Preston Pysh (00:08:14):
When you said that you had the tune it, is this really similar to what we see with the difficulty adjustment, where it gets easier, it gets harder depending on how much hashing power we see is on the network? Is that what you’re talking about when you’re saying you had to tune it?

Adam Back (00:08:30):
Yeah, it’s exactly the same. With the hash cash email postage stamp, I had set it to 20 bits, which is about a million tries. As a fixed difficulty, but I had the concept that the verifier should increase the minimum postage they would accept every few years as CPUs got faster and people started to do that. That is the difficulty adjustment, and of course, these are relatively cheap. It’s in a context of electronic cash curiously, and when I posted this on the Cypherpunks list and the crypto lists in 1997, isn’t a context where people were pretty excited. Electronic cash, David Shaun’s cash system was top of mind and very exciting potential for the world sort of thing. Like Bitcoin, fine, but on a far smaller scale, but it was centralized and it was difficult to bootstrap.

Adam Back (00:09:25):
A lot of people looked at this and said, wow, this is interesting. It’s like artificial scarcity, it’s like digital gold. Then started having discussions about, how could you control the inflation? They were hypothesizing that with Moore’s law and an incentive to know if you could do mining with this to create coins, that people would go nuts and make a ridiculous amount of coins, and that would erode making it difficult to have a stable value. I think people were … and by 1998, there were two types of proposals being with the ISP money and next up was bit gold, which by fused this proof of work and proposed ways to have a stable value as it were, or a market set value, but in a federated model with human market makers or a council or super node set of power users that would decide how much work was needed or how many coins were going to be issued in the epoch, things like that.

Adam Back (00:10:29):
If you scroll forward to 2008, when Satoshi started sharing drafts of the Bitcoin paper, it seemed to me that he had cracked the one thing that people hadn’t figured out how to do back then, which was, in hindsight it looks simple, but it’s to say, let’s not try to target a stable value, but let’s instead target a predictable supply curve, and let the market worry about the value. That it turns out is technically possible to do inside a distributed system with no human cancels or supernodes, and governance, and deciding how many coins per epoch, that kind of thing.

Preston Pysh (00:11:11):
It was funny, this Johns Hopkins professor that she just keeps on bagging on Bitcoin, just published an article. I think it was in CNN just this past week where he was talking about these, these governance structures. I’m thinking to myself, dude, the entire point of this is to not have a governance. Some people involved in the loop of managing this. It’s, how can people not see that this … Bitcoin is many things, but that is one of the chief things that this is all about is not having that. It’s just crazy.

Adam Back (00:11:46):
Even some Bitcoin technologists, technical commentators will talk about governance, by which they mean the change process with impact combined. I personally take exception to that terminology. There is no governance. The change process within Bitcoin is opt in, backwards compatible optimization and features, and there’s certainly no economic or core system metrics that there’s any plausible governance discussion to be had about, so Bitcoin has no governance, I would say.

Adam Back (00:12:19):
Yeah. If a theorem has governance, because there’s a group of people that are graph somewhere off the supply curve, and it’s all over the place. There’s labels on it where different people decided different things. I think, hopefully plan B said something interesting as a way to explain this, because it’s mathematical and software, people have difficulty understanding why it’s inviolable. They think, the software could be changed. His analogy was that it’s a game of chess, the game of chess. You could change the rules, but nobody will play with you if you do. You can make a modified piece of software with a different number of coins per block or something, and nobody’s interested in playing that game, so that economic consensus just continues.

Preston Pysh (00:13:06):
Adam, going back to the discovery here, what is the timeframe when you get this uh-huh moment about proof of work prior to even Hash Cash where you were just like, “I think this might solve this problem.” Where are we at in the timeline?

Adam Back (00:13:20):
That was in May 1997, I think, and I’d been reading about these house collisions on Usenet constantly, on a crypto list and found it interesting. I was looking at the mathematics of it in the background. Now it’s this ongoing spam war waging in general email, and a bit of creating a political problem for Removers, which I was one of the operators of a Remover. It occurred to me I spend, I don’t know, probably two or three days thinking about design variants of how to do it, and then I was thinking, I could post this. This is interesting. I think this would be the right design variant to use. I thought, in the ICF process you should have running code first. So I shut up and read the code for a couple of days then I posted it.

Adam Back (00:14:13):
It was, here’s the codes, here’s a description of how it works, and I was on a mailing list, and there was lots of discussion, and people integrate into REmovers and actually into a lot of different things. Even pseudonyms cost to create a persistent pseudonym should be like [inaudible 00:14:30] addresses in Bitcoin, and as storage, denial of service protection, and distributed false systems, and actually over time, spam assassin, which is a common ISP grade anti-spam filter, added support for hash cash postage stamps in the headers, so it would give you some negative scoring. It was trying to grade as the spam. It looked for spam in this metrics. If it had make money fast plus 20 to the score, this is probably spam. I had a valid hash cash header in it, big negative, this is not spam.

Adam Back (00:15:09):
It would protect you from being falsely categorized as spam, which happens to. They did that on a service side, and Microsoft made system as well, and integrate it into the whole suite of email things. The clients, the outlook mail server, things like that. But their protocol was essentially the same thing, but slightly different format, so it wasn’t cross-compatible. That tells you… I didn’t actually get round to writing a paper describing it more formally until about five years later. I’m generally more interested in building and deploying things.

Preston Pysh (00:15:44):
Action. You’re interested in action and actually doing it. I love that theme about you, and I’ve seen you post that on Twitter from time to time. It’s like, we can sit around and talk about things or we can actually create this and get things done, and that’s a cool story that you’re showing that that’s what you did from the very early days is that you coded it out, and you put it out there before you really even formally described what was actually happening with the code that you were publishing. I want to summarize something and just correct me if my understanding of this is wrong. But when I think about what this discovery really meant, this proof of work discovery, and especially how it applies today. I was taking this online course, I think it was this free Princeton course.

Preston Pysh (00:16:30):
It was like 70 hours just teaching you all the nuances of how Bitcoin works behind the scenes. I don’t fully understand the encryption. I know that the mathematics to take shot 256, make it applicable so that if there’s five people running five processors, and the difficulty is being scaled down for the shot 256. That math to do that to me is just a mind-blowing event. I can’t imagine trying to program or work out the math on how you would figure out statistically, how to adjust shot 256, which like you had said earlier, you could have all the processors in the world running on it till the sun goes out, and you’re not going to have this event where you’re having the same input produce the same output. When you’re thinking about scaling that difficulty down to now there’s five people guessing and they can figure it out in a 10 minute time period, the math that’s associated with doing that scaling down to me is an amazing feat. That’s pretty much what your proof of work discovery was all about, is what I just described. Is that an accurate description of how you would put it into layman’s terms for people that are listening to what this means and how it’s really applicable to Bitcoin?

Adam Back (00:17:50):
I think the point is the full collision. We know how to do it, it’s just too expensive. To make it simpler, faster and tunerbly expensive, it’s almost definition change. We’re saying, okay, we give up, we’re not going to find a full collision, not so expensive, but how about if we find a partial collision where the first 10 bits or 20 bits are by chance all zero. That’s what I did. Zero is as good as any number. It could be a magic string, it could be anything, but you’re trying to reach a target, and effectively by looping on a hash function, changing a counter in it, you’re throwing 256 coins and looking at the ones at the beginning, all landed heads. Of course, that’s very unlikely at the more heads you get.

Adam Back (00:18:49):
But if it’s 20, then it’s going to take, say half a second on a CPU at that time, and if you want to stay at a minute of work, after computers have doubled in speed, then you’re going to increase it to 21. With Hash Cash, I had a crude graduation with the amount of work, so it would only either double or half, but it’s pretty straightforward to make it take one and a half times longer. You just put a floating point representation of a number in there and say is it less than this? That’ll do it. That’s what Bitcoin does. I think how Bitcoin targets the interval is more like a control system. It’s like a feedback loop. You take a guess at a number, you start the system running, and then you measure over a period, what was the average time between blocks across this 2000 block period, and you’ll say, “It’s five minutes. I want it to be 10. Let’s double the difficulty, that’ll fix it.” And, if it goes in the other direction, you reduce it. It’s just a control system where you measure and adapt, measure and adapt.

Preston Pysh (00:19:58):
You hear all these different narratives, you hear all these different opinions on what’s going to work in the longterm. You hear a lot of people actually bash Bitcoin because it’s using proof of work. I’ve always had the opinion, which is the polar opposite of that, that proof of work is the essence of why Bitcoin is going to work because you actually have to perform. If we’re using a comparison to gold, you have to actually go out there with your shovel, and dig through the Earth’s crust and perform work in order to find whatever probability per dig. Let’s say you got to do a hundred digs to find whatever amount of ounces of gold, you have to do that work in the physical realm in order to create value behind what gold is, because it’s so scarce and hard to find. Why would that be any different when we move into the digital realm, that there doesn’t have to be some type of work performed in order to create value behind the units that are being mined?

Preston Pysh (00:20:57):
When I look at these other protocols and they’re not doing these things, and there’s just this pre mine, or there’s this proof of stake, and all these other things, to me represents more of what we’ve already got in today’s society with Fiat currencies, then it does something that is hard sound, immutable, fungible money. Assuming you agree, but is there anything that you want to add on to that, or do you believe that proof of work is really required for this to be successful in the long run?

Adam Back (00:21:29):
Yeah, I think so. I think that economic game theory is counter-intuitive even to people with a background in [crosstalk 00:21:38], yeah in economics. There is some very interesting effects here. One thing that I think there’s if you scroll through Sutashi’s [inaudible 00:21:48] it said something like, yes, it uses electricity, but as with gold, it’s far more efficient to the world to have a hard money versus the slippage and churn that happens when you have political money. Then another comment I’ve heard is Paul Stuart’s made the observation that there is an economic incentive to obtain money. People are willing to expand up to the commodity costs to obtain it, and if there is no clean cost, that effort will be expensive in other ways, ie in political lobbying, favoritism, audits, physical bank security, cross checkers controls, theft, inside a double dealing, inefficient political systems.

Adam Back (00:22:36):
We haven’t saved a thing, what we’ve done is we’ve had a messy uneven playing field. Another thing that’s interesting is Eric [inaudible 00:22:46], I had a discussion with him where I concluded that actually he was right in some degree that people look at, they look at the world as if a cost arose up in issue, but there’s no cost that doesn’t have an alternative. The say, electricity was used to mine Bitcoin, okay, but there was a forgone alternative. Instead of mining the Bitcoin, maybe they would have engaged in some other consumerish behavior. They would have bought a car. No energy was solved, maybe Bitcoin is probably actually reducing a number of pollutive and carbon producing things in the world for example. It’s really reducing gold mining because I think people are starting to realize that gold prices would probably be higher if the coin was not monetizing, and the alternative, and gold mining is extremely industrial and chemical process. I think that there is probably some necessary inevitability for the production of money to have, for hard money to have an actual economic cost.

Preston Pysh (00:23:54):
Adam, when we think about this, and whenever I’m looking at the price curve, the thing I just keep coming back to, and the thing I keep asking myself, is how in the world, because here I am, I’m a finance guy. I’m looking at stocks, I love stock investing, and I’ve never in my life seen a price chart that looks like Bitcoin. I’ve never seen something that almost looks like it grinds and has this perfect shape on the bottom of the price chart over a 10 year period of time, and I know a lot of people in the community don’t like to necessarily call it that it looks like Metcalfe’s law for various reasons because you’re comparing something that’s a little bit different. But when you look at that price chart and you look at it in log terms, it looks like Metcalfe’s law playing out in real time, but it’s a price chart. I’m telling myself, what in the hell is driving this to happen?

Preston Pysh (00:24:50):
There’s something mechanically that’s happening in the code that’s causing this to play out. The only thing that I can arrive at, is because when you look at these peaks that happen in the price action, it doesn’t seem like it’s bound. It looks like it’s more emotional. But when you look at the floor of the price action, there’s these moments where it almost seems like it’s just grinding through something that’s forcing it to go up. The only thing that I can come to the realization, and I go back and there’s an awesome book called the book of Satoshi that I’ve read and it’s pretty much all of Satoshi’s writings that was pulled from online. One of the quotes in there that really stuck with me is he really gets into something that you just described, which is this labor theory of value might actually be playing out with Bitcoin.

Preston Pysh (00:25:41):
You talk to any economists and they’ll roll their eyes at this labor theory of value. They’ll say that’s clearly not something that actually works in reality, especially when you get into specialized services, like say you’re a doctor or whatever. That’s just not something that’s applicable. But I think when you look at Bitcoin, and you look at the mining process, and you look at how commoditized the mining process is, and how competitive it is, it’s really the electrical cost to mine these things that’s setting the price floor, especially when you look at the scarcity that keeps getting tighter and tighter, like a new surround, like a collar around a dog that just keeps getting tighter and tighter every four years. This is my question, is proof of work driving this price floor because of the electrical costs that are associated with the flow of Bitcoin that’s being dropped into the market, and how much tighter it gets every four years.

Adam Back (00:26:38):
I think the complete inelasticity of the supply code is interesting, because if you look at any other commodity, the people who are extracting, or producing the finished products are going to react to market conditions. If the price of gold is up, they’ll reopen mines that are having an expensive per gram production cost. They’ll work shifts, people will recycle, reclaim gold from electronics, and everything will ramp up to the max. It takes the edge off the price increase a little bit, and similarly, if the price is depressed, they’ll shut everything down and it will take some edge out of the selling because there’s less to be bought as well. Bitcoin in comparison, and people say, Bitcoin doesn’t care, which is more insightful than it sounds. It applies here too. You’re saying the price is up, Bitcoin doesn’t know that actually, so it just keeps producing coins, and the miners of course, they will chase the higher cost by being economically incentivized, to bring more minors online and so forth.

Adam Back (00:27:46):
It’s an interesting question to why [inaudible 00:27:49] miners sell coins to pay electricity bills? At Blockstream, and me personally as well, have been doing mining for about five years now. Conclusion is that it’s better like back tested to, just passionately back-tested, it’s just a better financial strategy to hold the coins and not sell them. People will say, “Well, how could you do that? Where does the money come from?” I say, “Well, look, you’re about to invest some dollars in mining. Some of that’s going to go into equipment and some of it’s going to go into electricity.” If you’ve got $100,000 or $1,000,000, calculate the ratio between the equipment and the electricity you’ll need to run it for three years. Instead of spending all of your money on miners and then saying, “Oh, no, I have no money left. I’m going to sell the coins to pay for electricity,” you’re better off to mine at let’s say half the size, but you’ve got half the money set aside to pay the electricity bills, and can talk about more why that is.

Adam Back (00:28:48):
But basically I think that mining has some downside protection as compared to buying. Buying and holding is very sensitive to the enterprise and that catches new people. They look at the price and like, “I’ve been hearing about it, it’s in the news again. I want to establish a bitcoin position, but now is this a good price? Should I wait for it to fall? Will it just go up?” [inaudible 00:29:15]. With mining, it’s interesting because you don’t care as much about what happens. If the price goes up rapidly, you tend to get a derivative benefit because there’ll be a shortage of miners, or people can’t manufacture new miners fast enough to bring them online, so you’ll get a thrift of premium for a while until that catches up. That’s the current state of the market really.

Adam Back (00:29:36):
Last year the miner sales were weak, but this year it’s really hard to acquire new miners without very long forward delivery dates. If you started mining and the price falls, you would think that’s bad, but actually what tends to happen is prices falling, so some miners will switch off because they fall below their breakeven. As that falls, if you keep mining, you’ve got a cost basis that allows you to keep mining or you’ve pre-funded the investment. You’ve got the capital to pay for the electricity and you’re going to mine through it. Obviously you’re not going to mine below the cost of buying Bitcoin with electricity. That wouldn’t make sense, but there’s a big hysteresis between equipment breakeven and the initial investment.

Adam Back (00:30:22):
That’s typically fairly far off. You end up mining more coins than you expect through the bottom of the market, and then let’s say the market recover somewhat. We did one coincidentally, where when we started, the current price was around $15,000. If you had bought, that would have been your entry price, and when we finished, when these machines reached end of life, the price was about 7,500. If you bought and hold, you’d have made a 50% loss in cash terms of Bitcoin, but with mining, we ended up making a 25% profit in dollars. You wonder how could that be? You go back, test a bunch of things and try and figure out a pattern of what’s going on here. The point was, price fell all the way down to 3,500, which gives you an indication on this period, and we mined a lot of coins at prices below 3,500, because you’re generally mining a discount or you stop, and then a price recovered to 7,500.

Adam Back (00:31:19):
That was enough to push us into the discount on mining, plus the fact that we got more coins of expected because price really fell a long way in the middle of it. I think generally what you see is it’s less sensitive to enterprise, or timing. You have some downside protection, you still have a fairly good upside participation. We’ve seen across the periods we back-tested. It averaged about 60% upside participation as compared to buying, just buying and holding Bitcoin. For the trade off, I think, that’s an interesting trade-off, better than being frozen in indecision, let’s say for people who are new to Bitcoin or looking to establish a position.

Preston Pysh (00:32:03):
When you say 60% upside, that’s on an annualized basis?

Adam Back (00:32:08):
No, absolute return across a three-year period. Of course there are many periods where buying and holding up performs. Bitcoin’s price history is nothing but exponential, but it’s also volatile. The point being that you experience less volatility by doing mining, and there are people you could say, look, Bitcoin has performed well over all three previous X year periods, and that would be statistically the case, but that’s still unnerving prospects for people who are not used to Bitcoin, haven’t adapted. We’ve both participated in different conventional markets, and there’s enough volatility in those, but Bitcoin at times takes that to a whole different level.

Adam Back (00:32:51):
I think that the reduced volatility of mine investors buying, and the prospect of this downside protection, and some upside participation, got a pretty reasonable upside participation at 60%, statistically is something less scary than full Bitcoin, because some people would do a mixture. Other than newcomers who don’t have a Bitcoin position, the other half of investors we’ve seen be interested to do this are people who actually are very deep in Bitcoin, almost felt overexposed to Bitcoin. They had some dollars, and were interested to do something Bitcoin correlated, but with more downside protection. That made sense to them as well, but for a very different reason. I think another reason to do mining is, as we were talking about earlier, Bitcoin gets some of its value from being permissionless and decentralized. If mining becomes too centralized, that could expose it to governance like risks.

Adam Back (00:33:56):
I think if you look at the Bitcoin market cap, and you work out what it would take invested in mining, what percentage of that it would take on an individual basis or, on a whole system basis, it’s only a couple of percentage points of the let’s say 1 trillion in market cap, as composed to a handful of brilliance and money equipment electrical spend. One approach on that that was my personal philosophical point of jumping into doing some mining on more than a hobby basis myself, was maybe I should be part of the solution and operate. Some of them might not physically hand on, but they’re my miners, so I can say, if something traumatic is happening, I can instruct the service provider, “Look, I want you to do this with my miners,” and they’re going to do it.

Preston Pysh (00:34:47):
That’s an interesting point. I just want to summarize it, especially for a lot of the finance and investing types that are listening to this. In short, what you’re really getting at is this is giving you a better sharp ratio I invest in, because you don’t have as much volatility, and you’re saying that over a three-year period of time, you have demonstrated through back testing, which doesn’t necessarily mean it’s going to be what it is moving forward, that you’ve had a 60% out performance. If you’re having less variance in your price, and you’re having an out performance, that’s going to give you a higher sharp ratio than if you would just buy the underlying. That’s something to be said, because when we look at the sharp ratio on Bitcoin, and I know the sharp ratio I’ve looked at is over four year periods, but it has literally outperformed everything financial. Every financial asset on the planet over the last 10 years which is something to be said. That’s a really interesting stat.

Adam Back (00:35:43):
I would say what you said is accurate, but I would emphasize that the expected return is lower by mining, but the sharp ratio measuring the trade off between investment return and volatility, it has reduced your volatility by more than it has reduced your return. Maybe that’s attractive to some people, or they’d like a little bit of a lower risk. Of course, the other obvious thing you can do with risk, which is the way some people talk about Bitcoin for newcomers is to say, “Well, by one to 5% from the point of view your stock portfolio is moving around. You’re uncertain about lots of factors in today’s world. So what’s the worst that can happen? You could lose one to 5%, and looking at the other factors you’re looking at, including into money supply expansion and probable double digit asset price inflation, trying something for at a one to 5% ratio that may improve. That’s just an asset allocation and mixing a high shot ratio asset with higher volatility, it may repair your returns if things go badly. That’s another thing. Just asset portfolio allocation.

Preston Pysh (00:36:51):
Adam, what are you guys doing from a Blockstream level? Is this all internal as far as just you’re using your own retained earnings in order to invest in this, is this something you’re going to open up to the market that people can participate in it with you as well through equity or through debt somehow? What’s your approach moving forward for this?

Adam Back (00:37:09):
How we started was about 50/50 internal investment, use of company’s cash reserves and actually converted a bunch of US dollars into Bitcoin. So Bitcoin holdings and Chris through that. The other was hosting for high net worth individuals and institutions. There were Reed Hoffman as an individual, and Fidelity is one of the hosting customers, and there’ve been more that have been announced over time. A number of the recognized brand name institutions in the space who are doing mining, many of them don’t have physical operations, so they will host equipment to us. Something else we’ve had, now, we’re interested in decentralization, and us doing some institutional and in company mining as a form of macro decentralization. We’re doing it in Canada or the US, we’re a new voice. If there are 50 institutional miners in 49, that’s a small amount of decentralization, but it’s not very end-user decentralized.

Adam Back (00:38:13):
We have seen a lot of ongoing requests from individuals to say, “Hey, can I buy $10,000 worth of mining, or can I buy $100,000 worth of mining? That was something that we were interested to do, but once set up to do at the beginning. We set about trying to address that problem and meet that demand. More recently we have offered something called the Blockstream mining notes, which tries to do that. Now, on a regular basis, it’s only available to non-US investors, and there’s a qualification criteria which where the minimum investment has to exceed 125,000 Euros, and this has been non-US investors. But it does bring the barrier down.

Preston Pysh (00:38:54):
Adam, just for clarification, you said it’s a note?

Adam Back (00:38:58):
Yeah, it’s actually … I think it’s the first of its kind actually. We worked with a company called Stoker in Europe that is a regulatory specialist and they are the registration agent for this. It’s Luxembourg’s characterization vehicle. It has a foot in both worlds. It’s both a Luxembourg characterization vehicle with an ice in an investment serial number. You could potentially give that to a broker deals with a longer tail of assets and say, can you hold this as part of my portfolio? Can you imagine lend against it? That thing is possible if you have a bespoke brokerage, but it’s also an asset in a cryptocurrency tokenization sense. So it’s a liquid security token. It’s an STO.

Preston Pysh (00:39:46):
I love it. This is awesome.

Adam Back (00:39:49):
The security token means it will imply some quite interesting things for people who are able to access it regulatorily. One is that you can potentially transfer OTC. After the issuance phase, there are some different limits that apply later, so it can be transferred down to 0.01, but only to qualifying users, and to be a qualifying user, the user has to register on Stoker and they are the registration agent for these transfers, but there’s no conventional stock transfer agent fee, only network fees, which are deminutus. You could gift somebody a BMN, or part of a BMN. You could swap it OTC, and there are smartphone wallets, so that you do that. It’s private OTC scenario.

Adam Back (00:40:35):
There are some exchanges which we are working with that may end up being in a position to list STOs going forwards. In that sense, they would be a nominee ombudsman holder of these notes. The registration agent would be in the name of that exchange, and then the exchange would reflect the qualification requirements onto their users, so it would be accessible to a subset of the users, ie not in the US and reaching some level.

Preston Pysh (00:41:04):
All right. I have a million questions here. You said that it’s through Stoker that you’re registering for your ownership of the note, which is a token on liquid. How is the maturity of this, and is there a coupon, is a coupon list? I’m assuming there would be no coupon being paid, you would just get a payout at the maturity date?

Adam Back (00:41:27):
Right. We had some quite a bit of internal design discussion about the mechanism jurisdiction tax planning, so there’s quite a lot that goes into this, but yes, so it’s coupon less, so there’s no Bitcoin being dividend out of it, so the Bitcoins roll up inside until maturity, and then they paid out in Bitcoin to the holder at the time of maturity.

Preston Pysh (00:41:52):
So you hold this token, what’s the maturity on these?

Adam Back (00:41:56):
36 months.

Preston Pysh (00:41:58):
36 months. So I could buy it 12 months after it’s already been issued for whatever price it’s trading for on the open market, and then I hold it, let’s say I hold it through maturity. At that time, the token just disappears and Bitcoin shows up in a wallet that’s registered with that specific token? Is that how that would work?

Adam Back (00:42:18):
Yeah. If it’s on the exchange, they would probably take care of that for you. If you are holding in a wallet, you’d probably need to go to Stoker and deposit the token-

Preston Pysh (00:42:27):
Turn them in.

Adam Back (00:42:28):
… Bitcoin, put a Bitcoin address like having a oil future, you got [inaudible 00:42:33] at the end.

Preston Pysh (00:42:35):
Now are you guys going to go through just one issuance, are you going to go through multiple issuance’s to just continue funding? It sounds to me a little bit like what you had previously described, where half of whatever you guys are generating, you’re putting into hardware, and then the other half you’re retaining as payments for the electrical expenses, which is your maybe derivative strategy in order to make sure that your electrical POS have a predictable curve to them. Is that how you’re going about it from a strategic sense?

Adam Back (00:43:07):
Part of that is back-tested. We’re thinking based on our own experience, prop mining that, this is a better way to do it economically, as opposed to spending your capital allocation on the miners, and then paying as you go or selling Bitcoins as you go. We put those economics into the note because we want the note holders to have a positive economic outcome so they buy more of them basically, so it’s a win-win formula. It’s exactly like you say and of course the price is bundled, so how you ascribe value to the cost of the miners versus the remaining duration on the hosting contracts is a matter for the market to decide ultimately. Over time of course it’s got an additional makeup, which is the number of coins per notes, and there’s a dashboard where you can see that on a fairly real-time basis.

Adam Back (00:44:01):
Now, you asked another question, which is, do we issue more? So yes, we are intending to issue about $100 million, so 85 million Euros of this series. Even though they’re issued at different times, we do some clever things to achieve fungibility between them, so that they are all interchangeable and you shouldn’t care as an investor, whether you bought an early sales Tranche, versus a later sales Tranche versus in the market. That’s quite interesting to actually achieve because these first 12.5 million sales Tranche is powered up to early July, and let’s say there’s another Tranche that sold in September. For that to be equal, it has to have a 33 months hosting contract, and we have to mark it by the number of coins per notes that the miners have already been running [inaudible 00:44:54]. That’s what we do.

Preston Pysh (00:44:58):
I would think that you would do it in a way where let’s say you have your first Tranche, whatever you raise through that initial Tranche, that has dedicated servers that are basically partitioned saying, “Hey, this amount of processing power is dedicated to this Tranche of funding.” Then as the next Tranche comes in, whatever servers that are associated, and I’m saying servers, but really processing power and para hashes or whatever it might be, is dedicated to this Tranche of funding. Am I understanding it correctly that that’s how it’s being managed?

Adam Back (00:45:31):
No. It’s actually all interchangeable once. Think about it like [inaudible 00:45:38] that’s mining, and there’s a certain economic makeup of the per note value. Let’s say it’s August, they’ve been running for a while, there’s a certain proportion of Bitcoin per notes, there’s now not 36, but 35 months left to run on the contracts, so the value of the hosting quarter has come down a bit, the Bitcoin had a market value, and the machines have some depreciation scale of value. Now it rolls up into September and we want to add some more notes, which are interchangeable with the running notes. What we do is try to match the economic characteristics of the existing notes. We say, “Okay, let’s look at the makeup.” It has a defined number of Bitcoin. We can fix that. We just go market by that many Bitcoin. It has 35 months left to run on the hosting contracts. We’ll give it the 35 month contracts-

Preston Pysh (00:46:30):
I see how you’re doing it.

Adam Back (00:46:32):
Then the machine should be comparable, but it’s defined in terms of hash rates. Even if these machine shortages mean that sometimes you want to take what you can get. If the machines that come online are 42 jewels instead of 38, they’re less efficient, it’s still fungible because the definition is in the hash rate target of what it’s producing. It will mean that maybe we pay slightly less for the machines, but expense slightly more power, what is still interchangeable because the finished product is the hash rate you get from it.

Preston Pysh (00:47:07):
At any point in time post the initial issuance, let’s say we’re three months into the ownership of this. I can look at how much Bitcoin has been mined, that’s associated with that note. Is that correct?

Adam Back (00:47:20):
Right. It’s actually the same for all of the notes because it’s harmonized. There’s a pool of hash rates, so it’s averaged, but there is a defined, this is how many clients have been mined per notes or in aggregate, and this is how many notes there are. Another question people ask is, what if I want to sell the coins now because I can’t extract them? You can synthesize the equivalence of there being a Bitcoin coupon, by if you additional bitcoins outside, you could just sell those instead. Something else you could do, we were talking earlier about a yield strategy is you could … assuming there are exchanges, which on the BMN notes as collateral, you could short Bitcoin using it as collateral to the tune of the number of coins per notes, and that would be equivalent to selling because it would lock in a dollar value, plus it would give you a yield typically resulting from the Bitcoin perpetual products.

Preston Pysh (00:48:22):
This is such an interesting approach, and it’s so much different than participating in a mining pool, or just going out and buying equity in a mining company. It really has a feel that you are really participating in the funding of hardware, and then getting the kickback of whatever that hardware is pumping out. Fascinating. I’m really curious why not in the US? I think I know the answer that you’re going to say, but I’m curious, what’s the reason that you were not able to do this in the US?

Adam Back (00:48:50):
We may be able to in future, it’s just there are different regulatory requirements, and that’s for the process. You mentioned a couple of things there. One is that you are not buying shares in a mining company. This is more like a non-discretionary financial instrument, so that you’re not relying on some management discretionary decision. If you put money into buying shares in a mining company, now you are exposed to, did they make a good decision? Did they decide to use your money to expand a farm over there, or sell some coins to dollars to cover the prices falling, or pay a management bonus, or pay a dividend or not. None of that stuff applies. It’s all non-discretionary define what’s happening. There’s extremely thin deterministic behavior, and it’s like a Bitcoin ETF, it’s not an ETF, but it’s something in that direction where there’s a defined thing that does something very thinly managed.

Preston Pysh (00:49:53):
I’m curious. Let’s just say I buy $1,000 dollars worth of this note, when are you expecting over that three-year timeframe for the person to break even on the principle of the $1000 based on testing?

Adam Back (00:50:09):
I think obviously its difficult because there are so many exponentials that go into the Bitcoin world, exponential price, the high volatility, the hash rate is parenterally, really actually even exceed price because you’ve also got a factor of more modern equipment being developed over time that has a higher hash rate per jewel. I think one thing we can do is look at the back-testing, but it can’t be that the future doesn’t guarantee that and say that it hasn’t lost money over previous three-year periods, that it has this 60% upside participation as compared buying and holding. But what is very defined is the short term, because Bitcoin has a fully liquid market price.

Adam Back (00:50:54):
The current difficulty is you can look at it, that’s verifiable, and you can infer from that what your mined Bitcoin revenue would be. For notes, the list price of the notes of course, that may change based on the inputs later, is 200,000 euros, so that’s actually the minimum investment. If it were running now, I would say that would produce about 20,000 euros per month. If the metrics went such that it was a straight line, you would see a breakeven at 12 months.

Preston Pysh (00:51:28):
About a year. Intuitively that’s what I was expecting to hear you say, it was about a year timeframe.

Adam Back (00:51:35):
Right. Of course it can-

Preston Pysh (00:51:37):
It all depends.

Adam Back (00:51:38):
It’s not as volatile as Bitcoin, but it’s still volatile, so you got to buckle up going into these things. That can go both directions. If you scroll forward to some of these stock to flow derived price targets, or just price targets people are thrown out, or comparatives between previous having lows and highs or cycle lows and highs, $300,000 price into next year, of course the profitability is going to be through the roof because nobody can manufacture that amount of equipment in that timeframe. There isn’t enough command of capacity in the world if you manage to seize all the capacity that’s being used to build smart phone chips and so forth, which is hard to compete with in terms of their command of capacity, basically.

Adam Back (00:52:25):
But of course, if that were to happen, I think it’s fair to say you would have done even better if you just bought Bitcoin and held it now. But in the alternative there’s certainly people looking at the market now and saying, “Wow, $60,000 is a high price. I’m scared to buy,” and basically get stuck in decision cycle. Now, as an alternative to that, I think it’s a pretty reasonable trade-off.

Preston Pysh (00:52:46):
I’m curious on the Stoker thing. Are they doing this with equity as well, where they’re assisting in the issuance of tokens for equity?

Adam Back (00:52:54):
They are a company that specializes in that area, so they do the KYC, they are a Luxembourg securitization, licensed Luxembourg securitization manager. I don’t know the correct terminology, but they’re the experts in that domain, and they do fundraisers for these, it’s called a non-public investment in Europe. One they did is for a super car called Mazzanti. It’s an Italian bespoke, custom Super car company, that’s equity in the company or something like that, or equity or proportion of revenue, something, I didn’t look into the details, but they are doing things like that. Another one is infinite fleet.

Preston Pysh (00:53:38):
Yeah. Samsung was telling us about this. That’s how he’s doing it is through it. It makes sense now. Let’s transition to real fast here, and I know your time is limited, and I want to be respectful of that. I just want to hear what is the biggest news you’ve seen this year or something that really just made you go, “Oh wow.”

Adam Back (00:53:57):
It seems like the metrics and institutional, so almost stampede to participate, is there’s something new every day or two. Big fund managers, big banks where the CEOs have been skeptical. That’s just the [crosstalk 00:54:16].

Preston Pysh (00:54:17):
They’re writing stock, the flow charts now from fidelity.

Adam Back (00:54:21):
Yeah. That’s interesting to see. Of course the adoption level is still fairly low. The treasury and [inaudible 00:54:30] interesting to that Michael Saylor encouraged people to do. It’s something we’ve actually been doing since 2014, which is when we were in corporate, and that obviously works pretty well. We got the equivalent of probably a couple of rounds of investment through Bitcoin price appreciation and invested dollars into mining, that was also highly profitable in dollar terms, and putting all their current balance sheets. I think it’s an interesting precursor to transitioning to a Bitcoin monetary base if that happens, or at least alternative store of value. I think sometimes people overemphasize that fit currencies have fallen and even the best of them, 99% over a 100 year timeframe. But nobody in the investment space says you should put cash under the mattress.

Adam Back (00:55:21):
It’s not really a useful comparison. I think maybe gold is an interesting comparison, and Bitcoin may I guess in the long term, do a little better than gold, even at the top of an S curve after fully adopting whatever level that is. If that’s 100 trillion or 200 trillion, five to 10 million a coin, even then, because now having displaced lots of different artificially monetized goods, like stocks, real estate artwork, gold, things where people are not buying it for the enjoyment of it, but they’re buying it to preserve capital or to an expectation of price appreciation by other people seeking to do the same thing. Even in that case, I think it would outperform gold because it’s strictly scarce where there’s always more gold. So the supply inflation should taper off to well below gold I guess is my point. Just the sequence of positive news is just really keeps going. That’s pretty interesting.

Preston Pysh (00:56:23):
You and I have exchanged some messages with plan B in the background about this contango trade. What I find fascinating is you’re seeing this pretty much only materialize are these spreads, these large spreads between the spot and the future price, materialize on physically settled exchanges. When you get into the cash settled exchanges, it doesn’t seem like this is happening, but with the size of some of these physically settled derivatives exchanges all over the world, which are massive, billions and billions in size, what is causing this? Is this going to continue to persist, especially as the volatility gets larger as we go through this bull market we’re in, and does that pause the spread to even below out larger than what we’re seeing right now, the locking up of coins on the physically settled exchange, is this almost like a second having event that’s playing out in real time? Give us some of your thoughts on this.

Adam Back (00:57:23):
I think a submarine issue to many people, not issue, it’s a positive driver, but it’s not something that’d be visible to them necessarily, because it’s wrapped up in some advanced trading strategies, and it was mysterious, but it seems like actually has the potential to be a Bitcoin monetization driver because people who are not even interested in Bitcoin can get an extremely high us dollar interest return.

Preston Pysh (00:57:58):
30, 40%?

Adam Back (00:58:00):
Yeah, completely Bitcoin neutral. Of course once they realize that this is the case, and that they can do these, take these match positions on increasingly high tier platforms, more and more money will flow into that. One theory could be that, and of course there’s enormous pools of money outside of the crypto space, buying 30-year bonds in negative rates and things like that. There’s a lot of money out there. You would think that once the dam breaks and it flows in, the yields would slow down, but I think the problem is that it’s a universe expanding.

Preston Pysh (00:58:35):
When you say that, intuitively I agree with you, but in order for them to continue to participate, they’re locking up more of the underlying as they come in and try to chase those spreads. If they’re locking up more of the underlying, they’re clawing it off the market, which is almost like it’s supplying another having or supply suffocation of the underlying coins, because the only way that you can do these positions is you’ve got to put them in escrow, the underlying.

Adam Back (00:59:06):
I think there’s some positive reinforcement loop where it’s a mistake to think that let’s say there’s $4 trillion of demand to borrow dollars, so there’s only, let’s say half a trillion that is extent on crypto trading platforms, this is demand to your leverage long, because the people that are in Bitcoin generally want more Bitcoin, or regret former conservatism, and of course there are speculators too, but there’s clearly a high demand for leverage. As a shortage of it, they put the price up. The problem is basically the people who have doors on crypto exchanges, would generally be inclined to market by Bitcoin and hold it, so the only way you can persuade them to lend it to you is to bid the price up, and there’s obvious a subscription for that. You would say that there’s so much demand now, there’s more than that money outside the ecosystem, wants to overcome.

Adam Back (01:00:06):
There are many platforms where you can count physical Bitcoin as collateral, so you’ve got to use other collateral, so that takes some of the fun out a bit. But as you said, I think the thing is that it’s not a stationary picture because it’s also as more money flows in, it satisfies the demand to buy more Bitcoin and pushes the price up, locks up the physical Bitcoin, put his yield strategies, which is more scarcity. Somebody wants to institutionally buy Bitcoin, where are they going to go?

Preston Pysh (01:00:37):
Is it a perpetual machine? Once you get a physically-settled derivatives market, that’s mature in place. That’s the question I’m toying with. I have no clue what the answer is, and I don’t know that there’s any way that we could solve or say conclusively that that’s what this is, but in a weird way, it’s looking like that’s what’s potentially the case here.

Adam Back (01:01:01):
It does seem like there’s some hyper Bitcoin-ization aspect to this, which is, it’s just a self-feeding monster that wants to absorb all the money. Basically what it’s doing is it’s just shifting the Bitcoin dollar exchange rate. As that changes, it can absorb more money because now the price per coin is higher, so it is not 4 trillion, and then it’s 8 trillion and then it’s 20 trillion, and before you know it, you have full-scale global hyper Bitcoin-ization or something. We’ll see how it plays. One interesting part about it though is that, unlike the trader psychology that goes into pullbacks and during a growth cycle, like we’re in now, they’re typically being like a dozen, 10, 20, even 30% pullbacks on the way across 100X growth period or something which we’ve seen in the past.

Adam Back (01:02:03):
People will have to become accustomed to that, some people will panic sell, or make other mistakes, over leveraged that thing. But with the yield strategies, you’re immune to that. These are largely immune to volatility, so long as the platform you’re using is solvent, doesn’t get hacked. That’s where more mature platforms coming into play helps. Then what’s not to like about the yield in this environment? There’s a reason for people to buy Bitcoin to collateralize the dollar yield collection. Now they don’t even directly care about the price.

Preston Pysh (01:02:41):
It’s at least 10X right now on an annualized basis of what they’re getting on. Any type of traditional government issued long-term bond 10X. It’s crazy. Adam, I could literally talk to you all day. Thoroughly, thoroughly enjoyed this conversation, and I really want to do this again because when I posted that I was going to be talking to you on Twitter, I think I had three or 400 people send me questions as to what they wanted us to talk about. So, I would really enjoy if we could get back on and hammer through some of those questions if you’re up to it, but either way, I am so excited and just want to thank you for your time to come on today.

Adam Back (01:03:19):
Thanks for having me on, and let’s do that. Pay for some interesting questions.

Preston Pysh (01:03:24):
There were a lot of interesting questions there, yes, sir. All right, hey, we’ll do this again and thank you for your time today.

Adam Back (01:03:31):
All right. Thank you.

Preston Pysh (01:03:33):
Thanks for everybody listening to 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. Thanks for joining us this week and we’ll catch you next Wednesday.

Outro (01:03:48):
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