outside wants to know which of these coins have changed and which is the payment. And maybe you can tell because all the multisig ones are the green wallet, and all of the single stake is the other wallet. So, you can tell which has changed and which is the payment because they have a different discernable type. And so, with taproots, you don’t see that anymore, for two reasons. One is, you don’t have to reveal the full scripts when you spend it, you only reveal the normal case and there will be an exception like, oh, I need to use the time lock clause and you will reveal it if you need to use it.

Adam Back (01:31:58):
But, typically you don’t, 99.9% of these never exercise a time lock. So, you get a kind of more privacy in a default case, and the channel signature can also disguise or not use a block space with multi signatures. So, with Schnorr, a two-of-two signature looks indistinguishable from a single signature to the blockchain, which improves scalability. And it means that you can’t tell single sig from multisig. And you probably can’t even tell in a single sig from multisig from a Lightning channel, say apple close, in a normal case because the Lightning channel is also… It’s got infrequently used branches in its logic that the other party’s wallet stop responding.

Adam Back (01:32:43):
I need to close a channel, so I’m going to use this escape close to unilaterally close it, rather than collaborate with the other party. That’s not so infrequent, so if you don’t need to do that, then also people won’t be able to tell, because it provides a sort of anti fingerprinting, which is an incremental improvement. Now there’s less state that’s finalized to more ambiguity about which has changed and which has not. But I mean, there were more things that could be done. And that was actually how the… With Blockstream, I… Before Blockstream, I was interested in trying to improve Bitcoin’s fungibility and privacy. So, I proposed the confidential transactions as a way to do that, and it encrypts or hides the value of the transaction. The transaction is still there, you can still look at addresses of what’s going where, but you can’t tell whether it’s a 10th of a Bitcoin or 10 Bitcoins from the outside. People party to the transaction can look at that.

Adam Back (01:33:42):
And that makes another improvement because you won’t be able to tell… Sometimes you can tell what’s changed by the amount, it’s an even amount or it’s an odd amount that looks like that would have been changed. And it takes that away. Plus I’d say there is an advantage to not broadcasting the size of a transfer for a security basis, if you’re operating a business and you sent a large transaction, some of these transactions are as pair-to-pair network, which could reveal your IP address and therefore your location, and you don’t want to advertise to the world the location of larger coin, larger wallets could be a security risk. So, you get some kind of security advantage. So, we went on to form Blockstream and implemented back extension and liquids, and it’s a Bitcoin compatible kind of technology.

Adam Back (01:34:34):
So, maybe one day we’ll see a more space optimized version of that and make its way into Bitcoin. That’ll be an interesting discussion to have, because, scale gets… People would prefer retail payment use cases for Bitcoin arguing their case, as opposed to the store of value, no censorship resistant payment use case. But, I think there’s different sets of people agreeing and disagreeing. If you would say, let’s have an initiative to add confidential transactions to Bitcoin. And I think it’s an interesting thing to consider because it doesn’t, in one go, remove the transaction graph. So, people can’t say, Bitcoin has become Zika, zero cash or something like that. But on the other hand, it does incrementally improve things. And in a way that’s beneficial. You don’t… If you do a bank transfer, you don’t reveal to the public at large your bank balance or the size of the transaction, so in some ways, Bitcoin is less private than a bank account from that point of view. So, it could be an interesting discussion to have, and maybe we’ll get to see that and the following years at some point.

Preston Pysh (01:35:40):
Well, gentlemen, we’ve been going for nearly two hours here, and I just want to personally thank both of you your time. Is there any closing comments or anything that you guys want to throw out there before I close things out?

Plan B (01:35:54):
Thank you, Adam, Preston. It was a great chat and I’m so excited about the next phase of this bull market, and I’ll be watching all the things we talked about, the basis, futures basis, contango spread, the implied volatility in the options and all the on chain parameters, as well as the [inaudible 01:36:13] of course… Watching it like a hawk and very excited about the next couple of months.

Adam Back (01:36:19):
I’m also a sort of value investor, kind of by trading pattern historically, and that’s the way I look at Bitcoin. If it goes down a bit, I feel that it’s cheap. I buy some more and let’s see… We’ll see how it plays out and maybe have a play with some of the long-term call options as well, haven’t done that much for those yet. That’ll be interesting to play with, and on the Blockstream side, obviously we’re busy with these Blockstream notes at the moment.

Adam Back (01:36:51):
And so, if people are interested in that they should go to stocker dot I-O-S-T-O-K-R dot I-O and have a look at the notes for non U.S. investors. I think in our view, it’s very attractively priced and an interesting kind of risk price, diversification of volatility, but that still could be a Bitcoin on Bitcoin trade or a way to acquire Bitcoin with less volatility to get an entry point because you do get people who will… New chemists will get stuck in a decision, but they don’t know whether price is going up or down, and then they’ll just sort of sit on the sidelines. So, you can… You’re much less sensitive to entry price with mining. And yeah, there are also people who are very far into Bitcoin who even do it as a kind of a slight, an alternative to selling Bitcoin, to reduce the volatility on some of their Bitcoin and see where that goes. So it has that potential you see. So, great talking with you, [inaudible 01:37:54].

Preston Pysh (01:37:56):
I’m going to have links in the show notes, I know Plan B has a website planbtc.com, where you can go and you can see all of his previous interviews, some of his white papers and things like that, that he’s written. Adam, I’m going to have a link to your note that you guys have. We had that in our previous conversation as well, and you can also go to blockstream.com, we’ll have links for all of that in the show notes. Gentlemen, thank you for your time. This was so much fun. And I would really like to do this again in the future.

Adam Back (01:38:25):
Thank you.

Preston Pysh (01:38:26):
Hey, so thanks for everybody listening into the show. If you enjoyed the conversation, be sure to subscribe to the show on whatever podcast app you’re using, we really appreciate that. And if you have time, leave us a review. So, thanks for joining us this week and we’ll catch you next Wednesday.

Outro(01:38:41):
Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decisions, consultant a professional. This show is copyrighted by the Investor’s Podcast Network written permissions must be granted before syndication or rebroadcasting.