SBF talks to the founder of Real Vision: How do you think about the encryption market today?

Raoul Pal, founder of Real Vision, and Sam Bankman-Fried, co-founder and CEO of FTX, had an in-depth discussion on the macroeconomic environment and the crypto market.

On July 5, 2022, Raoul Pal, founder of macro agency Real Vision, and Sam Bankman-Fried, co-founder and CEO of FTX, had an in-depth discussion on the macroeconomic environment and the crypto market. BlockBeats excerpts some of the dialogue, organized and translated as follows:

On Macroeconomics

Raoul: Before we get started, we want to understand the chaos that’s going on right now and what you think about the market.

SBF: Obviously, the last month has been very confusing, it’s not just a crypto phenomenon. Across the economic system, something similar is happening in tech, where basically all the gains that have happened over the past year have shrunk dramatically.

It was initially triggered by the Fed raising interest rates, and it far exceeded expectations. But at this point, the grim picture we’re seeing in the market, I think, doesn’t match what a 3% rate typically represents.

Raoul: Yeah, I’ve noticed that too, actually, I call it monetary tightening, monetary tightening with the change in inflation, all these things and the dollar, I think it’s the biggest monetary tightening in economic history. And it happened very fast. So, as you said, this is not a crypto event. This is just a liquidity event. It’s happening – look at the oil market today. Everyone is very bullish on oil. I hear someone has a $350 price target. However, it is down 10% today alone. I’m actually very bullish on long-term assets like tech stocks and cryptocurrencies.

SBF: As long as inflation and liquidity concerns persist, those assets with huge capital inflows will suffer. As you said, industries with longer time horizons will be hurt compared to oil and bread. But it’s really just a general economic event that will still damage everything, but the transmission will change there.

In inflation, people see all asset prices go up and you’ll be amazed, gosh, this is a huge economic change. And then all of a sudden, the Fed starts tightening monetary policy, all the numbers are coming back down, and you’re like, holy shit.

But in a way, to put it another way, the current situation is just a split in dollar-denominated stocks. If you look at it this way, it’s a small episode. I don’t want to exaggerate this.

Talking about bailouts in the crypto market

Raoul: A longtime client of mine has kept a point in my mind throughout my career that having cash is king in a recession. I can see that you are in a good position to have cash in a recession, and for you, opportunities are everywhere.

SBF: Oh, sure, there’s a lot of dislocation here, and there’s a lot of potentially very good script to play out. If you have unlimited capital to support, of course, no one has unlimited capital to support anything. However, it’s still a good place if you have a lot of but limited capital. So, I think one of the things we think about the most here is what should we do, given everything that’s going on? Where is it most important that we deploy our money now?

Raoul: What’s your answer to that?

SBF: Yes, one of them, I think the one that gets the most attention, is in the crypto space, except for a very severe short-term liquidity crunch, there is absolutely no problem. The closer you are to the ideal, the closer you are to a place where money should be deployed from every angle. From both perspectives, are there good investment opportunities?

Maybe, but more importantly, in the sense that you can save some customers, save a company, stop the contagion, the bailout is basically permanent, because it’s not like a business that has to go out of business, it’s because of short-term conditions , an enterprise will actually have a crisis of economic inefficiency. So, it’s a platonic ideal, we’re looking for something above all else. Of course, nothing is Platonic ideal.

Raoul: No, it’s not just a business. It’s just for the greater good.

SBF: Right . So I don’t think we just want to put money in lump sum. But if in some cases we’re going to bail out a really good business or a business that has serious customer protection issues, then what we’re really looking at is that it stops the crisis from spreading. Not just bailing out crises dollar by dollar, but preventing a series of crises with less capital spending because it prevents the liquidation of the entire system. I think that’s what we value the most.

Talking about the CeFi Crisis

Raoul: What do you think is wrong with CeFi? What did it fail to do right this time, and what can it learn from it next time?

SBF: When you look at some of these CeFi companies that are storming, none of them have any transparency, there’s no way to really know what’s going to happen. How serious is the Celsius problem? no one knows.

One of the cool things about DeFi is that it’s actually pretty transparent. There is only one clear answer. So, how much remortgage is there? You can view it on-chain. In CeFi, the answer is I don’t know, maybe a lot, maybe not? who knows?

Raoul: Yes, it reminds me of the summer of 1998. I spent a bachelors weekend in Ireland with a group of friends in the financial markets. Everyone is asking, who is your biggest customer? “How much do you have?”, I had about 3 or 4 billion, and another guy said 3 billion, and I was like, I was from Net West and moved to Goldman Sachs. I think I might have done $6 billion or $8 billion. We started adding up, and the numbers were huge. I think we’re all screwed.

The exact same situation in the crypto market right now is that one client has a significant portion of the risk in the entire ecosystem and all the prime brokers are lending a lot of money because they are long term capital. Before you know it, everything has been re-mortgaged and no one knows who owns what.

SBF: Yes, yes. This is absolutely correct. This definitely mirrors what we’re seeing in the CeFi market today, and yes, it’s basically too late before people realize how serious it is. So now, we’re going to clean up what happened there.

Talk about ETH pledge

Raoul: I’ve been talking about this, the risk-free rate of return in crypto is coming: the staking rate of ETH. I don’t think people understand how big the impact is. I just wrote an article about it.

I think the most interesting point is that it will give us the “Treasury Yield” in the Web3 space. Then we can price all of its spreads. Then one can better understand risk pricing.

SBF: That’s a very interesting point. I think this is correct. I guess one thing I would add is what is the risk free rate? I think the risk-free rate has been seen as an uncertain number for a long time. In cryptocurrency value, is it zero? Obviously not zero. In fact, sometimes it’s like 20%, but sometimes it’s bizarrely large, and sometimes it’s bizarrely small. It’s everywhere.

Much of this depends on capital crunch in the ecosystem. But honestly, there is often a large arbitrage between different approximations of risk-free rates in cryptocurrencies, with some sources effectively priced much cheaper than others. But I think few of these sources have carefully considered what the risk-free rate really means. I think there is a lot of guesswork here. I think some people have gone too far with this.

Of course, risk-free is not necessarily easy to understand. I think one thing worth discussing is how long is it risk free? The risk-free overnight rate can be very different from the risk-free annual rate. If you have to lock in that rate for a year, because in a liquidity crunch, you can’t lift it. These are not liquid Treasury bonds. And there wasn’t enough liquidity in the system to sell cheap, and when Celsius started to come under pressure, you saw what happened to the staked ETH.

Raoul: Like trading spreads, it works. I think it works well, this is where liquidity risk needs to be priced and Stake ETH is the only place to get liquidity.

SBF: Yeah, it does, but I think one of the interesting things is that I think the impact on Staking ETH, I think it’s a lot bigger than people think. If you just look at the graph of Stake ETH vs ETH over time, I don’t think it looks like a valid market graph.

Over the course of the year, everyone assumes that Stake ETH should be based on ETH plus or minus 10 basis points. Then all of a sudden, on the same day, everyone realized that the number of discounts might not be zero. Everyone realized it didn’t need an anchor, and in one day, it was down 2%. Then a week later, it dropped another 2% in one day. So, I think that’s also part of what’s going on.

Raoul: So liquidity is the reason everyone is mispriced. However, I’d really like to see what the ETH 2.0 unlock will bring, because I even looked at how the market pricing of Solana staking yields versus potential ETH staking yields? It looks roughly priced right because you’re basically saying, well, Solana is a tried and tested protocol, but it’s more volatile, so the yield should be slightly higher. Works perfectly. Like, well, I think it’s going to be a big unlock for people.

SBF: I think that’s right. I think it touches on another interesting point, which is what has a market. There are many cases in the crypto space where there is a weird assumption that there is no market for something, and people sometimes don’t make it clear.

But we talk about assets that are frozen, like often assume assets are locked up and have no market, so cannot be sold or replaced in any way, and treat them as incremental rather than interest rates. I think we are starting to see stETH. In other respects, this assumption has become loose.

Talking about Solana’s Mobile Phone

Raoul: I’ve been following the Solana phone, what do you think?

SBF: Yes, I think it’s a huge opportunity. I think having a native Web3 phone will help most people get into the Web3 world. Now, if you want to use DeFi apps on your phone, it’s very difficult for the average person. So I think having a seamless wallet experience on mobile is actually a huge leap forward.

Raoul: Yes. And we’re still in a world where you have to have different wallets for different things, which is crazy. It’s not how the world works, and we don’t care. But I can see it coming. I think the breakthrough in mobile is huge. I think Web2 integration will be huge.

SBF: Yes. totally agree.

Talking about whether the market has bottomed out

Raoul: So, one last question. Where do you think we are now in this bear market?

SBF: I don’t see any particular reason why we can’t be at the bottom. I’m not saying we’re definitely at the bottom. But I think the liquidation that had to happen has happened. And I think if you’re seeing some reversal in general risk asset pricing right now, which I think is good, go with the flow. And I don’t think there’s anything directly stopping tomorrow from being the day when the recovery really starts.

Of course, good things will happen tomorrow, that’s just an assumption. If something bad happens tomorrow, it will be worse. So I’m not even sure I’m making a symmetrical statement between the upside and the downside right now. Obviously, I’m not giving financial advice.

Raoul: No. I have the same opinion. I think the macro economy may have changed and we’ve moved from concerns about inflation to concerns about growth. Of course, we move lower, and more excess liquidation comes from general market concerns. But in general, I think big things have happened and we usually have some instability before we get some stability. The macro background is changing and it feels like it’s in the right area.

SBF: Yes, I totally agree.

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