Episode #351: Leigh Drogen, Starkiller Capital, “If This Thing Isn’t Dead Yet, It’s Not Going To Die”

Episode #351: Leigh Drogen, Starkiller Capital, “If This Thing Isn’t Dead Yet, It’s Not Going To Die”

 

 

 

 

 

 

 

Guest: Leigh Drogen is the GP and CIO of Starkiller Capital, an institutional investment management firm applying quantitative strategies to the blockchain based digital asset space. Previously, he was the founder and CEO of Estimize, now the largest financial estimates platform in the world, which was acquired by ExtractAlpha in 2021.

Date Recorded: 8/18/2021     |     Run-Time: 1:17:32


Summary: In today’s episode, we start with a brief overview of the asset management space and what Leigh learned from running Estimize, the largest estimates financial platform in the world. Then we turn to crypto. We hear what sparked Leigh’s interest in the space and the process of building a trend and momentum model that led him to push his chips all in last October.

As we wind down, we talk about the importance of crypto’s incentive structure, what things like staking and crypto lending mean, and what some of the biggest risks are in the space.

Vinovest | LinkedIn


Sponsor: Today’s episode is brought to you by Vinovest. Vinovest makes it easy to invest in fine wine. Vinovest’s investment platform lets you buy and sell wines that have increased in value like Screaming Eagle and Chateau Lafite. Vinovest provides access, storage, and insurance. All you have to do is sit back, relax, and enjoy a glass of wine. In fact, fine wine has outperformed the S&P 500 over the last 20 years. You can get started in just minutes online. Go to vinovest.co to create an account and invest in fine wine today.


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Interested in sponsoring an episode? Email Justin at jb@cambriainvestments.com

Links from the Episode:

  • 0:40 – Sponsor: Vinovest
  • 1:32 – Intro
  • 2:24 – Welcome to our guest, Leigh Drogen
  • 6:56 – Lessons from building Estimize
  • 11:30 – Where the asset management industry stands today
  • 13:38 – Leigh’s initial interest in crypto
  • 23:52 – The portfolio construction, strategy, and investing framework
  • 27:52 – How Leigh approaches position sizes for a crypto portfolio
  • 31:56 – A 101 on staking and lending in the DeFi space
  • 35:51 – Risk factors to consider in such a largely unregulated market
  • 40:59 – Is it even possible to kill crypto at this point?
  • 45:06 – The current state of the regulatory side of crypto
  • 47:43 – How one can try to become an expert in this space
  • 52:23 – Exploring pre-token startups and investing in private sales
  • 56:17 – Is correlation an ongoing issue in crypto or will it change in time?
  • 1:01:40 – Will Bitcoin be the winning protocol in the future?
  • 1:04:10 – Whether or not some of the larger trend-followers are entering crypto
  • 1:06:20 – Leigh’s crypto predictions for the coming years
  • 1:08:37 – Leigh’s suggestions for those who want to start learning about the space; rainbow.me
  • 1:09:49 – His most memorable investment in both traditional and crypto markets
  • 1:13:25 – Learn more about Leigh; Twitter @ldrogen; insights@starkiller.capital

 

Transcript of Episode 351:

Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber’s the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Sponsor Message: Today’s episode is brought to you by Vinovest. Vinovest makes it easy to invest in fine wine. Vinovest’s investment platform lets you buy and sell wines that have increased in value like Screaming Eagle and Chateau Lafite. Vinovest provides access, storage, and insurance. All you have to do is sit back, relax, and enjoy a glass of wine. In fact, fine wine has typically had a low correlation to traditional asset classes. I recently added a case of 2018 Ceretto Barbaresco Asili to my portfolio. We recently had the founder of the company, Anthony Zhang, on the podcast for Episode 349. Make sure you check out that great conversation. You can get started in just minutes online. Go to Vinovest.co to create an account. Again, visit Vinovest.co to invest in fine wine today.

Meb: Our guest is the general partner of Starkiller Capital, an institutional investment firm employing both quantitative and fundamental strategies to blockchain-based digital assets. In today’s episode, we start with a brief overview of the asset management space in general, and what our guest learned from running Estimize, the largest financial estimates platform in the world. Then we turn to crypto. We hear what sparked our guest’s interest in the space in the process of building a trend and momentum model that led him to push all his chips in last October.We talked about the importance of crypto’s incentive structure, what things like “staking” and “crypto lending” mean, and what some of the biggest risks are in the space. If you want a deep dive into what’s going on in the crypto world, this episode is for you. Please enjoy this episode with Starkiller Capital’s Leigh Drogen.

Meb: Leigh, my man, welcome to the show.

Leigh: Thanks for having me.

Meb: You know, it’s been a long time, and been wanting to get you on forever, and here you are, now in Whitefish, Montana.

Leigh: Yeah, dude.

Meb: I have a Whitefish sticker in my refrigerator. And don’t ask me why, it’s probably due to my 4-year-old. I’ve never been, but I had a friend that came through, and he had a sticker from, like, a sushi restaurant. I don’t even know if it still exists, but I thought, “What a weird place for a sushi restaurant.” And that’s in my fridge. How’s Whitefish? Why are you there?

Leigh: Dude, the sushi here is actually great. They fly it in from Seattle every day, so surprisingly good sushi.

Meb: There you go.

Leigh: Why are we here? Why did we move from New York City, where I’m born and bred, out to the boonies? No, we’re not in the boonies. Whitefish is amazing, it’s a community of about 9,000 people, right on a lake, right next to the ski mountain, right next to Glacier Park. It’s basically like, all the Ironman people live here, so everybody’s always, like, running or biking or swimming or something.

And we’re right on the edge of town. It’s an awesome spot. And then I play a lot of hockey, so there’s a great hockey community here, and we are having a lot of fun, but we’re going to be going’ back and forth to New York.

Meb: I’m sure this is, like, the topic of every conversation, because anytime I travel now, particularly outside of the main money centers of New York, L.A., Chicago, the topic on 90% of the conversations is real estate. Has it gone bananas there too? I imagine with a town of 9000, the answer would be “yes.”

Leigh: It has, yeah. Her house basically doubled from when we bought it last June, and I guess what’s happening here is two things. You know, one of them is macro and one of them is micro. The macro aspect is like if you can work remotely, why not work from a really beautiful town out west where it’s dry and you’ve got awesome stuff to do outside, the airport’s literally a 20-minute drive down the street.

And then the micro aspect is, this used to be a pretty transient kind of vacation community, but after COVID hit, everybody just moved here for good. And that took just so much inventory off the market that normally would’ve been rental, and now, yeah, it’s gone nuts.

Meb: We’ve unsuccessfully tried to go to Glacier each of the last two summers, and it’s partially just a logistical headache on a lot of the lodges filling up. And we have some family down in Kalispell, is that how you say it?

Leigh: Yep.

Meb: So for 2022, fingers crossed, we’re going to make it up there. We’ll hang, we’ll give you a shout out when we’re in the neighborhood. But, we made it as far as, during the pandemic, up in, like, Bozeman, and up almost to Missoula, then over to Idaho, so we’ll definitely let you be our tour guide and show us around. You picked up a fishing pole yet? What’s your main…? So you said hockey? What else are you getting’ into up there?

Leigh: Snowshoeing, snowboarding. The mountain’s amazing, we get a ton of really good powder, although last winter wasn’t all that great. I don’t think it was all that great anywhere in the Rockies. Yeah, it’s basically anything outdoors, windsurfing, sailing, anything on the lake. It’s paradise for outdoor stuff.

Meb: You can hop up to the Powder Highway up in British Columbia as well. That’s not too far away.

Leigh: We’re actually heading up to Banff in early September to just go hang out up there, we’ve never been. So, yeah, stoked to explore all that.

Meb: Well, I mean, you had to put your surfboard down. I know you’re a surfer. Where are you from originally?

Leigh: I’m originally from New York, grew up surfing on Fire Island, and then down in Costa Rica, and then trips to wherever else around the world. But, yeah, dude, I haven’t been in the water… We were in Costa Rica in January for a week, so I got in the water a little bit there. But other than that, you know, can’t go to Indo, it’s closed, and it’s been tough for anybody to travel around the world.

Meb: Well, you’re welcome in Manhattan Beach any time. All right. Although, you know, I learned when I was on the plane pre-pandemic, going through TSA, that there is a Manhattan Beach in New York City, because I was heading to the city and somebody said, “Where are you from?” I said, “Manhattan Beach.” And he said, “Oh, New York City.” I said, “No. What are you talking about, man? Manhattan Beach, California.”

And he said there’s a Manhattan Beach, right? And this tiny, tiny, little strip of beach, so that’s my favorite New York trivia. Okay, we’re going to talk about a lot today, and spend probably a majority of the conversation talking about all the ins and outs of crypto. But from someone who was heavily in the bowels of the asset management, in particular quant and startup community with Estimize, you guys recently consummated? Have you finished the merger?

Leigh: Yep.

Meb: Is it still happening?

Leigh: Yep.

Meb: Congratulations.

Leigh: Thank you.

Meb: Would love to just hear your general thoughts on where the industry stands. You were doing it for a while, would love to hear just kind of the evolution of what our space looked like over the past number of years, and also give the listeners a quick overview of Estimize if they hadn’t heard of it.

Leigh: I started my career in kind of equity, quantamental, running momentum models for a hedge fund up in White Plains, New York, pretty isolated from the hoopla in the city on Park Ave. And then entered the fintech space with…first with Stocktwits to build that product at an early stage, and then left to build Estimize. And Estimize is basically a crowd sourced estimates data set for earnings revenue and a whole bunch of other fundamental things that we basically got the buy side to come and give us numbers in return for a whole bunch of other things, and then we turned around and we did two things.

We sold that data mostly to systematic, quantitative hedge funds, but then we also built our own kind of mid-frequency, high, Sharpe alpha factor models on top of the data, stuff like post-earnings drift, or pre-earnings drift, or earnings revision models, things of that sort. And so I’ve had an interesting seat over the last 10 years as we built at Estimize and sold the data, into kind of what was going on inside of specifically these quant funds in terms of this treadmill that they were running on to acquire new and interesting data sets to stay one step ahead of basically the machine learning models which were just eating everything else price associated, all of that alpha.

Along the way, we tried to dabble in a whole bunch of kind of, how could we build things for discretionary managers, but that didn’t really go that well in terms of the sales process. It really ended up being the quants and the quantamental guys that really were able to have a process at a pipeline to look at, evaluate, and then put into production signals coming from new and interesting data sets.

I think at one point, my assumption was that the discretionary world would be able to wrap their hands around it a little bit better, but I think my thesis was correct in that the variable that was going to determine whether they were successful or not was not going to be their technical ability to wrangle the data, it was going to be the point at which a quant on their team or a data analyst brought the PM a specific signal and said, “This is very predictive of the way this stock or your universe of names trades. You need to pay attention to it.”

And I thought that that PM would eventually say, “Wow. Like, there’s real efficacy here. I’m going to listen to those signals.” But what really happened was they said, “Get lost. I’m not listening to you tell me what trades to make.” And then they came back to the data analyst and said, “Please go find me some data that confirms my priors around why I’m making this specific trade.” And that’s kind of the evolution or what’s happened to data within the hedge fund world. The quants got it right, the quantamental guys have done very well. The discretionary guys, not so much.

Meb: Yeah, I mean, that confirms my experience of a lot of my friends in that world, and you see kind of it’s very bifurcated and there are two types. People that embrace it and go full hog like “Moneyball” sort of mentality as applied to their performance and analytics, and others that still are very extreme reluctance to embrace it. What was your perspective from sort of the pulpit, where we live in a world of increasing information, increasing competition?

I mean, I remember saying this many years ago on a lot of the factor ideas that were well understood, I said, “Look, everyone has the same data sets, the same PhDs,” so it’s always this…been this arms race of new data versus analyzing it in different ways. Where do we stand in 2021 as applied to traditional stocks? Is it an area that you think is getting totally commoditized? Are people thinking about it in the wrong way? Any general thoughts?

Leigh: I like to think about it like a treadmill. There are broad data sets, like Estimize, that have a large capacity and can be used in combination with a lot of other things, and I think there, the alpha comes from the unique nature of how you use it, as well as applying new analytic methods to the data set. And I don’t think we’re anywhere near tapping out the alpha. You know, we’re just getting into the use of nonlinear models in the quant fund world. There are very few funds that are completely reliant on really nonlinear things.

The ease of putting those models together is getting better and better, so I think for broad data sets there is always going to be a new analytic method that uncovers additional alpha. I think what’s happened in the last five, six, seven years in quant fund land, and this has bled over into the discretionary world is, there’s a lot of really great, unique data sets that are very narrow. So, for example, there is a data set where you can get every new car registration, like, daily. Well, that should give you a pretty good idea of what the car sales numbers are going to be at the end of the quarter.

But that’s going to get ARB really, really quick because it’s not like only one fund is going to have that. And so that’s the treadmill. And these funds, you just have to feed them like monsters for them to keep the alpha, and they’re running as fast as they can. And then the discretionary guys, they look at that data and they try and infer something, and then they confirm priors and do all the things you’re not supposed to do. And then sometimes some of them are actually able to piece together a quarter or what’s going on fundamentally in a company and make a really big bet in a direction, and it’s obviously been some of them that have been able to do it pretty well.

Meb: You’ve now, instead of just going snowshoeing into the sunset and hanging out as a mountain man in the lakes of…on the shores of Flathead Lake and nearby, you’ve decided to get neck-deep in a new and booming area of the world. Talk to us a little bit about crypto in general. We’re going to get to your new fund, Starkiller Capital, which, by the way, you have a knack for naming. Estimize and Starkiller, amazing names. Could’ve had a career in just marketing. But let’s go origin story. What was the original spark for you on crypto? Did you get it from day one, or what was the beginning?

Leigh: No, I honestly didn’t. In 2013 I wrote about Bitcoin on my blog, basically saying, “All right, I found the white paper, this is really interesting. There’s an interesting technological thing going on. Put aside the price, put aside the philosophical aspect of the privacy, the libertarian gold buggery kind of stuff, just think about it from a technology…” And I like to just dabble in anything that’s new just to understand it because that’s the only real way that you can understand some of this new stuff, that is, you just have to be elbow-deep in it.

And so I bought some Bitcoin, not a lot financially, but bought some just to hold it because when you hold something, like, you’ll pay attention, and then you’ll read about it, and stuff like that. And then in ’15 I wrote another post basically saying, “Okay, I think I understand what’s going on here from a philosophical and fundamental standpoint. If this thing isn’t dead yet, it’s not going to die. And if it’s not going to die, it’s going to grow.” And if you believe that, let’s just say it’s just Bitcoin at that point, if you believe that thing’s going to grow, well, there are some decent kind of fundamental models.

The stock-to-flow model from the Pantera guys that, yeah, kind of talk about what this thing should theoretically be worth, and so I made a decent financial investment in it at that point. But now what’s interesting is, we go through ’15, ’16, and then we have the massive run in ’17, and at that point, my viewpoint on the asset class was still, this is a utility list digital rock that doesn’t basically do anything. It’s got a really interesting philosophical piece to it, but there’s no actual utility here.

And then Ripple just went nuts, and that was obviously a fraud, which they’re getting’ sued for it right now, and I cashed all out, and just literally didn’t touch it again until last October. And I guess the reason was because I didn’t see any utility being formed in it while there was obviously an asset problem. So we get the crash, and I think the big thesis this time around is that in the first run, the asset class was made up mostly of Silicon Valley hackers. They didn’t understand anything about finance, right?

In fact, they made a lot of mistakes that if they had just read a financial history book, like, they could’ve skipped over for that number of years. But what happened in ’18 was that a bunch of guys left Two Sigma and Citadel and some other very sophisticated quant funds, to start building DeFi protocols. And at that point, I guess two things kind of flipped in my mind. One was, the real people are entering this space now, this is not playtime anymore. And the second was, if these guys, who are some of the most highly paid engineers, financial minds in the world are moving into this space to build things, en masse, then you always want to follow the engineers to the gold mine basically.

That is just a general principle of technology investing. Whatever protocol, whatever technology they are using, you want to follow right behind them as they flood into the space. And the other thing that had happened in ’17 was, I had looked at the basic time series momentum models on the top coins, and what would happen if you applied those really basic kind of CTA type models to this market. And the theory was that, if you have an asset or an asset class growing this quickly, then just fundamentally you have to have the associated vol. You can’t have one without the other.

And that we were going to have multiple 70%, 80%, 90% drawdowns in the asset class going forward because there’s a lot of leverage in the asset class, people play really fast and loose with it, it’s a lot of retail, there is just so much headline risk. And so, if you wanted to allocate to the beta of this asset class, you need to find out a way to dampen that vol so that you don’t puke everything up when you get an 80% drawdown at the wrong time. And it’s very hard, though.

Even if you have a really strong, fundamental conviction, a long-term, fundamental conviction in the asset class, it’s really hard for anybody to see their returns go absolutely nuts over a period of time, and then draw down 80%. You’re not going to behave correctly in that kind of environment. So, we wanted to look at whether we could use these time series momentum models to do long-term market timing. And it turned out that, yeah, they work really well, because basically, the whole market is momentum.

And that’s largely because, and this is philosophically arguable, but there’s really no…or up until recently, there’s really been no, like, intrinsic value to any of these assets. They’re just gambling vehicles, basically. Now what’s happened recently is there is intrinsic value to things like ETH and some of the lending protocols and some of these other things that actually produce cash flow to them, but the market is still largely a casino without any rel val trading going on. It’s just all momentum. So we looked at that and it worked really well, and that is the basis, that, and the cross-sectional momentum for the asset selection.

Because everything is momentum, if you look at the cross-sectional momentum between the crypto assets, they do basically predict which assets will outperform others over the following period, and you basically use both of those to build the basis for a quantamental, factor-driven data portfolio.

Meb: Where sort of like 2017, 2018 you’re thinking about this at this point, and I love the concept of the momentum and trend because there’s no more pure idea for an asset trading on this type of style than crypto. You have a lot of other markets where there’s a ton of other participants, whether if you think about the ag market or the precious metals, where there’s a lot of money sloshing around that are the users. You know, hey, a actual jewelry producer or you’re a cereal company, etc., etc.

And I love this concept of crypto being this price-based on one hand, and you mentioned some sort of quantamental ideas on the other hand. Did you start thinking about this in terms of your own investing and trading? Or was this sort of like a research concept and you said, “This needs to be a product or a strategy, or let’s put it into fund format”?

Leigh: I think initially it was, let’s just see, for the hell of it, whether this works. We had a pretty good hypothesis, just by eyeballing the charts, that it would, and I wasn’t quite sure whether it would be productized or not. I definitely ended up using it for myself. Basically last October I went all in on basically every penny I had, except for our house, and that’s worked out pretty well. But it was largely because, at that point in time, those momentum models flipped to very green, and we saw the run that, you know, everything has taken basically from there until April.

I think I was thinking a little bit about what the market needed in terms of a product back in ’17, but I…to be honest, it wasn’t my main goal, it was really more just research-driven, and for myself. And that’s worked out pretty well. And the fact that this run has confirmed the model, really set it in motion.

Meb: All right, well, let’s start to think…or let’s start to hear about it. You came up with this concept for Starkiller. What’s the origin story on the name, for the listeners? As well as, give us the overall concept of the strategy behind the launch.

Leigh: One of the fun things about crypto is, all the names are fun. It’s just, because it’s an experimental asset class, all the DeFi protocols are named for food. I don’t know why that happened. They’re all named for food, and we get to have fun with the names. The name really comes from the fact that there is another fund in the space called Battlestar, and I just really love the name. I’m not actually a fan of “Battlestar Galactica” at all, but I really love the name “battlestar,” and this was kind of the second best name I could come up with besides that.

Meb: It’s an interesting take, because if you have the thesis that beta is eventually free, as it is in 2021 for most asset classes, you can buy almost any long only market-cap-weighted beta for 0.05%, and that will eventually befall the fate of crypto, I imagine, although, thus far it’s been…most of the offerings are still pretty high fee. To have a approach that’s different, so a traditional hedge fund or alpha approach, it can’t just be just basic long and go on vacation for a year and rebound the end of the year. So talk to us a little bit about the general ideas. Portfolio construction, strategy, what are you guys…what’s the framework for how you think about the space?

Leigh: Yeah, so the whole thing starts with the fundamental conviction that we are probably somewhere in 1995 or so regarding building the Internet of money. And in 1995, you know, in the internet, the first round, you basically had a lot of really good ideas that didn’t have the infrastructure set up to actually support them, hence pets.com. And those companies would come public at $100 million, $200 million, $300 million-dollar valuations. Now, most of them went to $0 in the crash, some of them got through, like Amazon, by the skin of their teeth, and then ended up becoming $10 trillion, $100 trillion-dollar companies.

I think we’re probably in a very similar stage to this, although there won’t be as big a shakeout, because this time, one of the really interesting parts about crypto is that it is built on basically what is open source code, whereas Amazon or any of those other companies, the source code to their companies was sacred. Now, we put everything on GitHub, and then the Estimize source code is not public, it’s private, but all of the crypto protocols, it’s all just there, and so you can just go and grab it. And they call these “vampire attacks,” where you go and grab all the code and you change one little thing, and then just release it as your own protocol.

Well, because we can do that, we could iterate so much faster than we could in Web 1 or even Web 2, so the theory is that we’re going to see, over the next 5, 10, 20 years, the internet of money basically rewrite a lot of commerce, and a lot of the incentive structure behind collaboration, and behavior, and gaming, and banking, and all of these things. And the reason that works is because of this. I think some people get the overall thesis on crypto wrong because it’s been hijacked by the kind of libertarian, gold bug type privacy people.

That is not the interesting part to crypto. The interesting part is this. It’s that crypto provides the incentive structure to bootstrap liquidity in decentralized systems. And the best way to explain that is that if you have a chicken and egg problem and you need to build liquidity on either side of a market – let’s say the original Uber – if you wanted to go faster, what you would do is, you would say, instead of spending all this money on advertising to find customers and find drivers, you would say to both the customers and the drivers, “If you provide one side of that market, at some point I’m going to incent you by dropping you part of our business with the equity.”

Now before, you couldn’t do that because you can’t just, like, can easily hand out equity to hundreds of thousands of people. But with crypto, what these networks can do is say, “If you provide money into one of the protocols as supply, or if you take out a loan from one of the protocols as demand, later on we will drop you our governance token,” which is basically an equity instrument. And so you are incented to help them build liquidity in the platform, and this allows you to build these marketplaces faster and faster and faster, and that is what’s going to replace a lot of old-school Web 2.0 stuff. That’s the really, really exciting fundamental thesis here.

Meb: That’s pretty deep and interesting. How do you go about conceptually putting a portfolio together? Is this something where you’re going to target market-cap weights where you say, “Look, we’re just…this is going to be 70% Bitcoin, and then Ethereum, and Solana”? Is it going to be something that you have some other position-sizing algo where it looks more like…almost like a traditional CTA that’s trading 50 or 100 markets all the way around the world? How do you think about that sort of way to build a portfolio?

Leigh: As you said, the beta right now is expensive to access, the training is expensive. At some point, that beta will be relatively free in 5, 10 years or so. The way that we view it is that because the market is growing and morphing so quickly, there are going to be a bunch of different kind of sectors, so to speak, and we want to have exposure across those sectors. So right now it’s something like actual crypto currencies, which is Bitcoin and a couple of others, privacy coins, things like that, smart contract platforms like Eth and Solana and some others.

The Level 2 is on top of those, which kind of dovetail with them. Then you’ve got the DeFi protocols, whether they be lending or banking or any of that stuff, the DEXes, which are basically the casino itself. But then you’ve got really interesting stuff around games, like Axie Infinity, and metaverse stuff, and NFTs, and infrastructure stuff like Helium. There’s going to be a whole bunch of things, and who knows which one of them is going to be the eventual biggest part of the asset class. It’s totally possible that Bitcoin ends up just becoming digital gold and has a very low ceiling in terms of the overall nature of what crypto’s going to become.

So, we start with the time series momentum models to basically give us an understanding of what the beta of our portfolio should be at any given time, and then we go to those cross-sectional momentum models to look at, okay, fundamentally we want something in DeFi lending, we want something in, you know, Level 1 smart chain, we want something in metaverse, we want this. Let’s say we want a total of, like, 20 different positions in a portfolio. Within that sector, which one of these coins is performing better than the others? And then what we do is, we have a fundamental take.

So one of the really interesting parts about crypto is that whereas in equities you only get one report a quarter, if you’re in the U.S. – if you’re outside of the U.S., maybe even not that – and intra-quarter you’ve got to go try and piece together what’s going on in the business to get ahead of everybody else. But in crypto, it’s literally all just there. All of the data about what’s going on within any given chain or protocol is available freely to everybody. And you can go and build fundamental models that look at how fast is this business growing?

So we’re able to put together these fundamental factors, and eventually, we’ll be able to look at that cross-sectionally in kind of a rel val sense. You can even build stuff like a price-to-sales ratio for how they make or compound the lending protocols right now to figure out which one’s more expensive than the other. So, we take a fundamental thesis, a fundamental approach to, do we believe this protocol’s going to win out over the other one? But the primary selection model is that quantitative selection piece. And then the really interesting thing that we can do on top of it is, we can stake and farm the assets.

And what this allows you to do is produce relatively zero beta yield on top of the portfolio by basically providing liquidity with the assets that we hold, into those lending pools or decentralized exchange pools or the stable coin pools, all of which are really interesting. And we’re just the tip of the iceberg for the really interesting strategies there.

Meb: Can you unpack that a little bit? And let’s start with the basics, how all that works because I feel like this is a topic a lot of people are talking about that I don’t think many people actually understand. So, maybe give us the 101, then we can dig in on the 201 level, the education on all things staking and lending.

Leigh: Yeah, so here is the easiest way to describe DeFi as an example. J.P. Morgan borrows from you at 50 BPS, and then they lend back to you for a mortgage or whatever at 350, 400 BPS, right? So, like, the simplest incarnation of our financial system is, J.P. Morgan takes 300 BPS for being a counterparty to your financial transactions. They get paid that spread for, I don’t know, whatever. They get paid it for basically administrative costs at this point, and CEOs flying around on jets.

DeFi basically allows me, the asset holder, to take my ETH or whatever, and go and stake it inside of a lending protocol like Aave or Maker or Compound, and what happens is, I become basically part of the pool that you can then go and borrow from, permissionlessly. Now, it’s a collateralized loan that you have to take out, but I get that spread instead of J.P. Morgan.

And there’s a smart contract that just sits in between me and the pool and you and the pool, and it’s not technically peer-to-peer because I’m not lending to you, I’m putting my money in the pool, the contract is managing the pool, and then you’re borrowing from the pool. And, you know, those yields can be anything from very low – 300, 400, BPS – to incredibly high if the protocol that I’m lending into gives a reward to me as their equity, their governance token, for participating in that pool.

So that’s what we call liquidity staking, and that can be done either in a DeFi lending protocol, or it can be done inside of, like, a decentralized exchange like Uniswap where…and I take my USDC and I put it into the ETH-USDC trading pool, and anybody who wants to swap ETH for USDC or the other way around, Uniswap charges them a 30 basis point fee to make the trade, I get that fee. Or I get a pro rata portion of that fee relative to how big I am in the pool. So it’s a great way to basically get zero beta yield on your assets.

There is obviously a long-tail risk to it, that the protocol gets hacked or there’s impermanent loss associated with the stability of that pool, or the total locked value in the pool goes down significantly and you’re the only one providing liquidity. But there are ways to manage the risk around that. It’s a very interesting space. And then the other way people think about staking is the concept of proof of stake, which is one of the ways that these crypto currencies actually confirm their transactions, and that basically means locking up your asset inside of one of these protocols for a period of time.

And instead of Bitcoin being proof of work, where you pay the miners, you pay the stakers. The rewards aren’t as high for that relative to participating in liquidity pools, but if… And this is where, while the beta will eventually be free, interacting with this new banking system basically, this new financial system, requires literally just being able to do it correctly without losing your keys and sending stuff to the wrong address. But if you can do it, there is a bunch of basically free yield there, which is great.

Meb: They’re not black swan risk because you know what some of them are. How real are they? Meaning, like how worried are you about these various risks, and perhaps in what order? I mean, I think back to a decade or two ago, there was young quant that was…helped building some, like, sports analytic models for betting, and found a ton of inefficiencies, a lot of arbitrage opportunities, and that wasn’t the problem.

The problem was, is you had to put $100,000 across 10 different sports books, half of which were located in Jamaica or Barbados or Czech Republic. You know, who knows where? And the risk wasn’t that your models didn’t work, which is still a risk, but more that one of those would just disappear into the ether, or the U.S. Government would say, “No dice,” or whatever. Like, there was other risks. How many of these do you worry about? And are some the ones where you’re like, “All right, this is the one that I’m really concerned about, and there’s others that I’m like, ‘Uh, not so much'”?

Leigh: It’s a curve. One of the problems with crypto, I think, in the last cycle was just straight up counterparty risk at brokerages, like centralized brokerages, and there were a bunch of them that got hacked, and Mt. Gox, and… I mean, there was one in South Africa a couple months ago where the guys just literally ran away with $1 billion of Bitcoin. That is not as much a problem anymore. I think Coinbase is a public company now, and if they get hacked, I’m pretty sure they’re going to make people whole by just selling stock, and they can do that.

FTX is run by some really good people. The big centralized exchanges, I don’t think, are as much of a risk. Within DeFi, as you operate kind of in these protocols, there is a risk curve for sure, and it happens on a couple of different vectors. One of them is, how new is the protocol? Has it been audited? Did you read the audit? Who did the audit? Did you actually read through the code itself? And we’ve got a really great DeFi yield PM who’s been doing this for a long time, I’ve been doing…a long time is not that long in this space, but in a relative sense, I have been doing that kind of stuff.

And you really need to know what you’re looking at. And even so, even when you know what you’re looking at, there are still other variables like, how much money is in the pool? Who else is in the pool? You got to be in the Discord channels, you have to be on their Twitter, you have to be in this community, really understanding what’s going on. You have to know who backed the protocol. Who are the investors behind it? Who are the founders? Are these guys just going to rug you and run away with the money?

Because while all these things are smart contracts, you can write some really shady stuff into a smart contract that just allows you to pull the rug out from under everybody and run away with the money. And there are things like Tornado Cash now in DeFi where you can run that ETH or whatever through Tornado Cash and nobody will ever know where it goes. It’ll go to wallets that you control that everybody can’t track. There is a very serious risk management and fundamental process.

And even so, we still bake into our assumption that at some point there’s going to be what we call a run book, where liquidity starts to drain quickly out of one of these protocols, and we need a risk management strategy to be there when that happens so that we don’t lose everything because that just happens sometimes in this space.

Meb: And so, what are the ideas there? Is it A, diversification across instruments, B, across exchanges and listings?

Leigh: Yeah, so on the yield side, largely it’s, you just don’t want to be too heavy in any one pool. For us, you don’t want to be more than 10% in any given pool. You want to spread your bets out over stuff that is relatively lower yield versus allowing RPM to dabble in stuff that is much higher APR. You know, one of the things that we’re doing is basically liquidating the governance token. That’s the form of yield that you basically get paid in for participating, or some of it.

Liquidating that token every day so that we’re not taking the beta risk of the actual governance token. Other times, we absolutely want to own the equity, so to speak, of these protocols, but definitely not all of them. And yeah, you need to spread your bets out over pretty well so that if you do get rugged, you’re losing a very small amount of capital relative to saying, “Hey, we’re going to ape into this 100% APY yield protocol and double our book this year, beta neutral,” that’s not going to work out well in the long run if you keep making those bets.

Meb: While we’re kind of on the topic of risks, it seems that the cat’s outta the bag and there’s really no going back to crypto disappearing, really. But as you think about sort of industry-wide risk or like “what could kill crypto” in general, or Bitcoin – I used to say Bitcoin, but now it’s probably much bigger than Bitcoin – is there anything that comes to mind that you think is either worrisome or even if not worrisome, that people are worried about that’s not actually a big area of concern?

Leigh: On the kind of long-term thesis side, yeah, I think this is now an inevitability. I don’t think there is anything that could kill it. I have conversations with people, you know, friends like Joe Wiesenthal at Bloomberg a lot, where we talk about the regulatory aspect to it, and he says, “Well, here are the things that the government could do to kill it.” And I say, “Yes, that’s all true. But I think the more important variable is, what would they do? How far would they go at this point?”

And I don’t see the ability for them to go to the length that they would have to in order to kill this, which means to me, it’s a runaway train. Now there are a couple of issues for institutional investors and individuals just allocating to the space. One of them is…that they worry about is custody. The concept of custody in this space is completely antithetical to the historical concept of custody, right? We’re taking our assets, getting our data exposure at the centralized exchanges for now – eventually, we’ll probably be operating exclusively within DeFi to, you know, trade – and then we’re moving them into DeFi with a Web 3 wallet and holding things on chain.

Well, the concept of custody just completely breaks down at the point where you take something out of your centralized custodian, let’s say Coinbase, and you move it on chain. Now, the way that we’re handling that, and the way that the industry is handling that is, really it goes from being a custody issue to an operational security issue. How do you secure the wallet? How do you secure the passwords? How do you make sure that the traders or anybody else in the company can’t just send crypto to some random wallet or some random protocol?

So you have a whitelisted wallets and protocols and you have this thing called “sharding,” where basically you don’t hold your own private keys anymore, there’s a third party like Fireblocks that holds your private keys. But they give you a shard, and then in order to change anything in terms of those whitelisted addresses or permissions within your kind of ecosystem, you have to have, let’s say, three out of five people who hold shards agree to, like, change something within the system. So, there are pretty good protections at this point for operational security and making sure internally, nothing happens and that your wallet doesn’t get hacked and things like that.

From a broader, like, crypto perspective, I think there’s going to be massive headline risk. I think there’s going to be variable regulatory regimes throughout the world. You can see basically Rob Portman in the Senate attempted to get this rule in the latest bill. Yeah, it’s very obvious that the banks went in and said, “Please crush this in the crib,” and he did their bidding because he’s retiring, and I’m sure he wants a really cushy job on a bank board. And that’s going to happen but they’re not going to be able to stop it at this point, it’s kind of a runaway train.

There’s going to be more hacks, there’s going to be more hacks in DeFi, I’m sure some other centralized exchanges will get hacked, people will run away with money. But all of these things, to me, feel very much like speed bumps in front of a steamroller, where Pandora’s box is opened now and it’s going to be impossible to put it back in.

Meb: Give us your kind of expectations, thoughts on the regulatory side. We’ve kind of alluded to it a few times. What’s the sort of state of the union there? Also, I’m just thinking in my head about adoption and custody and if we ever get to the point where you have sort of the FDIC … insurance for people. What’s the regulatory breakdown?

Leigh: I would say that right now we’re in a regime where the individual U.S. regulatory agencies can’t even decide amongst themselves what these things actually are. Are they a security? Are they a commodity? Are they a property? So they’re fighting with each other, and the CFTC commissioner’s fighting with the SEC commissioner over basically who owns what, what is what. I find it very hard to believe that they’re going to figure that out before this thing just is completely outta control from a scale perspective.

So when people say, “Well, the government could crush DeFi because it doesn’t have KYC involved.” Well, here’s the thing. You could force the DeFi protocol teams, the owners of the protocols, you could force them offshore, but you can’t limit the access of the actual protocol to anybody who wants to interact with it, which is why it’s antithetical to the current set of rules that we’ve had since 19, what is it, 35 or something? Whereas, those rules are written for a local market of product providers meeting a local market of consumers. This market’s global, so the protocol teams can go offshore, and then all the demand can just access it from there.

And if that’s going to happen, then…and this is the debate that everybody was having a couple weeks ago is, why are you forcing the teams offshore? You might as well just write a new regulatory regime. So right now a lot of it is, okay, we know there is a ton of grey area, but within the people building the protocols, and even for the funds, at some level, there is a grey area for certain things, but the assumption is that the government is not going to either want to or be able to seriously impact the growth of that because it would stifle it quite a bit. And I think they know at this point that there are too many very rich, powerful people who own enough crypto that they can’t just straight up kill the whole thing.

Meb: How do you keep up? Do you have a team that’s working on this? I mean, it’s a lot. It’s not like you can go read a dozen books on the topic. Or there’s starting to be more and more academic research put out, but are there any resources you think are particularly insightful? How does one get to be an expert on this space?

Leigh: Yeah, one of the things about this space is that it’s moving at 3, 4, 5x the pace of Web 1, Web 2, or even mobile, which moved very quickly. And one of the perilous kind of aspects to it is, as an investor, as you know, one of the worst things an investor could do is dabble in a whole bunch of different strategies that are not core to them, right? That’s where you lose money. And there’s so many different shiny objects that get thrown at you every day in this space that make you want to go, “Invest in NFTs, or invest in this new thing, or participate in that thing,” and there are two ways to look at it.

One is, I think you really have to stick with your…whatever your investment philosophy and set of assets are. I think you really have to pay attention. And there’s just so much alpha there right now because the market is very inefficient right now, that people should do that. The other way to think about it is this, that the best strategies, the best knowledge that you’re going to get about a very quickly changing space, is to basically participate with an amount of money that you don’t mind losing, in everything. Just experiment in everything.

A friend of mine had a kind of pithy tweet the other day but it was very accurate, which is basically, all of the hardest things where you had to, like, struggle to set something up or learn something new in crypto, are basically the highest returning things, because they’re the earliest. And because this whole thing is basically being knee-deep in fiddling with a brand-new bank, the guts of a brand-new banking system, you’re not really going to understand it intellectually until you fiddled it…with it yourself.

And so I think that everybody should have a MetaMask wallet and they should play around inside all the C5 protocols, they should play in the games, they should own some NFTs. From an intellectual perspective, it’s…I think it’s really important for people right now to stay with it from a learning perspective. Twitter’s been amazing for me. One of the things about the crypto community is, everybody really looks at it as very non-zero-sum. There’s so much sharing that goes on relative to other parts of the market because these people know that the adoption thus far is so small.

I think there’s something like 100 million people globally that have touched a cryptocurrency at this point, and most of them are buying stuff on centralized exchanges. They’re not even operating inside of DeFi in any way whatsoever, so they haven’t actually even touched the guts of the banking system, they’re really operating with the asset inside of the old banking system. So, you go from 100 million, and, you know, we basically have 2 orders of magnitude left to go for people actually even knowing or holding this stuff.

And so, you should really keep up with really good sources on Twitter. Some of the biggest hedge funds, the…you know, the founders and PMs, will liberally share their ideas and what they’re seeing on there. There are some really great tools like Dune Analytics, where you can go in there, even as a non-dev, and you can basically build fundamental dashboards to see what’s going on on-chain, how much of this is growing and who’s allocating to this. And we use that kind of stuff because the open source tools in this space are actually really good, so that’s been a huge resource.

And then for me, you know, one of the things that I try and do personally, and at Starkiller Capital, what we’re definitely doing is, every day for half an hour, we’re just looking at one new protocol, learning about what it is. Who’s behind it? What kind of growth is it seeing? Because the space is moving so quickly, that if you’re not constantly learning, in 3 months you’re going to be way behind from understanding the competitive aspect of the actual assets to the other assets.

Meb: To what extent are you guys looking at actual companies, whether it’s in the mining space, or whether it’s in the exchange or brokerage, on and on, picks and shovels of the whole crypto ecosystem? Are you investing ever in startups or in more established companies? Is that something that is of interest?

Leigh: Yeah, I’ve done, personally, some pre-token launch, early-stage deals. Really, really great kind of one that I love right now called Hashflow. The concept basically that within DeFi, the decentralized exchanges are these automated market makers. And they do a good job for what they do, but they can’t scale in terms of the size of the trades. So these guys have basically built a dark pool, which is, like, semi-centralized in the sense that they’ve got some of these big market makers that have come in and they’re going to provide liquidity on the other side.

And so you just say, you know, “I want to buy or sell this asset,” and they’ll quote your price, they’ll flash your price at whatever size you want. And I think that that’s incredible. So I’ve done some investments like that, and I think if you have good deal flow, there is the opportunity to do really well there. So we are going to do that at Starkiller with a small minority of the book. I think there’s good alpha there but, you know, you’re going to get locked up for a year each time on those investments, and the market is moving very quickly.

So, you know, if you don’t have a portfolio theory view of making those earlier stage investments, if you just do them very specifically, I think you may get in trouble with that because the space is moving really quick.

Meb: When you’re in lockup, Leigh, when you get up to, like, three or five-year lockup, you don’t want people bouncing in and outta these things. Talk to me a little bit about capacity. I know you guys are targeting upwards of $100 million. What point does this become problematic at this stage in 2021 to be able to make some of these trades and investments? Is there a challenge already with some of them, or is size a big advantage? How does that play into y’all’s thinking?

Leigh: So our universe on the beta side right now is something like 200 to 250 different assets, and that’s basically your universe above, let’s call it a $300 million-dollar market cap for these coins. Not all of them are as liquid as we would want them to be at the lower end of that scale, but the liquidity is getting better and better every day. That’s basically our universe today. I’d say in a year, that universe will probably be significantly larger. Liquidity is building very quickly, especially on the DEXes.

In terms of capacity on the beta side, we could definitely run significantly more than that. On the yield side, I think you’d get into trouble at something like…let’s call it right now, we probably couldn’t run more than $500 million because spreading that out across those protocols, you would end up being too large a part of those pools if you wanted the kind of yield that we’re going to go after. You’d have to stretch it in ways that I don’t think I would be comfortable with from a risk management perspective.

Again, in one, two, three years I think that capacity’s going to be much higher. But to be honest, I think on the yield side as institutions enter the space, those yields are going to get compressed sometime in the next three to five years for sure. They’ll always be pretty good because the concept is dropping the governance tokens in return for participation, so there’s always going to be some really good yield there, but it won’t be as fat as it is right now.

Meb: How much is correlation an issue in this space? We’ve seen a couple big drops in Bitcoin as sort of the heavyweight gorilla. Is it a scenario where Bitcoin goes down 80% again, is that the expectation that the vast majority of the other coins and offerings would as well? Is it something you say, hmm, maybe it’s a scenario, just like in the equity market, where the leaders eventually change positions and maybe Bitcoin falls by the wayside and, you know, it may not be the case? How do you kind of think about building a portfolio, you know, with this in mind? Or is it sort of the trend, and momentum rules kind of act as a way to counteract that?

Leigh: I think it’s both, actually. So, the fundamental thesis here is definitely that we will have at least another couple 80%…70%, 80% drawdowns on the way to the eventual terminal value of this space, for sure. And the reason that happens is because there is really easy leverage in the system, and basically from a structural perspective what you have is the actual assets – Bitcoin, ETH, whatever – being used as the collateral in the system to get the leverage, so when the market starts to draw down, and those collateralized loans start to trigger, and the margin calls happen, you’re basically getting this liquidity cascade take place that feeds back on itself.

There’s no literal person picking up the phone and margin calling you, it’s just a smart contract that liquidates your stuff, and because it’s just liquidating your…in a flash liquidation, it’s throwing all of that supply onto the market and causing that volatility. I don’t think that’s going to end anytime soon, it’s just the structural nature to this market. I think the drawdowns will get progressively lower over time as the growth in the asset class slows somewhat. Right now, that growth is just insane. It can’t grow like this in perpetuity. It’s impossible.

So as the growth slows, that vol will come down and the drawdowns will come down. Now right now, yeah, the correlations are incredible. Our models are assuming, basically, that those largest market cap coins will drag everything else down with it, and then while calculating betas are hard right now in the space, the kind of smaller protocols will be higher beta and draw down even more. And we just saw that in the last cycle where a lot of the really good DeFi protocols drew down 80%, 90%, but Bitcoin and ETH were only down…I think it was 60%, 65% or so. So we’re going to continue to see that.

Now the market timing models and the relative strength models counteract that somewhat, although in a classic CTA strategy you would want to be playing long and short off of two different assets that you felt were uncorrelated. In the classic kind of Richard Dennis model, right, you don’t want too many lots of RBOB, nat gas and, you know, whatever other energy thing, right? There’s a total number of lots, and then that’s uncorrelated from gold or whatever else.

In this space, it’s just all correlated, and I think it’s going to be that way for a very long time because of the nature of the collateral in the leverage. I’d say maybe something in the range of, like, four to five, six years from now, maybe you get more rel val trading, and maybe that unlinks some of the correlations.

Meb: You can correct me if my assumption is incorrect, but I would assume that the time frame is, because of the volatility, is going to be condensed a bit from sort of traditional, long-term trading advisors. Is that right?

Leigh: Yeah, that’s definitely true. The other interesting thing, and this is research that we’re doing, is volume in the market, because the market right now is still so retail-driven, the volume is actually a really strong momentum signal in and of itself, the volumes on the exchanges specifically. What we’re looking at is models that kind of volume weigh the time series. There’s a point in time when just nothing’s happening in the volume and it doesn’t really matter what’s happening in the price at that point. But if you volume weight that time series, those momentum models, it seems that they tend to work better.

The cycles are going to compress as well, I think. We had a winter basically between, yeah, late ’17, and I mean, really last October, right? So, almost a three-year winter. I think the length of the up cycles is going to grow and the length of those troughs is going to be sharp, the length will be considerably less. I think largely because you’ve got more institutional players in the space now, they’re going to want to reallocate to the beta after these liquidity crashes.

Meb: The approach on sort of trend following and time series momentum makes so much sense to me in this world because the prospect and the emotions…I mean, crypto brings out the emotions in everyone whether you’re involved in it or not, having an objective take on it, I’m doing the pitch for you here, but it’s like, being objective, not necessarily having to bet on who the winner of the horse race is going to be because you’ll end up owning, just like in a market-cap-weighted trend following model, you know, the winners, but also hopefully the ability to sit out these just haymaker drawdowns on any one asset or security. So, obviously, I love the approach. I don’t really have a question there. That was just a little bit of fawning.

Leigh: You know, on the protocol side, I think we’re definitely in like an AOL-Netscape versus Google-Facebook kind of regime here. I can’t think of…and I’ve racked my brain for this and asked a lot of other people if they could think of another first incarnation of a new technology that was the eventual big winner from a business standpoint. And so, people can argue over whether Bitcoin is the genesis to this whole thing. I think it is. Other people will say, “Well, there were other blockchain’s or whatever before that,” but it…the incentive structure wasn’t the same, so I think Bitcoin is the genesis.

And, you know, while I think there’s a really great place for digital gold, I think it’s very unlikely that Bitcoin is the eventual winner. And personally, I don’t think I’m smart enough to pick fundamentally which one of these zillion different protocols is going to be the next J.P. Morgan. And one of them will be. That, I am almost positive of.

Meb: I mean, look, that’s the beauty of… I mean, you think about equities, you think about, I mean, commodity trading advisors, anything where you have these multi-bagger winners – 10x, 100x, 1000x – it doesn’t even matter what the others…what happened to ’em. And all of the great investments in history have this similar trait, it doesn’t matter if it’s startup investing, it doesn’t matter if it’s applied to ags or precious metals or stocks. You know, the ability to pick the ones with the outsize wins is really all that matters, that you’re in it, you know, for the exponential ride up.

Leigh: Just don’t want to puke it up, yeah.

Meb: You don’t want to puke it up.

Leigh: Just don’t puke it up.

Meb: So this obviously seems like something that would be attractive to traditional trend followers and CTAs. Are any starting to adopt this? I know a few that are. Jerry Parker, our bud at Chesapeake. A few that do kind of the majors, you know, the futures, so that’s, I think, restricted to Bitcoin and Ethereum at this point. But are the big macro shops, traditional, entering into it? I know we’ve heard Druckenmiller, I know we’ve heard Pantera, Yusko…

Leigh: Brevan Howard, yeah.

Meb: Brevan Howard. But are any of the traditional, like, trend followers entering? Most of those guys are more the discretionary kind of fundamental.

Leigh: As far as I understand, and I have had some conversations with some of them because a bunch of them were clients of ours at Estimize, they want to. What they are thinking about more are low beta, high Sharpe, long, short desks. They want to do ARB. There are still some really good ARBs in the space. We may do this eventually. I’m sure somebody’s going to do kind of a leveraged stable coin yield farming fund, because relative to a classic fixed income fund, like, these things look really good from a risk perspective right now, risk, return perspective.

But a lot of these firms are really looking at this, not from a beta…like asset class, beta perspective, they’re looking at it more from how they normally look at it. The issues that they’re having are around the legal aspect of custody and being able to actually trade these assets versus, yeah, just trading the futures, which they can definitely do right now. But that’s not where a lot of the interesting stuff is, that’s not what…where a lot of the interesting ARBs are. I would assume that sometime over the next 18 months, one of those big shops really gets its hands around it.

Two Sigma definitely has for a while, they’ve been doing really well. But some of the other ones, I think, will get their hands around it from a legal perspective, and then throw a bunch of their pods at it. I think right now it’s very experimental within those firms.

Meb: I know the academics have kind of been in this space for a while, we had Cam Harvey and some others talking’ about it on the podcast. As you look into the space in the next 3, 5, 10 years, give me some predictions, what does it look like? Anything that we’ve talked about, that we haven’t talked about that you think is particularly insightful or important not to miss?

Leigh: The academic literature in this space is going to be incredible over the next 5, 10 years, and the reason is because, unlike traditional markets where the academics have to hunt down me at Estimize for the Estimize data, or collect it or something else, all the data’s just available basically for free because it’s on chain, it’s all visible. So, we’re going to have some really interesting stuff come out.

I was talking on Twitter to somebody the other day about how there’s going to be really cool research into the endowment effect around NFTs, because we can see all of the NFTs and which wallets hold them, and when they change wallets, and after how long, and how the price impacted their decisions to sell their NFT, or how the trend in the rest of the NFT’s net set changed it. So, it’s going to be a bonanza for academics in this space, applying this data to everything they’ve done historically that maybe they didn’t have the kind of fidelity of data that they wanted. Investor attention stuff, all of it is going to be really cool.

I think you’re going to see a whole bunch of momentum stuff, We’ve already seen one good paper that was written on it. I think you’re going to see a lot of, like, non-academic but really hard-core AQR style stuff come out, and we’re already seeing that from some of the funds where they’ve basically taken guys from some of these other big quant funds and they’re just releasing publicly new protocols. Like the guy at Paradigm released the perpetual options contract. I mean, that’s pretty amazing, that is academic research in and of itself.

Comes with a huge, long white paper that even I couldn’t quite understand, so it’s a really interesting time for academic work. I think there are very few academics that are actually doing deep work in the space yet, but once they realize that all the data’s basically there for them, I think there’s going to be a flood of it.

Meb: Anything we missed, we didn’t chat about that you want to touch on, whether it’s in fund strategy, ideas you’re excited about? We covered a lot of ground today, Leigh.

Leigh: You know, I think I would just really encourage people to get elbow-deep in it themselves with a small amount of money, because I have witnessed in my own trading, in other people’s, people we’ve hired, that there’s a very big difference between understanding it kind of philosophically and, like, really understanding it, and that that big difference is just getting in there and playing around. It’s totally worth the four or five hours.

There is some really great resources at, like, rainbow.me, which is one of the crypto wallets where they kind of lay out all the syntax to everything, and what everything means, and kind of some steps to go through. So, it’ll be worth it to spend that time now for the understanding of the next 10 or 20 years.

Meb: I never heard of rainbow.me, so I’m glad to hear that one, and we’ll add it to the show note links. And if there’s any others you think about afterwards, email ’em over and we’ll include ’em in the show note links. We’re going to ask this as the first person ever with two answers you get, the question is, “What is your most memorable investment?” And so you get to give it as a broad question, and then also we’ll ask it to crypto-specific if there’s something that particularly stands out in that world.

Leigh: Most memorable investment, honestly, was last March at the onset of COVID, when I got the trade on the equity side really, really, really right, and then closed it out way too early. Way, way, way too early.

Meb: That doesn’t sound like a trend follower to me, Leigh, when you’re starting to…

Leigh: No, it wasn’t. I broke all of my personal rules and said like, “All right, that’s pretty good amount of money, and I’m out,” and, like, I missed 70% of the move. And the whole thesis for the trade was so correct and the execution was so poor.

Meb: I think about the trades where that’s happened to me in my life, and almost to a T would have been better saying, “You know what? I’m going to slap some sort of trend following exit on this, and I’m just going to walk away. You know, I’m just going to let it…”

Leigh: Yeah, just set your stops, just set the stops, let ’em move down, then, yeah.

Meb: Yeah, the same for me, and we talked about this publicly on Twitter, as you guys can go find the old ones, was during…the same time frame was Ackman’s fund, the closed-in fund, listed hedge fund, was trading at this just enormous discount. It always trades at a discount, I don’t know if just people don’t like him or what, but he had put on an amazing hedge, and end…he ended up a ton last year, but I didn’t think it…that the market knew about it because it was some complicated sort of derivative, but I… And he was trading like a 30%, or 40%, or 50% discount to NAV, and same sort of thing, piked out way too early. I’m not proud of that one because I was publicly talking about it, and then I, of course, was early to the party exit, which is embarrassing.

Leigh: Yeah, I got all the assets right. I was even short Playa Hotels, which ended up going from…it was 12 to 1, and I was out at 7 and just kind of…I got all the assets right, got all the thesis right, and just terrible execution. Totally broke all of my rules in terms of being a trend follower. But, I mean, to be fair, it was a difficult time for everybody, pretty…like we were literally moving to Montana in June and people were getting’ real sick. So I give myself half a pass on that, but that’ll be a really memorable one because there was a lot of money there to be made if you had just not screwed it up.

Meb: Anything in crypto space come to mind that is particularly seared in your brain?

Leigh: In October I went all in. After those models slipped, I did exactly what I should’ve done, and it paid off. I’d say getting long ETH versus Bitcoin at that point was a really good trade that I’ll remember for a long time because it got the fundamental and the technical theses correct. I’ll remember that. And that was a big wager for me personally. That’s pretty seared into my brain.

Meb: And does your fund ever go short, by the way, or get any sort of short exposure?

Leigh: We won’t be taking short exposure on a net basis, we will hedge at certain times.

Meb: Okay, make sense. Leigh, this has been a tour de force of the crypto space. I mean, we’ll have to have you on, my God, like every few months just to keep up with the progress of what’s happening. People want to follow along, Starkiller, everything that you’re writing about, doing, what are all the best places?

Leigh: Yeah, I share pretty liberally on Twitter, maybe more liberally than my team would like, and we plan to publish research publicly kind of AQR style. So, you can sign up for our newsletter, Insights. We call it Insights at starkiller.capital. My Twitter account @ldrogen. We probably won’t use our actual company Twitter account at all, that’s where it’ll probably be posted.

Meb: How many folks you guys up to? And you guys ever hiring if there’s some aspiring, young crypto blockheads out there?

Leigh: Absolutely. So we’re four now, probably be five at some point before the end of the year. We’re going to be hiring that fundamental analyst who has some technical chops, so if you’re out there and have been following these protocols closely, we’d love to talk to you. And we’ll definitely be hiring other engineers later on, probably eventually on the quant-side. But right now it’s four of us.

Meb: Awesome. Leigh, this has been amazing. Thanks so much for joining us today.

Leigh: Thanks for having me, dude.

Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews, please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.