ValueWalk’s interview with Dmitriy Berenzon, a Research Partner at Zenith Ventures. In this interview, Dmitriy discusses his and his company’s background, investing in early-stage cryptoasset and equity projects, realizing the ideal use-cases for blockchain technology, valuing new currency or asset like bitcoin, if bitcoin will replace cash and gold, a moat of liquidity for Ethereum, if Libra is a crypto or a money market account, if FedNow Service have any impact impact on cryptocurrencies, if SEC is doing the right thing with crypto regulation, and not taxing crypto purchases under $10.
Can you tell us about your background?
My career has largely been at the intersection of finance and technology. I spent six years at Deutsche Bank across multiple corporate strategy and innovation roles, which gave me a unique opportunity to work with emerging payments, big data, artificial intelligence, and blockchain technologies. I went all-in on blockchain during my MBA at Berkeley, where I became a consultant with Blockchain@Berkeley, co-founded a cryptoasset portfolio management startup, and worked for a top-tier cryptoasset investor. I joined Zenith Ventures in June 2019 to lead research and due diligence for the fund.
Q3 2019 hedge fund letters, conferences and more
When did you start your firm and what does it do?
We started Zenith Ventures at the beginning of 2019 to invest in blockchain ecosystems, including the digital assets that power them, the infrastructure behind them, and the businesses that build on top of them. We invest in base layer protocols, cross-chain middleware, and applications across various consumer and business-focused verticals.
What services do you offer?
We invest in early-stage cryptoasset and equity projects, backing the top technical teams and helping them bring their ideas to market and raise follow-on funding. We aim to be a thought partner for our founders. This includes working with them on their business models and go-to-market strategies, providing industry insights, and making connections to subject matter experts in our network.
What trends are you seeing with blockchain is it just a hype word or does it solve any pain points businesses have?
I certainly do not think it is hype, but it is also not as universally applicable as many people think it is. There are two ways I look at blockchain technology. First, can blockchain solve pain points for an existing business? Second, can blockchain create new applications and businesses that were not previously viable?
In the first case, I think there are a select number of uses that make sense, primarily in transparency and cost reduction. Supply chain is a good example — businesses lose millions of dollars to counterfeit goods and having the ability to track the provenance of goods along the supply chain will benefit both businesses and consumers. That said, enterprises move at a slow pace so it will take time to see these solutions deployed at scale. The last few years have seen a large number of pilots from a growing number of companies from around the world, but a relatively small number of those projects are live in production today.
In the second case, we are still trying to realize the ideal use-cases for the technology, but I do think it will involve a cryptoasset because it fundamentally represents value. Let me offer this framing: if we look at the early days of the internet, we did not hear people saying "I wish I could watch an online video of how to fix my car,” nor did we hear internet startups saying “people want to watch videos to learn to do things.” Even if they were, the internet was not a place to do that, given the hardware, software, and bandwidth constraints. It took decades of infrastructure, services, and customer development to build YouTube, which has 1.9 billion monthly active users and is responsible for 37% of mobile internet traffic (source: Statista). It is important to recognize that the atomic unit of the internet is data; we have simply developed a way to create, transmit, and represent data in a way that provides value to end-users. By that analogy, I think the atomic unit of blockchain technology is value. The use-cases here will be around creating, transmitting, and representing value to end-users. We are already seeing this today with the rapid innovation of blockchain-based financial infrastructure that allows users to create, exchange, invest, and borrow value. As such, perhaps the need that blockchain will one day address is "I wish I could store in an asset that’s not my country’s sovereign currency” or “I wish I could access financial services without a bank account.”
How do you value a new currency or asset like bitcoin - how do you decide if you want to buy, sell or hold it?
I would first ask why we think the U.S. Dollar has value. Since we have abandoned the gold standard, one could argue that fiat money today is backed by nothing more than peoples' trust in the U.S. government and its military strength. Similarly, with bitcoin, people have their own subjective reasons for ascribing value.
That said, there has been more academic rigor applied over the last several years. Let me provide one basic example using the “store-of-value” approach, which regards bitcoin as “Gold 2.0”. For valuation, if the world’s total value of gold is about $8.3 trillion (~190,000 metric tons at $43.5 million per ton), then each bitcoin should be worth about $395,000 given the fixed supply of 21 million bitcoin. This assumes that the store-of-value market remains the same and that bitcoin is a perfect substitute for gold. A related approach is to ask what percentage of the gold market you expect bitcoin to capture. If you believe it is 5%, for example, then each bitcoin should be worth about $19,800. There are many more approaches being used, such as the equation of exchange (MV = PQ), options theory, relative pricing models, and even variations of discounted cash flow models. I expect these approaches to be tested and hardened over the next several years, which will be important for institutional investors.
What about Bitcoin alternatives like gold and cash?
I believe that bitcoin is more like gold than cash because people will not want to use a deflationary, volatile asset as a medium of exchange or unit of account. In more colloquial terms, why would people want to spend an asset that they think will go up in value? I think there will be other cryptocurrency alternatives to cash that are price-stable, but they have a long road ahead to gain merchant and consumer adoption. For Bitcoin specifically, I think it has found relative product/market fit as a "Gold 2.0", and this will likely be the case for the next several years unless we see a dramatic increase in merchant adoption of bitcoin as a payment method.
Why about ether and other big cryptos?
I think that 95% of cryptoassets, big or small, do not have any significant usage or utility. That said, I am excited about Ethereum for two reasons: its developer community and “open finance” applications. For the first, we have seen that the vast majority of blockchain developers continue to build on Ethereum. Ethereum has about 1,200 monthly active developers while Bitcoin has about 300 and all of the other “big cryptos” have under 250 (source: Electric Capital). Furthermore, Ethereum had seven hackathons in 2019 with thousands of attendees from around the world, which creates a competitive moat of code and community that is incredibly difficult for other crypto projects to replicate. In terms of applications, I think Ethereum has hit a critical mass around permissionless financial services. For example, of the 203 projects listed on defiprime.com, 186 of them are built on Ethereum. There is currently around $650 million of value locked within these protocols (source: DeFi pulse) which also provides a moat of liquidity (no pun intended) for Ethereum.
Big talk about Libra: many saying it's just a PR stunt. What do you think?
I definitely do not think it is a PR stunt. It is an important project that has the potential to bring millions of people into crypto. That said, I think they could have approached their PR effort in a more measured fashion which would not have provoked such a negative reaction from regulators. Despite the bad press, Facebook signed 21 out of the 28 council members and they are continuing to build the network to comply with regulations. If they do manage to make regulators happy and launch the network, I think it will be the “Netscape moment” for the blockchain industry.
Is it really a crypto or more like a money market account? How would Facebook make money off of it?
It is not a cryptocurrency in the traditional understanding of the word because it does not use a blockchain as its underlying data structure. It is also not a money market account because the assets are not used for short-term borrowing and lending.
Libra’s design is actually similar to that of a currency board, which is a monetary authority that maintains a fixed exchange rate with a foreign currency. A currency board issues into circulation local notes and coins that are anchored to a foreign currency, referred to as the reserve or anchor currency. The anchor currency is a strong, internationally-traded currency (e.g. USD) and the value and stability of the local currency are directly linked to that of the foreign anchor currency. The most prominent example today is Hong Kong, which operates a currency board known as the Hong Kong Monetary Authority. From 1879 to 1933, the U.S. also maintained a special case of a currency board where the value of the U.S. Dollar was linked to the value of gold instead of a foreign currency.
Libra is not a 1:1 peg to any single currency, however. Instead, it has a floating exchange rate based on an underlying basket of assets. In this sense, Libra resembles Special Drawing Rights (SDR), which is an international monetary reserve currency created by the International Monetary Fund (IMF) in 1969 that operates as a supplement to the existing currency reserves of IMF member countries. It is essentially a synthetic reserve asset that’s built from a basket of fiat currencies. The SDR basket is reviewed by the IMF every five years and currently consists of the U.S. Dollar (41.73%), the Euro (30.93%), the Renminbi (10.92%), the Japanese Yen (8.33%), and the British Pound (8.09%).
The two ways that Facebook will earn money from Libra are interest income from the low-risk securities, and through growth of Facebook’s ecosystem (e.g. marketplace, WhatsApp) which will directly benefit from a native cryptocurrency.
What is the Fed real-time payment system it plans to develop is this competition to any of the cryptos?
It is an around-the-clock real-time payment and settlement system, called the “FedNow Service,” in the United States. For context, it currently takes up to five days for a check to clear, so this would certainly be an improvement for many consumers and businesses. I think this is moreso competition for larger banks who already operate private infrastructure for real-time payments. I do not think this has any meaningful impact on cryptocurrencies as they are used today because none are really used as a medium of exchange within the U.S. and they currently provide the most utility in high-value cross-border transactions.
Do you think the SEC is taking the right approach to crypto regulation? What could they do better?
I think the SEC has received a lot of pushback from the industry, but I think it is doing the right thing. Regulators operate with consumer protection in mind, and what happened in 2017 was not good for consumers. The SEC has provided increasingly greater clarity with their various rulings on Kik, Props, Blockstack, EOS, and Telegram, and I think regulatory clarity is the main ask from projects operating in the U.S. They are not saying "please let me sell unregistered securities to the public," but rather "please tell me what constitutes an unregistered security so that I could plan my business accordingly." That said, I do think the SEC needs to move faster. We have already seen many entrepreneurs either leave or avoid the U.S. and we are at risk of losing our position as innovators and thought leaders.
How do crypto regulations impact those managing money like yourself?
We need to be conscious about where the most promising projects are building and be comfortable in evaluating and investing in teams outside the U.S. We’ve met many talented teams from the U.K., Germany, and Korea, for example, which is a testament to the global nature of the industry. At the same time, we need to be cognizant of the regulatory risks and not invest in projects that have not put sufficient thought into how to remain compliant across jurisdictions.
What about FINRA and the CFTC?
The CFTC has also provided helpful guidance around what's under their jurisdiction and how it classifies Bitcoin and Ethereum. For example, in 2015 it issued a ruling against an unregistered bitcoin options trading platform and classified bitcoin as a commodity that is covered by the Commodity Exchange Act. In October 2019, it confirmed that Ether is also classified as a commodity.
I think FINRA is different because it is a self-regulatory organization for broker-dealers and thus is only responsible for regulating and licensing broker-dealers, whereas the SEC and CFTC oversee the broader markets. That said, I think FINRA needs to move faster on approving or rejecting broker-dealer applications, since companies currently need to wait months for a response.
I would not tax crypto purchases under $10. I think the IRS is doing a disservice to crypto adoption by not creating an exemption for transactions below a certain threshold — imagine having to pay taxes on your coffee purchases. It doesn't make sense. If we want consumers to use this technology, we need to make the regulatory environment more conducive for them to do so.
