Crain’s Chicago interviewed my buddy CME CEO Terry Duffy and CBOE CEO Ed Tilly on the failure of FTX. It was interesting reading, but it’s paywalled. I will let you figure out how to get around the paywall. It’s not fair to cut and paste the whole article here even though I don’t particularly care for the far-left-leaning business publication. I will repost points I see that are salient to reinforce my thoughts or plow some new ground.
People and local politicians tout the “diversity of Chicago’s economy” but the reality is the city was built on the futures industry and the wheels that turn are entirely greased by Big Finance. Former Illinois Democratic Senator Carol Mosely Braun didn’t say that “Exchanges are to Illinois as Dairy is to Wisconsin as Oil is to Texas” for her health. She wasn’t wrong. Duffy and Tilly are the key people that lead the Chicago economy. The many trading firms that operate there follow their leads. How they are thinking is important.
If you don’t think Exchange Finance and all the ancillary industry it spawns is the biggest economic deal for Chicago, imagine this. If the two exchanges were to leave for another state what happens to property taxes, sales taxes, and all other user fees? How about donations to non-profits? I dare Illinois politicians to pass a transaction tax on trading. As a matter of fact, please do. Go for it. I dare you. I am issuing a personal challenge to all the knuckleheads in Springfield and Chicago’s City Hall. You know they are salivating and they will sell it as something “fair”. The house of cards will fall. Chicago will be Detroit-like.
CBOE ($CBOE) bought startup exchange, Eris X. The deal closed last May. I guess if CBOE’s people would have read my blog of last December calling Crypto Winter, they might have waited and paid a bit less. CBOE had to write down more than $450 million of the value of the platform. Cboe never disclosed what it paid but it has to be more than $450MM. I don’t know but I am going to guess a billion. To ease the stench of the writedown, it’s been renamed CBOE Digital.
CME ($CME) listed cash-settled Bitcoin and Ethereum, and that’s it. As Duffy relayed to legendary exchange leader Sam Bankman Fried in their conversation about clearing, it is a $30MM top-line revenue business for CME which in the grand scheme of things is small potatoes. It’s better than a sharp stick in the eye and if it was a money loser for them I bet they’d kill it.
Duffy makes a great point about crypto which I have made here. No one has built anything of value yet. Nothing is really usable. It’s all hope and change without any meat. Reminds me of the Obama Administration.
I think this chart from Trading View is a good way to look at macro crypto and start to wrap your head around it. You can see how interest rate increases, combined with frauds, and the loss of hope around speculative bubbles have impacted the total market cap this year. Conversely, you can see how hope and 0% interest rates inflated it. Look at the volume lines too as they relate to the trading movement. Interesting.
Because no one has built anything of note, it allows detractors to talk about having the “good idea” of blockchain and tossing the “bad idea” of crypto tokens. The problem is you cannot have truly decentralized finance without the combination.
That’s the innovation that crypto promises. Promises promises…
If it’s done right, decentralized finance rejiggers how producer and consumer surplus are allocated and should do away with non-productive pieces of the distribution system. I watched an HBO documentary on Carl Ichan on my plane flight and one thing he said was on Wall Street, people are paid entirely too much money for providing no value. I don’t disagree. Crypto can be a game changer there.
As an aside, after seeing the documentary I am a huge fan of Mr. Ichan. Would work for him in a minute.
I think when Big Finance Establishment CEOs talk about innovation, the innovators tend to throw rotten tomatoes at them and say they don’t “get it”. In some industries that’s true. See the former Chicago catalog houses, Sears, Montgomery Ward, and their friends. But, finance people at the top generally aren’t stuck in the mud.
Finance is the most innovative industry in the world because it is the most competitive.
Sometimes, the reason financial innovation doesn’t work is that it runs into a wall of regulation. But, most of the time it is either executed poorly, it was a bad idea in the first place, or there is some other structure that the entrepreneurs cannot overcome with their business to disrupt the existing structure.
I know Duffy personally and he is an innovative thinker. He revolutionized the hog contract ($HE_F) at CME prior to becoming Executive Chairman and created millions in value. Mr. Tilly, I don’t know, but I am going to make the assumption he is the same.
CEOs at that level have to tread lightly into radical game-changing innovation. The reason being is they have shareholders’ interests to answer to. It is often more capital efficient for them to buy the innovation than build it. See ErisX. Even the write-down doesn’t hurt as much as blindly wading into innovation and having it fail. When will Mark Zuckerberg write down the intellectual property and intangible assets Meta ($META) has created with Virtual Reality?
This question and answer stood out to me.
Q. Does it need to be regulated?
(Duffy) A. I do believe regulation lends credibility and helps the world advance and you can hopefully take out some of the unscrupulous people. The problem is, if people are hellbent on trying to commit fraud or Ponzi schemes, and I’m not suggesting anyone in that system is, but if they are—just look at history—they don’t go away, they just keep coming at you. People are hellbent no matter what.
He is dead right. If Congress regulates crypto, it will have credibility even if it does it wrong. I can almost 100% guarantee that Congress and the SEC/CFTC will screw it up. Winners and losers will be chosen, and broad rules subject to lots of interpretation by regulators and judges will be written. Lobbyists will need to be hired. Innovation will get more expensive.
Pro-tip. If they regulate, buy crypto stocks, like Coinbase ($COIN) that are already public. They will go higher.
Personally, I own some Coinbase but I don’t want to see the sector regulated yet. I’d prefer to let innovation happen and let the market speak.
I agree strongly with what Terry said here:
Q. Obviously, we’ve got a lot of very sophisticated investors who’ve been embarrassed about how much money they’ve lost on this.
A. I don’t know if they’re embarrassed. I really don’t. The only thing I’ll agree with what Bankman-Fried has said is that venture capitalists know that there’s a ton of risk to the downside. I just don’t believe they think they know there’s a ton of risk to the downside when people are potentially not running the companies properly. They understand that the ideas fail, and that’s OK, but they shouldn’t fail because of bad behavior or a lack of understanding what the hell’s going on in your own organization.
Q. That’s due diligence, right?
A. That is due diligence. You know, when somebody’s walking around with a gimmick in shorts and a T-shirt or in the case of Theranos a turtleneck and a weird voice, I think that normally if they have a gimmick, they’re selling a gimmick. I’m a little surprised more people didn’t ask for the due diligence of this thing and got kind of sucked into the whole FOMO or whatever it’s called.
VCs blew this one big time. In the seed, or possibly Series A stage maybe you might say there was an honest mistake made. Happens. After that, no way. A few simple knowledgeable questions were not asked. Sure, as a VC you make mistakes and not every investment gets on base and makes money for the fund. That is part of the business. But, to unnecessarily lose money when you didn’t have to is the big issue here. That points to other things that are going on.
Duffy goes on to talk about friction in payments and settlement and I agree with him. Watch Twitter and payments in late 2023 or early 2024. I bet they play in the space. Where we disagree, and I might add that I disagree strenuously, is that governments should issue their own digital currencies. I don’t think they should for a lot of reasons, the number one being privacy. The second is since it’s software, they can just turn it off if they don’t like you. Anyone reading the Twitter Files dump from
ought to realize that. If you haven't read, or consciously ignored their reporting, don't. This is also very important and the trio hasn't gone down this path yet but they should.Ed Tilly talks about the repositioning of CBOE Digital and that it can pick up the pieces left by FTX, and possibly Binance if Binance fails. We will see but I wouldn’t short the CBOE in a head-to-head competition with Binance.
Ed Tilly when asked about regulation:
Q. What do you think the chances are that the next Congress does something along these lines, where you have Republicans in charge of the House and Democrats in charge of the Senate, a presidential election in two years?
A. We’ve found the committees that are charged with safety and protection for investors pretty bipartisan, which is really refreshing from an operator’s perspective. I’m actually optimistic that something moves forward.
I haven’t pinged my old friend Lita Schilling who lobbies for CBOE, but my guess is they will be working with CME, ICE($ICE), NASDAQ ($NDAQ), regulators, and Congress to move something forward. Lita is an amazing lobbyist and if you knew her you’d discover she flies in the face of the lobbyist stereotype. This sort of stuff takes time but with FTX collapse, Congress, the SEC, the CFTC, and particularly the Democrats need to save some face. I suspect something will come out in the late fall prior to Thanksgiving.
The real market size is what established exchanges are really trying to calculate with the precision and discipline that public companies should energize inside themselves to make decisions. It’s not like venture capital calling a market a “billion-dollar opportunity” while doing back-of-the-envelope math to get there. It’s also not taking a pie-eyed entrepreneur’s calculation at face value. Everyone says they are going for a billion-dollar market, billions even. It’s in the pitch manual in every college undergraduate entrepreneur class.
But this comment from Tilly is food for thought:
Q. Confidence, too.
A. It’s huge. The trusted market will just trade larger than it does today. So share today would be interesting. Share of what we envision, what we think the potential is, is just much bigger. I’ll take the same share today and the vision of the size I think this market can be.
Q. What happens if these efforts don’t bear fruit in the coming year or next few years? How big of a risk is that for what you’re envisioning here?
A. It’s big. It’s the speed then, a ramp-up. I think the speed at which we can offer other exposures and then the confidence that our partners have in launching other coins on their platform. And where does that exposure go if not for the list exchange? I think we don’t grow as fast and the lack of confidence as a result will hinder the potential and the growth. Things will always be better when exchanges who have a mind on that experience are involved, but it’s just going to be the rate of adoption and the rate of growth.
A couple of opportunities will arise.
First, for innovators, having established or startup exchanges that know what they are doing, like my seed investment Bitnomial, list, and trade tokens helps them monetize and get real credibility. That’s big today since the crypto market has imploded itself and lost all credibility due to fraud. FTX isn’t the only one, just the biggest. The goodwill and hope they had post-Satoshi paper are gone.
Having real rules similar to insider trading and traditional IPO standards about management and early investors in tokens around the way they sell them will be good for the industry. No more pump and dump. Transparency in how they sell is very very important and knowing percentages of what early investors and management own is great for building confidence in a marketplace. A lot of us are still feeling the burn from Helium (HNT.X). No one involved has been transparent about their actions on selling at all.
Taxing crypto as a commodity is a good idea. Mark to market on December 31 and have 60/40 tax treatment for it similar to futures. That will impose some discipline on trading and holding positions. Certainty here and taking all ambiguity away is a great objective idea. The AICPA and FASB people would endorse it.
Second, the city that controls the trading could become a fantastic place for innovators to build stuff if the city has the guts to embrace it and put in place policies that encourage entrepreneurs to house themselves there. Clearly, the current state of a city like Chicago isn’t a shining example of that but neither is innovation hub San Francisco or other big Democratically run cities in the US. Maybe watch ICE and Atlanta since Georgia is a friendly place to do business. NY City is always in the running since NYC is one of the largest financial centers in the world and even with the flight out of NYC, it’s not changing in my lifetime. Miami maybe, but it needs to get all the trading funds and HFT firms there. That creates network effects. Entrepreneurs and innovators having the ability to talk directly with staff at exchanges as they build so exchanges understand what they are building, what their target market is, and why they are building it isn’t a bad idea. This is not unlike a traditional industry working with an exchange to build a product to help the traditional industry grow.
Exchanges will understand why you can’t separate blockchain from crypto tokens.
Capital will continue to find itself from the venture community to crypto, but I suspect there will be a newfound discipline over company structure and valuation. A fair amount of funds will close up shop, or merge, sell their assets to other venture capital secondary vultures, or reconstitute themselves to look different. I suspect diligence will take longer, and actual objective investment memos which stand the test of time will be written. By the way, if you didn’t know already, outside equity investor capital is the most expensive capital an entrepreneur can raise and the cost of that capital increased more than the Fed raised interest rates.
At the same time, everyone needs to be careful and thoughtful. Don’t pull a Lizzie Warren and make political points with no depth or data that support them. Washington DC can get carried away when they draw up the rules. A 4000-page legal document that businesspeople don’t even begin to understand and need teams of lawyers to interpret isn’t hard to imagine, is it? That wouldn’t help. It would be crushing and frankly, Big Finance has the incentive to put crypto out to pasture and use it when they need to in order to fend off competition.
Crypto Winter is not near over. The dust isn’t close to settling. There are no tourniquets and we are still “bayoneting the wounded” as my friend Jeff Minch likes to say.
Someone somewhere has to build something that someone uses every day, and the “take rate” or revenue from the industry that uses it needs to be split up in a way that changes the game and lines between consumer surplus and producer surplus so that token holders get the tangible monetary benefit of assuming the risk to hold a token, instead of just the speculative fever they enjoy and talk about when they hold it.
An old trading floor friend that was pretty successful and is actually graduate degreed sent me a link to Mark Twain's Roughing It. Chapter 40 https://www.gutenberg.org/files/3177/3177-h/3177-h.htm#linkch44. If you are incredibly bullish crypto, read it. If you aren't, it's worth a read anyway since Mark Twain was a great writer. Here is a cut and paste:
These are actual facts, and I could make the list a long one and still confine myself strictly to the truth. Many a time friends gave us as much as twenty-five feet of stock that was selling at twenty-five dollars a foot, and they thought no more of it than they would of offering a guest a cigar. These were “flush times” indeed! I thought they were going to last always, but somehow I never was much of a prophet.
To show what a wild spirit possessed the mining brain of the community, I will remark that “claims” were actually “located” in excavations for cellars, where the pick had exposed what seemed to be quartz veins—and not cellars in the suburbs, either, but in the very heart of the city; and forthwith stock would be issued and thrown on the market. It was small matter who the cellar belonged to—the “ledge” belonged to the finder, and unless the United States government interfered (inasmuch as the government holds the primary right to mines of the noble metals in Nevada—or at least did then), it was considered to be his privilege to work it. Imagine a stranger staking out a mining claim among the costly shrubbery in your front yard and calmly proceeding to lay waste the ground with pick and shovel and blasting powder! It has been often done in California. In the middle of one of the principal business streets of Virginia, a man “located” a mining claim and began a shaft on it. He gave me a hundred feet of the stock and I sold it for a fine suit of clothes because I was afraid somebody would fall down the shaft and sue for damages. I owned in another claim that was located in the middle of another street; and to show how absurd people can be, that “East India” stock (as it was called) sold briskly although there was an ancient tunnel running directly under the claim and any man could go into it and see that it did not cut a quartz ledge or anything that remotely resembled one.
One plan of acquiring sudden wealth was to “salt” a wild cat claim and sell out while the excitement was up. The process was simple.
The schemer located a worthless ledge, sunk a shaft on it, bought a wagon load of rich “Comstock” ore, dumped a portion of it into the shaft and piled the rest by its side, above ground. Then he showed the property to a simpleton and sold it to him at a high figure. Of course the wagon load of rich ore was all that the victim ever got out of his purchase. A most remarkable case of “salting” was that of the “North Ophir.” It was claimed that this vein was a “remote extension” of the original “Ophir,” a valuable mine on the “Comstock.” For a few days everybody was talking about the rich developments in the North Ophir. It was said that it yielded perfectly pure silver in small, solid lumps. I went to the place with the owners, and found a shaft six or eight feet deep, in the bottom of which was a badly shattered vein of dull, yellowish, unpromising rock. One would as soon expect to find silver in a grindstone. We got out a pan of the rubbish and washed it in a puddle, and sure enough, among the sediment we found half a dozen black, bullet-looking pellets of unimpeachable “native” silver. Nobody had ever heard of such a thing before; science could not account for such a queer novelty. The stock rose to sixty-five dollars a foot, and at this figure the world-renowned tragedian, McKean Buchanan, bought a commanding interest and prepared to quit the stage once more—he was always doing that. And then it transpired that the mine had been “salted”—and not in any hackneyed way, either, but in a singularly bold, barefaced and peculiarly original and outrageous fashion. On one of the lumps of “native” silver was discovered the minted legend, “TED STATES OF,” and then it was plainly apparent that the mine had been “salted” with melted half-dollars! The lumps thus obtained had been blackened till they resembled native silver, and were then mixed with the shattered rock in the bottom of the shaft. It is literally true. Of course the price of the stock at once fell to nothing, and the tragedian was ruined. But for this calamity we might have lost McKean Buchanan from the stage.
Have really enjoyed your substack this year. Keep it up!
True is your point "No one has built anything of value yet. Nothing is really usable. It’s all hope and change without any meat. Reminds me of the Obama Administration."
What get me thinking are guys like Saylor. Obviously a smart and experienced business person. He's old, which has benefits too. For him to bet the farm on crypto (on margin too boot) and publicly proclaim that his "plan" is to ride the thing to zero if need be will never cease to amaze!
And, seemingly, a lot of folks think that this makes sense. I've read a fair number of debates about him. Even if he does get back to breakeven, the trade is a loser. His Sharpe ratio sucks, lol. I just don't get it. Is the human brain designed to embrace speculative greed? MSTR has tapped the 150 zone now 4 times and almost there once again. Regardless if one believes in chart patters or not, it is a PICTURE PERFECT head and shoulders and a massive descending triangle. Support tends to weaken each time it's touched. I do not see how price does not breakout to the downside. But maybe Saylor's magic wand will save his ass. But I think the Street wants his head in a sling. He's trapped like a rat and everyone knows it.