Preston Pysh (00:04:13):

Willy, when did you see that transition really play out? At the start of 2021, would you say, that the miners are now taking out fiat loans?

Willy Woo (00:04:22):

Yeah. I think so. I think with Michael Saylor popularizing the idea of Bitcoin as an investible asset class within investors inside the equity markets, I think that’s opened the door. And just looking at the filing numbers and the reports, it looks like that started to happen in 2018, the first companies that were listing, maybe even before that. So there’s that side of it. That’s just on the mining. The only thing we used to look at was the mining which was a supply. So that supply is slowly reducing and deviating off what the Halvening would suggest.

Willy Woo (00:05:02):

But then you’ve got this other side of things which is, other supply coming in from sale pressure from exchanges. So for example, now we’ve got very, very high volume futures exchanges, and they generate masses, billions and billions of dollars in fees. Some of that will be sold into cash because I’m generating it within crypto, they’re making Bitcoin as their fee, and then they sell some of it because they’ve got operational costs. So that’s a new supply. If you were to take those numbers … I was talking to an OTC at one of the larger desks, and obviously they’ve got more information because they handled some of these trades. That sale pressure is like 30% higher than the theoretical max of the 900 Bitcoins per day is being mined.

Preston Pysh (00:05:53):

This is for the ETF that you’re talking right now?

Willy Woo (00:05:56):

No, this is just the current Binances, FTX, BitMEXs of this world.

Preston Pysh (00:06:01):

Wow.

Willy Woo (00:06:02):

That is a really significant, probably over two times more sale pressure than the miners selling. Then you take the ETF, and you take not even with the latest ETF that’s been accepted by the SEC, but we take the Grayscale, which holds 650,000 Bitcoins in its trust. That charges a 2% fee, and you can look at it. Since the premium has gone negative on it, it hasn’t added new coins into that trust. So you can actually see it slowly dropping in coins under management, and that’s from their 2% fee being deducted off it and sold. That is already 4% of the theoretical max of the mining network. So now you’ve got another 4% there on top of the exchanges, and then you’ve got this now futures ETF. The futures ETF is another thing which is extracting fees and selling.

Willy Woo (00:06:56):

Effectively, it looks like a sale pressure because if an investor comes in and buys, say, a million dollars of Bitcoin, if they go through a futures ETF, maybe they take and buy a million dollars of futures long contracts. So then the futures long contracts increases in premium above this spot, and you call that contango. Contango runs away and gets bigger and bigger. So that creates an incentive for like a hedge fund, a delta neutral trading fund which says, “Okay, I’m going to buy this spot since the futures ETF is not doing it. I’m going to buy it as the proxy to hold it.” And then they’ll sell the futures to bring their contango down because it’s incentivized. These guys will make … We saw this in the early part of this year. They were making 20 to 40% yield on their cash and carry trade, hold the spot, sell the futures.

Willy Woo (00:07:50):

The futures ETF is really incentivizing more of that to happen. So that guy that put on a million dollars to buy Bitcoin in the futures ETF, only be getting 800,000, 700,000, 600,000 Bitcoin spot exposure through that. The hedge fund and all the guys in the middle that are taking the yield out of it is really extracting the final value. Remember, this is an annual cost to hold it. So that effectively is a sell pressure because what was bought was not bought spot. You’re only buying a fraction of it and the rest goes to profit and fees. So now we’ve got much bigger sell pressures than miners. And miners are minor, miners are the minor sell pressure, no pun intended. So it just does not look like the same dynamics where we had this pristine, simple demand and supply within this network. Now we’ve got the full complexity of a new financial system with derivative markets and so forth.

Willy Woo (00:08:51):

You’ll see it in the chat, ever since derivatives came on board with BitMEX really starting to ramp up volume in 2018, you can see that the shape of the chart’s completely different. Gone are the parabolics, huge wicks, big ups and downs, sheer verticals, and it’s choppy over … We can have three months of down and then we have three months of sideways, and then we might have a really hard run. And then it’s just weird compared to what maybe an OG would have gotten used to over the 2010 to 2017, first seven years of Bitcoin. We’re in a different era and you can see it in the price chart. And so I don’t think that we’re going to have the same four-year cycle. If you were to think the end of the four year cycle is a one-year bear market, 80% pullback, I think that that’s gone.

Willy Woo (00:09:46):

I think a lot of the FOMO gets hit on its head because you got sell pressure coming from all of these new players. Then the underlying demand can push it up in a rally again. Then it’s kind of, it’s good news in that we won’t, if I’m right, have to wait through one year of 85% pullback. And so if you were to zoom out, I think the chart looks like a random walk of saturation. What evaluation that is, if it’s a hundred trillion like PlanB thinks, then it’s a random walk. Up, down, up, down, up down. And that doesn’t invalidate the stock to flow. It’s not a demand and supply model, which is what I’m talking to here. Stock to flow just puts a number on it and says, “That’s how much this network is valued next to real estate, next to gold, next to silver and these other assets based on their scarcity.”

Preston Pysh (00:10:39):

So Willy, when you’re saying all that, which was quite profound, all the different angles that you’re thinking about and you’re seeing just through the raw data. From a net basis, do you think that it’s tighter than the stock to flow model that is much simpler? Or do you think it’s a little bit looser?

Willy Woo (00:11:01):

It’s a relative and a shorter timeframe model I look at. The stock to flow, you can see it varies, it’s a theoretical. But it doesn’t look at like the details. It doesn’t look at how much is the real flow coming out because how much of that flow we thought was flow was from miners is actually now being HODL’d by miners. So it doesn’t take that into account, so it’s much more broad brushed. But it gives you absolute numbers because it’s comparing its stock to flow to… With the cross asset model, it’s comparing it to gold. And so, it does give you this … And with the standard model it’s comparing to the last 12 years of history or more we’ve had. It gives you better absolute numbers. What I’m doing here, it gives you more relative, like I can say we’re entering a phase now for the next six months or more of bullish numbers.

Willy Woo (00:11:54):

And then if we’re ever in a bear market, I can actually get a price model that goes, “Okay, now we’re retracing down into a demand and supply metric that we once crossed three months ago, four months ago.” And we can look at how the market valued it back then and go, “Well, that’s where it should be if the mark was feeling the same way about it.” And so, it can give you much more precise numbers compared to stock to flow when we were down at, I guess, 35 to 40,000 a few months ago. But see, look, this whole thing is out of balance. We’re totally imbalanced right now with the underlying demand was huge. Everyone was bearish, yet this model was saying we needed to get to about 55,000, mid-50s, to find balance again and retrace to the prices that the market liked to value it at back a few months ago, back early 2021.

Willy Woo (00:12:55):

All it took was the fears to be shaking off, and we quickly reverted back there. So, it’s useful for these shorter timeframes. I find it more useful as an investor investing. I’m constantly buying and I’m sometimes selling, but mainly I’m buying. And I need the confidence of where this thing’s going to go over the next six months, rather than where it’s going to go over the next four years. I think PlanB’s got some new models there that’s a little bit closer to the monthly models rather than the full broad macro. But yeah, it’s quite different. I think you’re more able to take a position, hold it for maybe six months, and then get out using these kinds of models. It’s more suited to a swing trader, I would say, and a long-term investor who’s looking to buy the dip in the best possible time. Maybe you’re a CEO of a corporate and you want to enter and look good over the next six months without too much shareholder pushback.

Preston Pysh (00:13:57):

Hey, Willy, I want to talk about a chart. And for people that are watching this on YouTube, they’re going to be able to see the chart. Because hopefully my editors are going to have this pulled up on the screen. But describe it for people that are maybe just listening to the audio. The title of the chart is Bitcoin Longterm Holder Supply Shock. When I’m looking at this chart, it’s kind of insane, because down there on the bottom where you have it listed as peak accumulation, this thing is peaking out. You’re seeing some of the highest levels that you’ve ever had for peak accumulation. And here we are, what is it, almost a year and a half post-Halving, and you’re seeing the highest peak accumulation number that you’ve ever seen on the chart. Which has typically been core sequenced with big sell-offs, historically, or bottom of the market during the four year cycle. So what in the world does this mean? Just give us a little bit more context on the chart.

Willy Woo (00:14:58):

So there’s a whole series of these metrics which I’ve labeled supply shock. This is the equivalent of on-chain demand and supply. It’s an alternative to stock to flow. It’s an on-chain model, and we’re looking on-chain for different ways in which to measure demand, which demand is if you’re holding Bitcoin, every day you’re saying … That’s HODL’d demand. I’m holding it. I want to expose the asset. We look at coins that may potentially be supply. These are the coins that aren’t locked up in long-term holding situations. They look likely they may be sold, so you can run the ratio between demand and supply. So those guys that aren’t selling are on the demand side, and the guys that might be selling are on the supply side. And you get a whole family of supply shock metrics. And Will Clemente was the first to suggest this and running this ratio.

Willy Woo (00:15:59):

He suggested doing it on this thing that Glassnode created called liquid supply. Now this metric was … I talked to them and asked them if they could create something that could look at the behavior of individual holders and their history so that we could kind of validate what was happening on exchanges. We were seeing that the coins were starting to deplete out of the exchanges and move into long-term storage. But I really wanted something that was more forensically accurate than just exchanges, because exchanges are very reliant on you pegging particular wallets as being owned by exchanges and these low data areas.

Willy Woo (00:16:39):

So they created this metric, and it’s called liquid supply and it looks back, and it goes, “All right, for this cluster of wallet address spaces,” because on the blockchain, obviously, you only see addresses, you don’t know who it is. They forensically cluster all of these address spaces together and they resolve them to individual holders. Now you’ve got the individual holders. You look back across their wallet history and you go, “Okay, there’s three categorization.” There’s what I call the Rick Astley, the guy that just keeps stacking and does not sell. For every three Bitcoins that’s bought, no more than one Bitcoin moves out or sold. So anything that’s stronger than that is what you call illiquid. They’re not selling. And then you’ve got two other tiers which get more and more liquid. The highly liquid side is just totally nets out to zero consistently. So they’re full on speculators. And then you’ve got the middle kind of swing trader-y, part HODL-y guy.

Willy Woo (00:17:40):

So you can run these supply shocks and you get the original supply shock. That’s a very good metric, even down into trading a five day sort of swing. And then you’ve got this, what we’re looking at here, which is the long-term holder supply shock. If you were to look into wallets, because as coins enter a wallet, they kind of age like fine wine. You can measure how long the coin stays inside the wallet, and there’s a probability distribution that you can see. If this coin is dropped into a wallet and it’s been there for one day you know, statistically, the probability of it moving tomorrow, or the next day, or the next day, or the next day. And it just starts to drop slowly and decay. But at five months of age, there’s a cliff and the behavior starts changing.

Willy Woo (00:18:38):

It starts to drop off a cliff and you know if a coin can stay in a wallet five months or more, that’s very unlikely. There’s a sea change in action. That now starts to become more likely not to be sold and held for years and years and years. So this thing takes, obviously, five months for you to reach that. So it’s quite a smooth, reliable metric for the macro. What we’re doing here is running the demand supply over this definition of what is on the demand, which is HODLing, and what’s in the supplier, which is the probability, higher probability of selling. Then it’s a very clean chart. Wherever you see a peak in HODLers versus the HODLers that are potentially going to sell, coins that are under five months aging, that’s always the bottom. That’s always the bottom of a bear market and an accumulation phase or a rear accumulation phase, having pulled back from a prior run. And we’re in that right now. And we’re at peak. We’re at peak. Usually-

Preston Pysh (00:19:45):

Is it rounding out? I can’t tell from the chart, whether that’s rounding out, or is it still going higher?

Willy Woo (00:19:52):

It started to round out, but we only had like a week or so of data. It looks about right. Looks about where we’ll round out. And generally, we stay at peak levels. Generally stay at peak levels a few months, but you can’t rely on that. What actually is happening is these guys that have these coins that have aged more than five months, they start to sell. Once we get a very, very strong rally and then you’ll start to see this number start to decline. And you would have seen this in the last run up from 10,000 to 60,000 from fourth quarter of last year that we saw. Effectively, the last generation of those long-term holders start to sell down. And these new guys came in to buy. It’s those guys, they were high-net-worth purchases. They were like family offices, high-net-worth individuals. They were buying significant, $1 million exposure at a time. So they weren’t retail. and they were buying and buying.

Willy Woo (00:20:56):

And that’s why we’re in peak right now, because it’s been five months since they bought in. The last wave of those long-term holders sold to them. And so we’re at that point now, the aged. But all the new guys we brought in the first half of this year, and now these long-term holders, and they’re at peak. And so they’re providing the lockup that’s necessary to drive us into the six figure. I’m pretty certain that we’re going to go past six figures in Bitcoin in the next, I can’t say which month, but in the next six months, looking at this demand and supply structure. That’s what? Another 50% climb, we’ll be there. I think we’re going to do that, almost certainly over the next six months, probably much sooner. It could be in a month or two, or a week or two, the way things are going. But this is a high reliability metric to say we are in for a bull run for the next six months or even longer.

Willy Woo (00:21:49):

It could go for another year. So it’s a very good time to be accumulating that we’re just coming out of this re-accumulation phase, and can see that on-chain very, very clearly. As we did this step, it was an accumulation. It was not a bear market.

Preston Pysh (00:22:05):

I just sent you Dillon LeClair’s version of this chart, which is different than yours. We’re going to put it up on the screen for people that are listening to this on YouTube. But Dylan titles his Cost Basis Ratio of Longterm Versus Short Term Holders. And when that metric is appreciating or going up, it’s indicating a long, hold it long. And then when it’s declining, it’s showing that you probably want to either hold or, if you’re a trader, you’d be selling it and trying to buy back in. And when I’m looking at the … Which is not what I recommend, by the way. I just recommend people buying it. I’m a long-term value investor of Bitcoin. I’m sure people get a chuckle out of that.

Preston Pysh (00:22:46):

But when I’m looking at this chart, and I’m looking at the historical calls that it would have made, it’s kinda mind blowing. And for people that are watching this, this chart literally just turned green today, representing that we’re getting ready to go on a big bull run, just like Willy represented, like a Willy just said. So Willy, my question for you, is there anything else that you wanted to highlight about this chart that might be different than yours? I know I just kind of plopped it on you without having much time to kind of review it.

Willy Woo (00:23:16):

This chart is more, if my understanding of it is correct. It’s new to me. I don’t know the exact calculations underneath, but it is using the price domain of these two, whereas I’m using the supply domain. How much of the supply is locked up, so therefore it’s demand and supply. But this is more looking at the ratio of the cost basis in which these two cohorts are ratioing at each other. And, I don’t know, it’s a very clean chart because it picks tops and bottoms of bullish and bearish phases relatively reliably.

Willy Woo (00:23:54):

It doesn’t get … It’s a little bit delayed. I think it takes a bit of time for the price to move downwards or upwards. And then it relies on the holders actually transacting coins in relation to it. So you know that a lot of times you see the price drop and there’s no coins being transacted because no one’s being shook out of the market. And this is looking at the price coming down and they’re compounded with actual investor behavior selling down or buying at the bottoms. And so it’s neat because it’s a nice way of defining, with on-chain metrics, that this is a bearish phase and this is a bullish phase. Now red is like a bear phase and green as a bull phase. And it’s unlike the Wall Street definitions. They’re very fluffy. What is it? Is it like … Do you know Kristen? Is it a 20% pullback within a timeframe? I think two months or longer or something?

Preston Pysh (00:24:52):

That’s close. Yeah. I don’t know the definition either, but it’s something like what you just described.

Willy Woo (00:24:56):

I just don’t like it because particularly in Bitcoin, we’re in such a volatile asset, and the price can go anywhere. And it doesn’t … Like we know whether or not this is a buying or selling. And now we’re looking at this and saying, “Okay, on-chain, it’s structured as a bull or bear market.” And that’s what I really love about this. And then the second thing to pull out of this is the chart I’m looking at right now, 2012 to 2000 and almost 22, so almost 10 years. In there, we’ve got two full blown Bitcoin bear markets. And define that as like a year or so of bearish structure. And we’ve got that there. And then in there, we’ve had three additional red strips that showed bearishness, but they only show bearishness over no more than like a quarter.

Preston Pysh (00:25:44):

A quarter. Yeah, maybe two quarters.

Willy Woo (00:25:46):

Maybe six months or so. We had that in 2013 in the double pump where it shot up and then it went sideways to re-accumulate. So that red strip is picking up the bearishness, but it was a re-accumulation phase. And so like we had that in that kind of 2019 to 2020 era where Bitcoin chopped around and we had COVID. It just went sideways for a really long time at around the 10,000 range. And then we had that just recently, which has just ended as of today, I think, where we pullback from our 50, 60,000 trading range down to as low as 29,000. And now we’re back up there again and above it.

Preston Pysh (00:26:29):

I got a question for you on this though. When we look at this run that we’re getting ready to go on, let’s say that what you’re suggesting, that it’s going to run for the next six months, or in the next quarter or two, let’s say that starts playing out. Let’s say we go into six figures on the fiat value of Bitcoin. Would a metric like this continue to hold up, in your opinion, for people that maybe want to take a pause, or they want to take some chips off the table, and pay down a house or whatever it might be? Everybody’s got their reasons for why they want to do what they want to do with their resources at various points in time. But with this metric help provide them, “Hey, yeah, we’re probably going into a bear market for at least three months or whatever it might be.” Would that continue to work into the future in your opinion?

Willy Woo (00:27:18):

I don’t know if it’s something you want to use for price signaling. Like if you can just look at right now, and it’s said to sell it about 50,000. And now it just turned green today, which is 65,000 as I’m looking at the price right now. So would have told you to sell low and buy high because it’s a little bit laggy. But it’s really telling me the structure of the market that will be in re-accumulation in these strips. So I’m liking it as sort of a big, zoomed out structure of the market. And it’s now we’ve got two small red strips, not even close to a year each. And I think that’s actually the sign of what’s coming, these big four-year cycles are ending. So that’s what I’m curious about. I wouldn’t necessarily just use … When it goes green, it’s very safe to buy. I mean, I’d use it as a buy in.

Preston Pysh (00:28:12):

Just stop selling is what you’re saying.

Willy Woo (00:28:14):

Yeah. Never sell a exponentially growing asset, but the green signal’s a good time to enter. Like if you’re scared of big, large drawdowns buy in the green zone and hold. I wouldn’t trade it to sell high and buy low using the red zones. Because that’s not very reliable.

Preston Pysh (00:28:34):

Hey, Willy, let’s change subjects here. So you had a couple of comments on the ETFs earlier. You were talking about contango. This is something that I was kind of jumping up and down about at the beginning of this bull run. Obviously, the contango disappeared whenever we went into the big sell off that we had with the mining reorg and everything that was happening. But now that the bull market’s starting to pick back up again, especially now that you have these futures settled ETFs, I think this contango thing is going to be a really big talking point for the next six months. When you have such a high return, cash carry trade in place, I just can’t imagine what that’s doing for participation in this market. I’m curious to hear more of your thoughts on just the ETF in general, and what you think it might mean moving into the next six months.

Willy Woo (00:29:25):

It’s really interesting now because you got those ETF, which is features based. So in theory, you can buy more than 21 million Bitcoins. That’s a starter. You can buy more than 21 million Bitcoins through ETF exposure. Of course the underlying doesn’t change. In a futures market, you can trade to infinity. As long as you can find someone on the other side that’s going to sell you that paper contract.

Preston Pysh (00:29:50):

Which has no impact on the underlying Bitcoin protocol if you’re dealing in spot.

Willy Woo (00:29:55):

No it doesn’t. It doesn’t inflate the coin supply, but it’s just interesting. So now imagine a sovereign nation state. So I want to deploy more … It’s just an interesting metric.

Preston Pysh (00:30:08):

If they want to manipulate the price, they can put larger gyrations or more volatility into the spot price, but can they do it at any type of duration I think is the real question.

Willy Woo (00:30:22):

We see this in the gold market where it’s consistently being suppressed by the derivative markets. So even since as early as 2018 with BitMEX being around, we could see the impact of these derivative markets. So it’s kind of a net negative, I think, for Bitcoin,

Preston Pysh (00:30:43):

If I was going to push back, the really big difference is that you can immediately settle, physically, at any moment. And the exchanges around the world that allow you to do that are just unbound. Relative to a gold market, if you want to take physical settlement, it’s extremely difficult. If I was going to do that and I wanted to buy a substantial amount of gold and physically settle, you’re not doing it immediately. And you’re not doing it with the liquidity that you’re seeing on the spot exchanges. So let’s just pull the thread on that scenario that you described. Let’s say that there is a state actor that’s trying to cause mass volatility into this market. I think because of the construct of how much spot availability, liquidity access there is for immediate settlement straight into my hardware wallet, people that understand this are going to totally take advantage of that.

Willy Woo (00:31:38):

I think what you’re saying is you can leverage and use the liquidity on futures exchange to do effectively buy in. So, it’s maybe five times more liquid, so you can buy a position size six times what you could without moving the price as much. That’s a positive. Obviously, like the ETF, the ETF is going to increase the derivative’s dominance, the volumes on the derivative exchanges. That is on the CME, which is not physically settled in cash. So if you wanted to buy in, you’d still need to … Well, you’d do it on offshore exchanges, which are physically settled. I’m thinking-

Preston Pysh (00:32:24):

Anyone who truly understands what this is, is not going to take a paper contract for this. They’re going to take the physically settled Bitcoin.

Willy Woo (00:32:32):

But you might take the paper contract temporarily whilst you fill your spot position. So if I’m going to buy like a billion dollars of Bitcoin, I’m not going to dump it on the spot markets. I might buy 200 million on spot markets and I’ll buy the rest on derivatives because I can deploy right now. And then the price is going to run up, but I’m fine because I’ve locked in my price in that one hit. So I’m getting a cash settled profit. I take the cash sale profit. I pull it over to Binance, FTX, some of the offshore exchanges which physically trade, or you can even do on Coinbase. You just buy it on Coinbase using your cash profits/ for a proxy, you can physically settle, and that’s relatively easy to do. It’s not the same as like maybe the futures of gold, where you get cash and now you’ve got to still find the supply that’s going to sell you that gold. And they have huge spreads, whereas the spread on spot is so tight.

Preston Pysh (00:33:35):

I think the other piece too, so in your example that you just used, I go out and I would buy 200 million of the spot and physically settle. The other would be paper. If the person was truly concerned as to their ability to get the full billion worth in the physical, they’d step into the market, they’d bid the price, and they could capture all the physical. Even though they know that they would probably move the market way more aggressively, they could still do it. Price would go nuts.

Willy Woo (00:34:04):

You can capture all the Bitcoins on exchanges, but you can’t capture all the Bitcoins. It comes back to physics, right?

Preston Pysh (00:34:11):

Yeah.

Willy Woo (00:34:11):

If they’re available to be sold, you can’t capture it all. [crosstalk 00:34:14]

Preston Pysh (00:34:15):

So you think that there’s limitations there just based on how much do the exchanges have have to offer?

Willy Woo (00:34:20):

Yes. [crosstalk 00:34:20]

Preston Pysh (00:34:20):

But think about how much to think about how much inventory. There’d be so much inventory that would come in if the price went parabolic like that in a short amount of time.

Willy Woo (00:34:28):

Yeah. I think you eventually do incentivize for that. But I think at a certain point you can’t because you don’t have enough monetary base to buy it. And because the … As Bitcoin’s value’s going up, it’s capturing more of the monetary base. We’re at 1 trillion. And let’s say fiat’s monetary base as 100 trillion, it’s 1%. So to a certain point, you don’t have enough fiat monetary base to buy the Bitcoin. So you just can’t capture all of it. You run into systemic maximums when you start to look at … You build a big box around the whole system, you go, “Well, that’s our system. There’s the cash, there’s the Bitcoin.”

Preston Pysh (00:35:11):

For people listening to the conversation that Willy and I just had that are not like financiers or anything like that, the reason that we’re like pulling the thread on this is because in traditional markets, especially in gold, there’s this idea that the gold market is highly manipulated because there’s so much cash settled derivatives, future-based derivatives, that it can suppress the price of gold. There’s many arguments about this. And so people in the Bitcoin space have been concerned that because they’re offering this future settled derivatives product with the ETF that’s coming out, that there might be an attempt by a sovereign nation or whoever to be able to suppress the price action of Bitcoin through these derivative products. And so that’s why Willy and I are going down this rabbit hole of back and forth for people that might be listening to this being like, “What are they talking about?” That’s what. We’re trying to just understand that at more depth.

Willy Woo (00:36:08):

Yeah. And if we could move back to the ETF, the futures based ETF conversation. I do think that … Kristen, you were talking about this whole cash and carry trade and that being this big black hole engine that sucks more and more capital. I can see that. That’s interesting because-

Preston Pysh (00:36:26):

You want to push back on this and I like it. Go ahead. Let’s hear it.

Willy Woo (00:36:31):

I can see what you’re saying, because there’s a lot of long demand. There’s a lot of speculative demand on Bitcoin. And therefore, it draws in the cash and carry hedge funds that come in, hefted by the underlying to be able to extract the yield.

Preston Pysh (00:36:49):

If you’re over-collateralizing on the borrowing and lending, then that was kind of the angle that I was going at the start of the year, whenever we were talking about this a lot. But from what I understand, a lot of institutions are not being … They’re basically not playing by the rules that the retail borrowers and lenders are playing by as far as the over-collateralization is my understanding.

Willy Woo (00:37:13):

And so you’re saying that they don’t have to hold the Bitcoins by the same amount of spot? [crosstalk 00:37:18]

Preston Pysh (00:37:19):

So like when a retail person is going out and doing these LTVs of 70 or 50 or whatever it is, they’re putting a whole lot more immediately settled crypto, whether that’s USDC or Bitcoin or whatever into escrow in order to conduct that loan. But if you’re an institution, they’re letting them under-collateralize that borrowing because they’re considered way more trustworthy. So in that scenario, I don’t know that you necessarily get the full implications of what I was trying to say, which was like locking up coins.

Willy Woo (00:37:54):

Oh, I see. I see. I see what you’re saying now. So it’s really the over-collateralization.

Preston Pysh (00:38:00):

Yes.

Willy Woo (00:38:01):

So you were betting on this guy that’s going to put in two Bitcoins to borrow one Bitcoin, and then the hedge fund would then also match that with one Bitcoin. So you’re actually getting three Bitcoins instead two that’s being bought through that system. Right, interesting. I don’t know. It’s like we need to see this really play out. I don’t think these lines of credits, where you’re under-collateralized is … I don’t think that’s necessarily widespread. Do you have better information than me?

Preston Pysh (00:38:34):

No.

Willy Woo (00:38:34):

I think that the majority of them actually … I’m involved with huge funds, and sometimes you can get a line of credit. You still have to collateralize, but it’s very seldom. I mean, there’s more and more of these hedge funds coming out now. And it’s not like exchange is going to give you that line of credit willy-nilly anymore. We are seeing things like loan providers that will lend you cash without collateral. And so that’s kind of doing the same thing. So to do that, you have to have a very good reputation. You have to have been around for years. And Sean, you’ve got a history of operating well, so maybe. But I don’t think that’s the majority of the market. Maybe we’re seeing maybe 10, 20% under-collateralization from these institutions.

Preston Pysh (00:39:22):

Truly, Willy, this is one of my biggest concerns, as all of this would really heat up. Like here in the States, you can go to like this FTX exchange and you can deposit Bitcoin and you can start making 5% just immediately. It just starts streaming you interest on that exchange. And I think when you look at your uneducated investors that are just having massive returns, they’re making deposits on these exchanges, they’re getting these kinds of interest rates. And let’s say the Bitcoin price really runs. Let’s say we’re at like $200,000 Bitcoin. Everyone and their kid sister is talking about this. Everyone and their kid sister’s making deposits onto these exchanges, making what I would call real interest rates. The whole planet has been starved from any type of interest rate for a long time. This is looking like you’re in a different universe to be receiving these types of yields and interest rates.

Preston Pysh (00:40:11):

My concern is if the traditional market starts to look at this, and this gets so big, everyone’s going to be like, “Oh my God, this is literally ripping the face off of like traditional finance and traditional interest rates.” And then you’re looking at this whole different calculation on the value of everything. Now, if the institutional borrowers and lenders are not over-collateralized in this market where this yield is being generated, and they have counterparty risk, because these big institutions that are borrowing and doing these activities that are quote/unquote, low risk, that don’t have to over-collateralize because they’re a trusted agent. They have other things on their books. Everybody knows that. And if the price of that equity, or whatever those quote/unquote assets are that are mark to market in the old world of finance, at 30X or 35X capitalization rates to earnings, all of a sudden coming and get dropped down to 10 or 15 or whatever that math would become.

Preston Pysh (00:41:16):

And you have them get repriced mark to market based on different multiples, because there’s this realization that everybody’s been duped into thinking that interest rates are nothing percent. All the sudden, those institutional buyers become enormous risks to the overall market in these massive platforms, and I’m not saying FTX specifically. You can name any one of these borrowing lenders as far as I’m concerned, because they’re all competitively trying to capture clients. And they’re trying to capture clients by offering high yields, as high of a yield as they possibly can.

Preston Pysh (00:41:51):

And so my concern is that, and what that might mean in that space. And I think, I guess my whole point of saying all this is, it’s really important to people now to take self custody of their coins. Because if things start getting a little squirrely in the equity markets and you’re seeing things sell off and maybe get repriced and all that stuff that I just described, the last place you want your coins to be sitting is on an exchange, squeaking out 5% yield, and you’re sitting there with all this other risk that you have no clue of because of all the institutions that are borrowing and lending.

Willy Woo (00:42:22):

Yeah. It’s let me have a look today. I think it’s squeaking out 17% yield as of today. It just jumped again the last two days with this huge run up.

Preston Pysh (00:42:34):

Let’s say that goes more. And I’m sorry to interrupt you, but let’s just say that contango gets crazier, do you think these platforms are going to increase their yields to capture more customers?

Willy Woo (00:42:45):

For them to increase the yields, most of these exchanges aren’t doing fixed yield. They’re providing lending markets. And then there’s, again, people and institutions that are running arbitrage from contango to spot loaning. You run the arbitrage funding trade, and then you’ll get this is loosely coupled. The futures contango impacts the lending. But to your point, it’s really … So effectively, this is the domino of house of cards, if it plays out, is the funds, the institutions that are playing these trades are getting lines of credit based on some amount of trust and some assets in their books that may not be priced properly. If they turn out to be toxic, then they can not cover their losses if they make a loss first. If they make a loss and they can not cover their losses in that line of credit, then the exchange is up for it.

Willy Woo (00:43:48):

And then the risk to the retail person who’s got money on exchanges lending their coins out is if the exchange hasn’t got enough asset backing to cover the loss on the line of credit, which they don’t take any collateral on. So there is certain things that need to happen. Like you need to blow out these institutions that are trading with lines of credits. They need to have toxic assets. They need to also trade very badly. And now we’re talking about cash and carry trades. We’re talking about delta neutral trades, what we call. The relatively low risk analysts, they break. Like the algos break or something like that. But generally, if you look at like a 36 month history of these funds, they don’t put in a down month, and if they do put them down month, it’s just relatively small because they shut down their algos.

Willy Woo (00:44:38):

So that risk is actually low. They’re not doing the same ridiculous trades that we’re seeing the banking institutions did in 2008 and before that. They were taking very large risks. In fact they bought up trading firms that were very good at taking large risks. Goldman Sachs was the first, and then everyone else copied them. And so I actually spoke to the guy that was acquired into Goldman Sachs that did this high risk trading. And they understood risk very well. The problem was these other banks said, “Whoa, that’s like more than half the profit of Goldman. We’re going to copy them.” Then they started doing the same thing with very little understanding of the same risks.

Preston Pysh (00:45:18):

And that is markets in general. What you’re describing there is perfect for anybody to understand how things get out of control at the end of a cycle.

Willy Woo (00:45:29):

Yeah, right. And currently, we’re talking specifically on these kinds of lines of credit for kind of cash and carry type trades is very low risk. And if they have to blow up the assets that are off the books, they’ve got to blow up their trades, and then that’s got to be big enough to blow up the exchange. So I think the risks involved with that in the current state of crypto, it’s very young. It’s very early.

Preston Pysh (00:45:56):

Very early.

Willy Woo (00:45:58):

It’s not like that kind of thing where it’s decades old, where banks are getting so greedy that they’re squeezing out every last dollar and they don’t know where to get the next dollar from apart from taking huge risks. We’re not in that stage in crypto right now.

Preston Pysh (00:46:08):

Not even close. Yeah, not even close to that.

Willy Woo (00:46:10):

Not close. It’s new, right? It’s the old world that’s blowing up.

Preston Pysh (00:46:13):

When I tell friends and family, they asked me all the time, “Well, so-and-so is making this yield on this exchanger or whatever it is.” And I say, “Hey, you know what? Me personally, if you want to do that, have at it, but this is what I’ll tell you. If you start to see a lot of headlines and you start to see the news that interest rates are all out of whack, and they’re comparing it to the yields that are being achieved inside of the crypto economy or the digital asset economy, and people are talking about the repricing of equity based on these interest rates, you might want to start clawing everything out of the exchanges.” You have no idea what exchanges it’s going to be.

Willy Woo (00:46:55):

I’d make a nuance point. When we’re talking 17% today on lend out rates, that’s nuanced. The lend out rate on Bitcoin today is 3%. And usually it’s 0.8%. I’m not talking about putting a Bitcoin on an exchange is lending out. I’m talking about putting your US dollars on exchanges and lending that out at 17%. And that’s a different proposition because what am I doing right now is it would be in a cash account with a bank who I trust even less, because the banks are the ones that I think are going to go out of business, not the new finance.

Preston Pysh (00:47:29):

Totally.

Willy Woo (00:47:29):

They’ve got bail-in clauses over a hundred grand. You think over a hundred grand they can take, and I can’t move it. And moving any kind of significant funds in the bank gets blocked. So the first thing I want to do when I get cash in the bank is get it out of the bank. And even though I want to exposure to cash for just the sheer liquidity, certain amount of safety net, if the volatility of Bitcoin’s down over a month, I’ll move it into exchange. I’ll move into exchange in our lend it out 17%, and then I can move it and use stable coins, like USDC to fund investments. Most of the investments that I’m doing now take USDC. Even an exchange that I’m working with, they take USDC. And even AngelList. If you’re doing angel investments, they take USDC now.

Willy Woo (00:48:18):

So it’s like the traditional side of the divide, the banking divide, is like quick sand for my money to be stuck. The first thing I do is I move it into this new speed of light finance, where I can move dollars across a blockchain in seconds and not get blocked and get yields of 17% every second that it’s being packed. That’s just worlds different. And the risks aren’t anymore, if we’re talking US dollars. If we’re talking US dollars, the alternative is the risk of your money being in the bank. So I think that’s a different proposition.

Preston Pysh (00:48:53):

So Jack recently tweeted about considering building a Bitcoin mining system based on a custom silicon and open source software. I know you had some comments back to him. What are your thoughts on the idea and why is it important?

Willy Woo (00:49:08):

I think it’s fabulous. I mean, fundamentally, the idea is to de-centralize the mining network. And if you can give individuals that are mining it in their homes, that’s maximum security and de-centralization of this network. My comment to him was he talked about the kind of efficiency of the network. You want to be efficient on electricity, which it’s an easy trap to get into because you don’t need efficient hardware, but the incentives are going to push for more and more efficiency. But as you get these devices that become more and more efficient, well, it just means I need less dollars to run, to produce the same hash rate. So the incentives just work out there. The amount of electricity that’s going to protect the network is going to be a cost correlation to the price of acquaintance. How much electricity am I going to burn to protect the network to how much is that network worth.

Willy Woo (00:50:07):

And so there’s always going to be the correlation. And if your hardware is more efficient, well, I need more of the hardware to burn the same amount of electricity. That’s not the right way to look at it. I think the way you want to look at it is to extend the hardware cycle. Like it used to be, if you’re mining Bitcoin a few years back, the shelf life hardware might be nine months before the next ASIC generation would come in and it would obsolete you. And so you had this huge waste issue, but more than that, you had mining operators that would fly and charter a 747, load up with miners, and then fly it to the location to save maybe 36 hours in transit because the shelf life on that hardware was ticking and it ended up being millions of dollars of lost revenue because of the shelf life of that hardware.

Willy Woo (00:51:02):

Now we’re getting to these nanometer sort of scale chips that are like down to the frontier of what we can produce. And so these, the shelf life of these new ASICs are longer. And that’s what you want because the longer the shelf life of this hardware before it goes obsolete, the more retail can come in. Because retail is not as efficient. There’s not many people I know as a retailer that can fly to the manufacturer and then bring it back in person like a highly centralized mining facility can do. So I think more and more development into hardware like this will push these cycles out further. And that’s going to help more retailers come into the mining and then that’s going to also de-centralize the network. And it’s also going to de-centralize where you can capture the energy.

Willy Woo (00:51:57):

When you’re very highly concentrated, you want to be parked next to a hydro electric dam and a nuclear power station. When you’re wanting to small scale mine, you can be anywhere in the world with good sunlight, where I’m next to a stream. And so the de-centralized is that part of it. So yeah, it’s ultimately good. And pushing to get this network more and more decentralized because as you get as this network more de-centralized, we effectively create a monetary base that’s similar to gold, but without the flaws.

Willy Woo (00:52:30):

Remember, the flaws on gold, is that it’s held in a very centralized manner. And so centralized gold leads to fiat. We saw that in 1971, when we decoupled off gold because the guys that were meant to have gold didn’t. They didn’t, so they decoupled. And so we need the holders of Bitcoin to be very de-centralized. And part of that means every aspect of this network needs to be decentralized because if you get any single centralized choke point, then you can start to control that asset, and then any central point that gets big enough can push us into a new era of fiat. So, yeah, ultimately it’s a good initiative,

Preston Pysh (00:53:14):

Willy, I don’t have anything else. Is there any is there anything that’s hot right now that you want to talk about?

Willy Woo (00:53:21):

You probably don’t know. I’m a junior partner in three hedge funds in crypto, and I’m an analyst, And that’s really interesting to me because when we talk about risk, the standard metric for risk is Sharpe ratio, which is essentially your returns divided by the volatility of returns. And we run this thing called … The volatility is using a standard deviation calculation. And I’ve just realized, Sharpes crack because it punishes up upward volatility. If Bitcoin moons, the risk increases where you only really want to count downside risk. So there’s this thing called Sortino, Which is let’s remove all the upside. And every day it puts in a down day, we’ll take that as a sample point. We look at the volatility of the downward side.

Preston Pysh (00:54:10):

I love where you’re going with this,

Willy Woo (00:54:12):

This is like … Sortino, it’s much better if you’re going to run a fund to track on Sortino. And I just realized today, because I’m running optimization algos to the fund. And I’m like Sortino’s crap as well, because if you ever think about the downside risks, and then you run a standard deviation, volatility calculation on the downside, it assumes it’s going to be a normal curve. But it’s not. It’s going to be a normal curve around the high mean return. And we’re just going to do a cutoff of anything that’s negative. And we’re going to try and think that that’s going to behave in a normal probability distribution that’s normal. It’s not. So I’m just flabbergasted that all these metrics that the traditional world has been using, they’re fundamentally broken.

Preston Pysh (00:55:00):

Yes.

Willy Woo (00:55:01):

But like how we understand risk is in traditional markets. And owning crypto has gotten me into these markets. And you’ve got these wild assets, and you go, “Well, that’s not going to work because it’s upside volatility. That’s not risk. That’s just huge reward.” And now let’s try and get a bit of metric. And what Wall Street’s got is like pretty crappy. So that’s my takeaway this week. I’m running these metrics through algorithms and they’re giving substandard results. And I think where there’s room to improve these metrics. So I haven’t been tweeting much because I’ve been deep in the rabbit hole of looking at the stuff and it’s just eye-openingly bad what we’ve got out there.

Preston Pysh (00:55:45):

That’s something that Buffet would always bag on at shareholder meetings was how much disdain he had for the Sharpe ratio. Because when you’re talking about equity, you’re talking about what is your risk? Well, your risk is really kind of like losing your competitive mote, or your ability to price, or a network effect, or whatever that might be, an impairment of the underlying assets of the business. Your risk isn’t the fact that the price had these large gyrations that you could leverage and actually buy whenever it would go in the direction that you feel isn’t in keeping with the fundamental value that you think the company’s worth. So he would describe that volatility as your opportunity, and your real risk is whether your assets are becoming impaired or not. And so it’s funny that you go to any business school, they’re teaching you that risk is that volatility.

Willy Woo (00:56:34):

I mean he’s taking it one step further because he’s adding human intelligence and a qualitative view of what risk really is.

Preston Pysh (00:56:41):

Yeah, no doubt about it.

Willy Woo (00:56:42):

But even if we were to go to a quant world and be like a Renaissance, I’m sure they don’t use these crappy metrics, not like … I ran the optimization algo on the fund. And I did it on Sharpe. And it’s rock solid return, very low return. And then like our fund manager did a qualitative pick based on knowing what was underneath these funds. And it just blew it out of proportion. It was like over-performed every time. The Sharpe optimized thing tried to get everything rock solid and not move. And then you run Sortino and it’s a little bit better, but it still didn’t beat the human thing. So it needed a new type of risk matrix, which I’ve done now. And it’s much better.

Preston Pysh (00:57:29):

At the end of the day, the risk is is the network effect of Bitcoin becoming impaired by some other protocol? Those are the real risks

Willy Woo (00:57:40):

It’s going to be the qualitative thing. It’s going to be Michael Saylor type analysis.

Preston Pysh (00:57:45):

Yes.

Willy Woo (00:57:46):

You know that this is good. You look at using human intelligence, not just all these kind of Paul Kruger saying it’s too volatile. This sort of stuff just doesn’t fly. It’s just the wrong way to look at this asset.

Preston Pysh (00:58:00):

Totally agree. Willy, this is what I want to tell you. I really appreciate these conversations. When I think of a person who just has some of the deepest critical thinking in the space, you’re at the top of the list, man. And I just really appreciate you making time to come on and have this conversation with me because I know I really value just the conversation. So thank you very much.

Willy Woo (00:58:21):

Well, thank you, Preston. I really enjoyed this podcast even from before you were inside crypto. And I mean, I’m still like listening to the old episodes of We Study Billionaires. And I listened to the one with Charlie Munger and Warren Buffet and how you did commentary over it. So it’s such deep knowledge in these other value investing [crosstalk 00:58:44]

Preston Pysh (00:58:43):

Thank you so much.

Willy Woo (00:58:45):

This is great stuff. So I’m still getting great value from this podcast and super happy to be part of it now that it’s inside crypto.

Preston Pysh (00:58:52):

Thank you so much, Willy. Hey, you got a newsletter. Anything else you want to highlight to folks that we’ll have in the show notes?

Willy Woo (00:58:59):

Yeah. So I’ve got a newsletter. You just go to my Twitter profile. I think everyone knows it’s @woonomic, it’s linked there. So I do now it seems like one or two times a week, I do on on-chain structure and demand supply forecasting Bitcoin’s next few weeks to months ahead. So it’s great if you’re an investor and looking just to take some of the anxiety off of these wild moves. Yeah. So that’s the newsletter I write. And yeah, that’s pretty much all I run these days and something that know people can actually action on. So just go to my Twitter profile and that’s about it really.

Preston Pysh (00:59:39):

Willy, thanks so much for joining me. And I look forward to the next time we’re able to do this.

Willy Woo (00:59:44):

Sounds great.

Preston Pysh (00:59:45):

If you guys enjoyed this conversation, be sure to follow the show on whatever podcast application you use. Just search for We Study Billionaires. The Bitcoin specific shows come out every Wednesday, and I’d love to have you as a regular listener. If you enjoyed the show, or you learned something new, or you found it valuable, if you can leave a review, we would really appreciate that. And it’s something that helps others find the interview in the search algorithm. So anything you can do to help out with a review, we would just greatly appreciate. And with that, thanks for listening. And I’ll catch you again next week.

Outro (01:00:18):

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