“Bitcoin-backed Dollars” and How the Blockchain could Enable a Billion Unbanked to Enter the Middle Class - Patrick Dugan Interviewby Allen Scott @ 2014-07-03 04:35 PM
Out of Argentina, Patrick Dugan is the CIO of Crypto Currency Concepts, a company founded by a team of Americans and Argentines across various backgrounds that is looking to transform financial markets with the blockchain, cryptocurrencies and other new tech.
Patrick's experience in start-ups, automated Forex trading, social game design and ecommerce lead him to see the opportunity in automating cryptocurrency liquidity.
The CoinTelegraph had the pleasure of interviewing Patrick Dugan who shared his thoughts on everything from cryptocurrencies in Argentina to world financial systems and detailing what his company has been working on in the past few months.
CoinTelegraph: What type of work have you been doing in cryptocurrency algo-trading? Has your company developed any innovative trading platforms?
Patrick Dugan: My co-founder and I just spent the last 4 months building a tech stack for automated trading that is competitive with major hedge funds, though we're glad to be early. We can trade with high-throughput across multiple exchanges in real-time, and we can do market analysis on historical data the way Wall St. pros with Bloomberg terminals can slice up data to study correlations and make their own indicators.
The most innovative edge in that regard is, our data-base doesn't just include price and volume, it also includes snap-shots of market depth going back about a month in the hot DB (long-term storage via Amazon Glacier), which allows us to study the nature of other high-frequency algorithms and the correlation between order-book activity and actual price movements in different contexts. Soon we'll start publishing charts and analysis at c3.vc
CT: You recently stated that you’re planning to allow general Bitcoin holders to invest in a market making fund and create “Bitcoin-backed dollars” later this year. Could you please elaborate?
PD: Using a crypto 2.0 protocol like Counterparty and Mastercoin, we're going to have addresses where someone can send Bitcoin, and they'll receive Participation Receipts in a fund based on the most recent Net-Asset-Value of the fund. The receipts will receive a payout whenever the fund reaches a new high, 15% of the new profits go back to the investor, 15% goes to us as a performance fee, and the value of the Receipt is now higher because our NAV went up.
We'll charge no management fee, though we will earn some profits trading in the secondary market for these receipts, so if people want on-demand liquidity to get in or out with a click, we'll offer a tight spread.
The purpose of the Remittance Market Maker fund (RMM) is to turn-over as much volume as possible 24 hours a day, 7 days a week, between the USD markets where we'll be running inter-exchange arbitrage, and the minor-fiat markets, so people can buy BTC with dollars or Euros and then send it to their family members in other countries, for a total cost of under 1%. This is the promise of Bitcoin but it can't be fulfilled if these markets remain illiquid and volatile.
The dream is that people can send tokens representing fiat-currency, redeemable for BTC, using the blockchain technology, but without taking risk on the price of Bitcoin tokens. Later this year, work I've done for Mastercoin may facilitate decentralized futures markets for BTC/USD and a host of other markets. If you take 1 bitcoin, put it in escrow (like gold in a bank vault, but the vault is governed by code instead of legal contracts) and then you add a rolling short contract to hedge that 1 bitcoin, you can automatically issue a number of dollar coins at the execution price of that futures contract. I sell short 1 BTC @ 650, backed by 1 BTC; it's almost like I sold 1 BTC on an exchange for dollar deposits, but these dollar deposits live on the blockchain and are mobile.
When non-technical people can save or make payments fixed in a liquid, low volatility currency in the dollar, but backed by Bitcoin, we'll have decentralized banking and begin to see the mass adoption phase for cryptocurrency. As BTCs are shorted and held in reserve to create the hundreds of millions and then billions of dollars in balances that customers will need for personal and business use, the supply of BTC on the open market shrinks. This usually has a positive effect on price.
“When non-technical people can save or make payments fixed in a liquid, low volatility currency in the dollar, but backed by Bitcoin, we'll have decentralized banking and begin to see the mass adoption phase for cryptocurrency.”
Then those reserves addresses the need to roll their short contracts, so we'll see a strong correlation between Bitcoin price and the total USD value of decentralized deposits. If a billion people have an average balance of $100 USD stored on the blockchain, the value of all Bitcoins would have to be 2-5 times that hundred billion dollars, which would put the price of BTC above $10,000. That's the bull case.
The bear case is, maybe the structural problems in Bitcoin derail it before then, and another currency takes its place. Either way, the aggregate value of cryptocurrencies, currently under ten billion dollars, will have to rise 10-40 times over the next few years as mass adoption with fiat-pegged tokens gets underway. We want to be a major liquidity provider in this process, and provide nice but stable returns to investors.
CT: Given Argentina’s active BTC scene and strict capital controls, would you say that the country is a perfect breeding ground for Bitcoin and crypto 2.0?
PD: It's like that Economist article said, if it can't make it here, it can't make it anywhere (http://www.economist.com/blogs/schumpeter/2014/06/bitcoin-argentina). I live in System D. I get my cash after I click the dealer bitcoin, usually at a 5% cost, too high. I've tried to figure out a way to cycle cash so this can be cheaper, perhaps even offer an arbitrage profit, but the capital controls leave one option: cultivate internal demand.
Argentina has well over 100 billion in physical cash literally under people's mattresses. That's dead money, earning -2% a year (USD monetary inflation is 10% a year, but the US economy is Japan on steroids so CPI is only 2%) the Argentines think they're holding green gold, the joke is on them as the US government is only a more fearsome and successful version of the Argentine government.
Imagine what will happen if the everyday Argentine can buy digital USD at a 1% discount, and then put it in foreign banks, or better yet, invest it in the emerging ecosystem of funds like ours, or crypto-securities backed by real assets like rental properties and farmland. Shorter term, the benchmark is to get burgoise Portenos (residents of Buenos Aires) carrying around a petty cash balance in their Android phones so they can pay their bar tab with a discount.
We see profit potential in providing a market-maker quote to these users for trading into other things, but we're also ideologically motivated to see this place go from zero to hero over the coming years. We know a network of merchants, cash dealers, and of course, local start-ups, all the kindling is in place to light this fire, I suspect after the peso devalues further in the aftermath of this Paul Singer-induced bond fiasco, the spark will be struck.
Kyle Bass thinks this place will offer the best investment returns for the next 3-4 years, and he's not even tuned into the possibility that folks like us will be underwriting a trillion dollars in real asset securities bought with cash at firesale prices.
CT: Do you think Bitcoin is better suited than fiat when it comes to addressing the System D economy? Can Bitcoin bring that segment of the economy above ground and increase transparency?
PD: I don't think poor people trading bitcoin for daily business makes much more sense than doing so with shavings of gold, but local or foreign currency-pegged tokens are going to enable a billion unbanked people to enter the middle class via System D merchant activity. Beyond the Southern Cone of South America, East Africa and SE Asia are very interesting zones to watch.
The big investment theme for the next 10 years, we believe, will be the rising differential between formal-economy GDP growth and shadow-economy growth. I think System D, as a global agglomeration of untaxed, unregulated activity of the next billion people to enter the middle class will grow an average of 5-7% a year while developed nations do between -.75% and +2% growth. You compound that for a decade and you're living in a different world.
So now you've got a public ledger where these petty profits of all these millions of emerging merchants could be analyzed. Maybe they'll choose a blockchain like Monero's, keep that private; but even with bitcoin there's a cost/benefit analysis to be done on going after these people for the unpaid $500 a year. This may put governments that are less equipped in terms of data-analytics and coercive force in a position where public spending really requires public support, because 50% of your tax revenues are paid on a voluntary basis, with no bank account to lien.
Most likely NGOs will become the major political force in many localities. Whatever your thoughts on that ideologically, you don't want to be in government debt earning a negative real yield when you could be exposed to the great economic story of the early 21st century.
CT: Besides the BTC Market Making Fund, the Alt-coin Tactical Rotation Fund (ATR) is also on the slate. Could you explain how this will work?
PD: The second fund we will release will have its price denominated in BTC, so people can see how much they are out-performing Bitcoin, while RMM will be priced in USD because the goal there is protection of capital. These alt-coins are so volatile and so illiquid, they can provide huge out-performance to BTC (which already outperforms the QE-pumped S&P 500 by an order of magnitude) - but the risk is proportional.
The only sensible way to approach them is to filter, and then have some limited trading volume to take advantage of the 5-20% daily volatility, while accumulating a position and cycling that position into other fundamentally promising coins in the portfolio while one is out-performing.
Only when you see significant adoption, which will ultimately mean integration into a crypto 2.0 platform and the ability for people to use the coin as a reserve commodity for fiat-pegged currency, do you start to concentrate your eggs in a single basket. We're calling it the Altcoin Tactical Rotation Fund.
CT: Bitcoin’s price has a strong impact on the incentive for miners, users and investors. What market cap does Bitcoin or any other coin need to reach in your opinion to really make its presence felt in today’s global economy?
PD: To be brutally honest, I don't think there is a price level where Bitcoin becomes permanently "safe". The structural "problems" in Bitcoin (capital "B" connotes the mining security paradigm) require that Bitcoins go up at least 23% a year to keep up with the block reward halving, multiplied by the increase in difficulty, divided by the $/GH gains made by large players investing in mining CapEx in scale.
That means BTC needs to go up about 5-10x a year. I'm not bullish on BTC beyond the next 3-5 years, I would liquidate in the 15-20k price range and happily be underweight the next 80k, should nothing come in quickly to supersede it. That's a 30-40x return in a few years, but a balanced altcoin portfolio may do significantly better.
A positive counter-example might be something like Tendermint (http://tendermint.com/), which aims to do proof-of-stake in a game-theoretically viable way. The idea there is that stakers need to put up a bond, creating a situation where the network becomes exponentially more expensive to attack as the number of participants increases linearly. Experiments like that are why the alt-coin markets are so important.
Despite the Austrian fervor around limited money supply, having a flexible stock of transaction credit really is essential to dynamic modern economies. I'd rather have low inflation than high transaction fees. Those interested in learning more about this bear case for bitcoin should read this paper (http://cryptome.org/2014/05/bitcoin-suicide.pdf).
I realize this is somewhat gloomy way to end an otherwise optimistic interview, but my job as an investor is to know what I don't know and allocate accordingly.
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