Join Delphi Research today and immediately get access to our full Member Portal!
Join Delphi Research today and immediately get access to our full Member Portal!
Back

Crypto Venture Capital Series Ep. 3: Michael Jordan of Galaxy Digital

Jul 16, 2021 ·

By Tom Shaughnessy

The Delphi Podcast Host and GP of Delphi Ventures Tom Shaughnessy sits down with Michael Jordan, Vice President at Galaxy Digital, a diversified financial services and investment management innovator in the digital asset, cryptocurrency, and blockchain technology sector. The two discuss types of investments, adding value to portfolio companies, token economics, and more.

Every Delphi Podcast is dropped first as a video interview for Delphi Digital Subscribers. Our members also have access to full interview transcripts. Join today to gain exclusive early access to every new interview before it’s published.

Resources:

More

 Music Attribution:

 

Show Notes:

(2:42) First Question: Michael’s Intro and what does he do at Galaxy.

(6:27) Michael’s thoughts on traditional funds getting access to equity deals in crypto.

(9:33) Differences between crypto equity plays today vs. a couple of years ago.

(12:04) Whether projects like the OpenSeas, the Fireblocks to IPO in the NASDAQ or decentralize the community in some way.

(16:40) Michael’s thoughts on party rounds vs. Galaxy taking all of a deal.

(22:38) Retail vs. Institutional / what they see when they look at a project.

(24:41) Michael’s thoughts on the value flows between the equity and the token.

(29:19) Are we going to go completely crypto native with tokens? / will the stock exchange go away? / Michael’s thoughts on old traditional financing methods and where we’re going with crypto.

(32:09) Founding teams / the spectrum of due diligence Michael does on a founder / how Michael diligences founders on the qualitative basis.

(39:00) What Michael thinks is the most important sector within crypto to invest in – from a retail perspective.

(41:06) Michael’s advice on diversification versus concentration.

(43:54) The best advice Michael’s ever gotten.

Interview Transcript:

Tom (00:02):

Hey, everyone. Welcome back to the third episode of our VC Series. I’m Tom Shaughnessy. I host a pod. I help run Delphi Ventures. Today, I’m joined by Mike Jordan, who is Head of Investments at Galaxy. Mike, how’s it going?

Michael (00:15):

Good, Tom. Thanks for having me. Appreciate it.

Tom (00:17):

Mike, tell us a little bit about yourself and about what you do at Galaxy before we dive in.

Michael (00:22):

Yeah. So, I’m one of the Galaxy OGs. I’ve been here since we started. Back in the day, Galaxy was a hedge fund. It turned into a crypto hedge fund. At the time, I actually came to build out our software. A lot of the stories you’re going to hear in today’s conversations about what starts as a retail asset class and what happens when people start trying to run strategies that are more complicated and complex than normal, my first job was to come in and build all the software to do that.

Michael (00:48):

So, like any good crypto investor, we’ve got some great war stories like when we accidentally bought a bunch of Bitconnect, because we bought BCC. It turns out what we thought was Bitcoin cash on Polo was actually Bitconnect. So, there’s some great stories from trying to run more complicated algorithmic strategies at institutional firms. So, we have some good war stories there.

Tom (01:14):

Is that still a thing at Galaxy, those crazy algorithmic type plays, or was that the beginning? How did that go?

Michael (01:21):

Yeah. So, everyone’s constantly exploring these market neutral strategies. They tend to be pretty quiet because they’re capacity limited. I know a lot of outside investors have asked us for, “Hey, I assume the volatility of the asset class suggests a really interesting delta neutral strategy.” Unfortunately, nobody wants to talk about them. They generally don’t take outside capital. So, we do a lot of research often in bigger conferences, that would come out of a research group, of signals group. So, we certainly research them. We don’t have any external products today that investors can think about, but I would say there are five to six really high quality, stealth, market neutral competitors out there.

Tom (02:05):

I like how they’re all stealth. One thing that’s cool about Galaxy is your firm’s massive. You guys are not capital constrained, at least in my opinion, especially with your network. Does that change the level of investing that you guys do, because it’s very different from a retail or an early VC side?

Michael (02:22):

Yeah. So, capacity is such an interesting question, because it’s changed. In even one lifecycle, venture funding changes, right? So, when the Paradigm first went to market with this, it felt like a superfund, right? I think at the time, it was $400 million. Bitcoin was at 6K. A lot of LPs, the investors in the venture fund, looked at Bitcoin as a venture bet. So, I think the question in crypto VC land right now, specifically at the LP level, is, “Is Bitcoin still a venture appropriate? Can it get that convex return? Can it do it in size?” Generalist venture is not a homogenous single bucket, right? There’s growth that’s looking for 3X to 4X return. There’s more seed and series A that’s looking for the 10X return.

Michael (03:10):

So, previously, the only asset that could take real AUM and not be capacity constrained was Bitcoin, but the emergence of 2020 and 2021 was the story of things like Solana. You saw that $340 million fundraise that looks like a growth round. I don’t know about you, but every big growth venture fund in the world has called us and said, “Hey, we want to look at your series Bs, Cs, and Ds. We want to put 50 to 500 million bucks in these companies.”

Michael (03:37):

We say, “Our investments don’t raise series Bs. They’re networks. They launch. They do seed and series A and then the retail participants come in that general users of the network are providing value to start to own and operate.” So, that is a really big shift in the general capacity question in the general venture landscape. So, we are starting to see the manifestation of that in 2021. I think it’s a really exciting thing for the general investor.

Tom (04:03):

Mike, that’s a really good point in that traditional mega funds, pension funds can’t actually get access to a lot of these deals, because they’re just not raising on that level. In your opinion, is it just, “Let’s leave them behind,” or are these guys taking half of that Solana deal? How does it work?

Michael (04:19):

Yeah. So, the biggest thing to understand is venture math works via convexity, right? You have a lot of losers. A lot of people probably heard this that your winners have to pay for your losers. So, if you’re going into market and you’re buying Solana… I’ll use Solana, because it’s a canonical example of a recent large raise. … the challenge is you have to factor in enough upside, so 5 to 10X in that token price to pay for the other nine Solanas that don’t turn into Solana that don’t work. So, what we’re starting to work on is, I think, [Uma 00:04:51] is at the very bleeding edge of this. You saw this with their range token last week.

Michael (04:55):

They did their own treasury diversification using a range token. The range token is the concept of you have a Dow and the Dow has a treasury. What’s the most useful thing to do with it? There’s a lot of questions around that. One of the things you could do is you could sell it to a growth fund or a venture fund. That venture fund should say, “I believe in your project. As a venture investor, I’m going to make your project worth more. How am I going to do that? I’m going to connect you to whatever my network is. I’m going to market. We’re going to provide developer talent. Whatever those things are that are limiting your growth, we’re going to provide that.”

Michael (05:28):

So, as a Dow starts thinking about, “Who should I sell my tokens to?,” we’re starting to see new constructs emerge. So, I don’t know if you’ve seen this, but we think that there’s a lot of innovation to be done at that level, which is as these things go from bootstrapped to growth protocols, what does the financing of them look like? What does the financing them look like at scale?

Tom (05:49):

Yeah, no, we were in the Solana deal for disclosure. I agree on having inactive treasury. I think Joel Montenegro champion that too, the efficient treasury. But going back to your point, though, you don’t have nine other Solanas for these funds to do, right? You only have one. So, that you really can’t run that strategy, where they’re taking the 10 Solana bets of $50 mil because they just don’t exist. They have to go this route that you’re talking about, which is about buying part of the treasury, I guess.

Michael (06:15):

So, there’s that on the token side, which is a great point where there just isn’t that much capacity. There are not that many top 10 coins that can absorb $50 million checks, but on the equity side, we’re seeing all those rounds priced in the billions very quickly. So, that’s the OpenSeas of the world, Fireblocks, Sorare, Genesis. These are bread and butter enterprise SaaS, OpenSea, maybe not, but these are bread and butter enterprise SaaS companies that a generalist venture fund can come in and look at and say, “I understand the growth metrics, the churn, the margins. I understand what the customer base looks like. I can think through the TAM.”

Michael (06:50):

That’s where we’re seeing really aggressive round after around, three, six-month fundraises. There are board seats. There’s serious secondary transactions in these things. So, a lot of that has leaked into the private equity side of the crypto market, which is really picks and shovel infrastructure.

Tom (07:09):

No, your equity comment is awesome. Our VC fund’s only a year old. We don’t do a ton of equity plays. Can you give us some color on the difference between crypto equity plays today and a couple of years ago? Because a couple years ago, they all seemed like cash grabs for Wall Street, but nowadays, you’re getting stuff like OpenSea and Fireblocks, which are extremely legitimate companies.

Michael (07:28):

Yeah. So, we think of it there’s three structures that we invest in. We think of enduring equity, which is just like a traditional public equity like Coinbase, where you invest early stage. It looks like any other FinTech cap table with the type of investors in need. You need hiring. You need capital. You need connections, those type of things. You underwrite those compared to the rest of the FinTech market with a really strong beta, right? How fast is the market growing of crypto? So, that’s number one. We’ll talk about how we think about the growth factors of each. The second one is this hybrid model that’s very crypto native. That came out of the Compound and Uniswap vintage of the world, which is you first finance equity.

Michael (08:13):

The equity builds a lot of the network. There is a few different relationships between the equity and network. There’s difference with legal structures, compensation structures, financing structures, treasuries. They both generally have their own treasury. You have an equity treasury and a network treasury. They’re used differently. The governance is different. So, that’s this hybrid model where there’s a relationship between the equity in the network and the network’s treasury. The last one is the most crypto native like the Wi-Fi’s of the world where you go network first. You capitalize in network via some type of fair launch or crypto native mechanism. That’s the one where VCs have candidly just been second place.

Michael (08:55):

Our big thesis about crypto is you haven’t got paid to be early. That’s a big misconception, right? You can wait for Bitcoin to launch. You can wait for Ethereum to launch. You could wait for things like RUNE and Wi-Fi to launch. You can get your hands on them. You can use them and understand what they’re good for, why you can identify with them. You really participate in a lot of economic growth.

Michael (09:17):

We believe that that’s what makes crypto people part of the community. They get in early. They see what it is and they participate in the growth. They certainly identify with it. They start to say we. They don’t say they. The pronouns and prepositions with which people use to describe things are what real communities are built around. So, that’s how we think about these three structures.

Tom (09:40):

Damn, I never thought about that dealer and the pronoun side. That’s awesome. Just going back a little bit, I’d love to get your take on the equity side and the hybrid side. On the equity side of things, do you expect the projects like the OpenSeas, the Fireblocks of the world to actually IPO in the NASDAQ? Are you seeing these as projects that will ultimately decentralize the community in some way?

Michael (10:00):

I think you’ll see both. I think in some projects, you’ll see both. So, for people who don’t know, Fireblocks is the custodians that most of what’s called the dealer network when you hear OTC. Some people use this a dealer network. That’s people like Galaxy, Genesis, Jump. These are people who provide liquidity to exchanges into people like miners with constant liquidity needs and financing needs. So, Fireblocks is this high velocity, high turnover custodian network. It’s funny, most retail don’t know what it is, because there’s no reason. They’re used to using MetaMask. The MetaMask for institutions is called Fireblocks and most people use that. They make money by selling software as a service. We pay them.

Michael (10:42):

Most people pay something between $10,000 and $100,000 in a very structured contract. That looks like any ARR business I’ve ever seen. So, that equity endures that way. You can underwrite it. A person like Sequoia or Benchmark really understand that business model well. So, that’s an enduring equity that you would expect to go through a traditional IPO on NASDAQ. Like Galaxy, Galaxy is a much more centralized equity business. What’s interesting about Fireblocks specifically and I think it’s a great example is it’s actually a network, where it gets better the more people that use it. If Delphi and Galaxy are both on Fireblocks, we get better than network performance. We get insurance on our transaction.

Michael (11:21):

We can get less confirmations, because we can control both of the wallets. You get identity discovery. You can use wallet turns without the operational risk of turning wallets, all these cool things. So, what may happen with Fireblocks is the governance of the network. The parameters of the network may move out into the participants to control it. So, that’s like what exit community at an enterprise level looks like. We have great analogs there. That looks like a CMEC. So, the Chicago Mercantile, there are seats that people own and they’re revenue shares. They’re the right to participate in the network. We think that some of these centralized equity exit to enterprise look like that, which are the network has shown itself. They’re active participants initially owning governance networks.

Tom (12:05):

So Fireblocks is an interesting opportunity, because that’s enterprise focus, major institutional focus, but let’s talk about an equity play like OpenSea. How does a company like that build a community within crypto when they don’t have a token for incentives or alignment, things like that?

Michael (12:23):

Yeah, this is the question of traction then token or token then traction, right? Uniswap and Compound famously went traction then token, right? They said, “We’re going to put out this public utility. Everybody wants to use it. The users will find a lot of value out of it, both on the LP side and the liquidity taking side. At some point, we think that those are the right people to own and govern our network.” So, that’s the traction then token model. I think that was proven out very well. And then you have the nuances of governance of that site. To your point on, “How does a traditional centralized equity start to think about exiting to the community?”, maybe we’ll point to something that didn’t go well like Clubhouse.

Michael (13:01):

I think Clubhouse for me was the first time I felt a non-participatory ownership model, where I was like… I was talking to Novo about this. We’re about to invite our entire network to this business. You could build Clubhouse in a month. It’s not really complicated distributed systems technology. Under the hood, there obviously is some, but it really felt ancient and retrograde. The first time, you’re like, “I don’t get any of this stuff. I’m bringing all my friends and a VC and a very small group of…” I think the team is 20 people, own all the upside in this. He had that visceral reaction where he said, “Okay, I’m not excited about sharing this.”

Michael (13:43):

So, we think that that is where this community driven exit to community will happen, which is… I don’t know. You guys have a really active community on your Discord or your Telegram. The moderators raise their hands and say, “I’m an active participant. I really believe in this.” They don’t work for Delphi, but they’re really as much a part of Delphi as the people who you pay every day. So, we think that that’s a lot of what happens. People raise their hand and say, “I love this stuff. I’m super active. I will be a moderator. Give me ownership of this, and I will participate anyway.”

Tom (14:15):

That’s a really good point. Yeah, I did my episode with Novo on Clubhouse as apartment. You’re right. We start to think, “There’s no buy in. There’s no ownership.” That’s a good segue, Mike, to another question just on sizing of these rounds. I feel like one VC taking an entire round just sends a horrible sign, because one, you’re not including other VCs, you’re not including your teams, you’re not including their communities. It’s really hard to build. To your point, it feels archaic. What are your thoughts on party rounds versus say Galaxy taking all of a deal?

Michael (14:48):

That’s a really good question. I think the fundamental question VCs are asking themselves today are, “Should we be the customer of these products and networks?” In traditional venture, this is a bit cynical, but you generally want to invest in people who don’t need you, who would work without your participation in success, right? These founders are so good, the market’s so strong. Not giving them capital, they’ll work without you. A lot of the story of crypto is, “Well, we need our investors to bootstrap our product,” maybe or it’s meant to be much more community driven and they need specific expertise that other places can’t get. So, you see people like Paradigm do a really good job of recognizing what the founders need, right?

Michael (15:30):

So, what they provide is security audit, mechanism design, research. Delphi does this as well, right? You say, “Hey, we really understand the mechanisms of games. We’re experts at Axie.” So, the question is, “How do you round out your cap table with the fact that you get to a point of diminishing returns from each participant, right? What is enough capital to make Delphi excited to really work on it and that you put all of your activity behind this?” At some point, it helps to get another group of people in that. So, that’s much more of an art than a science. I can’t say today. The tension is that our funds have gotten so big. The capital has gotten so big and the rounds don’t need that much capital. Defi is this incredibly capital efficient machine.

Michael (16:18):

There’s functionally no OPEX or CAPEX in launching a Defi protocol. You need to pay your employees. Most of them want ownership of the network. And then you launch the contract for 100, maybe 500 bucks during really bad gas times. Your user start paying day zero. So, the capital needs of these projects are pretty de minimis compared to its centralized equity that wears all that OPEX and CAPEX of the AWS bill and then they have to pass it on to their venture investor. So, that’s the thing we haven’t really squared, which these are very capital efficient structures and there’s so much capital being managed.

Tom (16:52):

Now, that’s a really, really good point, Mike. A followup question for you is just on the rounds are very competitive, they’re small, but there’s other things that you bring to the table on a value add side, mechanism design, token economy, et cetera. But one of the things that I feel like Galaxy has the unique ability to add to teams is your network and your ability to bring on capital is insane. So, maybe investigating a compound seed round, I don’t even know if they did a seed round, but just as an example, [inaudible 00:17:20] seed round or something like that. I have their shirt on, by the way.

Tom (17:24):

You might not be able to get a large portion of that deal, but you’re able to bring massive amounts of capital to these projects in that they can use to foster communities and grow their project. How do you think of that the dynamic between doing that and promising that but also getting a small round, because it’s two different investing opportunities there?

Michael (17:43):

Yeah, so we also do strategic investing. So, this is something that founders in the community should understand. When they’re talking to Coinbase or Galaxy or Gemini or Genesis, someone who has his other operational revenue generative business, there may be different ways for them to monetize an investment than a traditional asset manager. Often, that aligns you with the team, right? So, if you are taking Coinbase money, you would really like to talk to their custody team, their asset listing team, their security team, their diligence team. These are resources that are non-monetary but really valued at. So, at Galaxy, we have this very diverse global business with definitely a financial bent in terms of our background.

Michael (18:30):

So, what we often hear from teams is, “We’re building a decentralized derivative play. Talk to us about why use perpetual swaps and how you think about them, how you think about collateral management. How do you think about cross margining? How do you think about these things?” So, that’s the very simple value we can provide, but the way we capture value is also important for the founder to understand, because at some point, it may become antagonistic. It’s unlikely, but you should really understand our businesses. Let’s go more concrete than abstract. Something like Index Coop is an on chain asset management product. I know you guys are familiar with it.

Michael (19:07):

We just announced an investment in it. We have a centralized asset management business. We raise money for Bitcoin funds, Ethereum funds. We have an index product. There are different ways with which Galaxy’s TopCo equity generates revenue. That is, in theory, not in competition, because I really think right now, we’re in a value creation mode. We’re not in a value extraction mode as an industry, but the team should understand we may have a competitive product in market Index Coop, right? We may have an index fund and we’re going to make fees off of that. That model may be in your mind antagonistic. So, it’s really important when you start to think about the operational businesses in the space, how you think about it.

Michael (19:45):

Now, the really new one is the CMS, Alameda of the world or Three Arrows, which are very crypto native concepts of, “As Defi grew, these are the masters of the trade.” They understand the tools really well, because they are the right customer. They’re able to really help companies, but it’s not this traditional venture structure. So, the duration of the capital, the decision with which they make the hold themselves is different from a venture fund. It’s important that people start to understand how and why that works.

Tom (20:15):

Geez, Mike. Yeah, no, it’s a really good context that the team should really understand how you make money and what you can do beyond that, because a lot of ways to work together, incentives can get misaligned, stuff like that. I’d love to zoom back out and just think about the differences between, I guess, what retail sees when they look at a project, aping into new yield farm, looking at new code, stuff like that, versus the institutional angle that you see, because you’re in a unique position where you’re not some old firm in crypto trying to wait in. You guys are at the forefront, but on the flip side, you’re not exactly going to ape in the Sushi farm of last summer, even though Sushi is super legit. How do you think about that difference?

Michael (20:57):

Yeah. So, our challenge is your opportunity. I see that from a couple different lenses. So, institutions are regulated very tightly. We have so much brand equity and equity value at risk on anything we do that losing a marginal dollar could destroy a ton of value. So, if you’re a retail, it’s good to understand how the big pools of capital are thinking, because people have famously said this. Retail has front run institutional game. There are a lot of places that retail can play that we can’t for two reasons. [inaudible 00:21:30] $1,000 into a project. It’s just not a useful piece of our capital base or my resource. So, there’s a lot of really interesting 10X, 100X opportunities at the lower capacity that the big funds just aren’t going to be able to operationalize yet.

Michael (21:48):

So, that’s where most of the alpha happens. Now, the question is, “How many real projects come out of that pool?” There has been this nasty professionalization of crypto VC, where every real project, these people that are really high quality are able to raise so much money, so fast that some of the opportunities have dried up for retail. So, it’s important to understand, “What is the duration of the base in a project? What is the lockup?” There are these weird liquidity games people are playing today that retail is able to play between the launch and lockup. So, that’s this weird new shadow of institutional adoption.

Tom (22:30):

Mike, you mentioned earlier this hybrid model of having equity and tokens. I think most on the retail side, maybe on the more Defi, VC native side focused on the earlier stage things, they don’t want anything to do with equity, right? How do you think about the dichotomy between value flows between the equity and between the token? What would be your pushback to people in the space that say, “Equity is a joke. I would never want to get involved with a project that has both”?

Michael (22:57):

I would say, call me back in a year, because every year, we have this conversation. It feels like [inaudible 00:23:04] concept of flat circle. As we start to understand why a token will have terminal value, it is some type of economic surplus capture. The unclear thing is we all understand that that’s a precedent. The question is, When does it need to realize that?” So, a lot of the debate on token economics right now is, “Should we have dividends or not? Should we be distributing capital back to the participants as some type of fixed income type product, or is it insane for series C startups to be distributing capital and should really all go to growth?”

Michael (23:42):

So, the question is, getting back to your question on the equity side, “Who is creating that value? What is their incentive, enduring incentive to do so? How do you think about that relationship as an investor in the token?” The honest answer is everyone’s figuring it out. I have not sat down with an equity team that also has a token that can tell you what’s going on 18 months, because they just don’t know what the protocol is going to look like, what the market’s going to look like, what the competitors are going to do.

Michael (24:11):

Think about if you’re sitting in a Uniswap equity and SushiSwap launches, you no longer get to stick to your game plan. The market’s immune system has come out and said, “We want a token. We need to launch a token now. If you don’t launch a token now, we’re going to start the vampire liquidity.” So, you have this very weird market forces telling you what to do on your equity side when you have a token in market. So, it’s impossible to predict that far out.

Tom (24:40):

I like how you’re keeping it not vague, but that the projects can react in real time. I guess my question, though, for you to play devil’s advocate, if you have two OpenSeas, one with equity and one with equity and a token, it just seems like you’re sitting on the side of the fence, right? Because token holders are going to think, “Hey, I’m only getting 50% of whatever the revenue is. Why not just have a token?”

Tom (25:01):

But the flip side of that is if OpenSea were to give all their equity holders tokens, the denominator would just be higher, because you’re giving more revenue to just more token holders. So, that’s pretty much the same thing. Do you think that eventually, these projects should just make a decision to go to one extreme equity or one extreme token, or do you think that we will see very large projects that are both?

Michael (25:25):

The most successful project in the space in the past 18 months, in my opinion, is FTX, Alameda, the FTT Complex, right? What they show is that tokens can be very thinly sliced partitions of value in governance. So, FTT, for people who don’t know, is the exchange token of the FTX platform. What they did was they said, “You know what? We are the exchange for market makers, professionals who run tons of risk at scale. What we need to do is get them incentivized to use our platform. To do that, we’re going to launch this exchange token.” This exchange token is very application specific built.

Michael (26:00):

It’s not a representation of the most senior equity that sits somewhere else and that exists and that has some relationship, but what it allows you to do is really, with a scalpel, slice value, attribute value, and get it to the right people to use for the right portions. So, I think that’s actually the future. This happens in traditional markets, right? You can take a house and chop it into nine different layers of tax equity, of actual equity, the mortgage, ABS, all the stuff you can do with it. So, my gut is that the market leads towards more tokens, more slicing, and partitioning of value and not just this gross senior equity.

Michael (26:38):

The funny thing is when you look in traditional markets, Facebook’s equity actually has governance, right? Mark Zuckerberg controls Facebook. You can own a public equity. That doesn’t mean you have any say what happens at Facebook. You actually have more say what happens with FTT than you do with Facebook, which is this common misconception that these tokens are values. They actually can do things and affect the system you’re using.

Tom (26:59):

Now, those are really good points, Mike. I mean, FTX Complex has crushed it. Their ability to drive revenue while also attribute revenue to the token is awesome and then raise money on the equity side is super interesting. Not zooming out, but looking ahead, we’re talking a lot about the difference between equity and token structures. You’re also at a firm that is a large public company. A lot of people in the crypto space think the stock exchange, the NYSE, NASDAQ, they’re all going away. They’re artifacts. What would your pushback be there? Do you think we’re going to go completely crypto native with tokens? Do you think the stock exchange go away? How do you think about old traditional financing methods and where we’re going with crypto?

Michael (27:42):

So that’s the expensive question. Let’s talk more concrete examples of why things haven’t worked yet, why things have not disrupted the legacy markets. So, regulatory capture is a big one, right? Which is that large pools of capital have very strict partitioning, right? Defi right now is the most global and open it can be. At some point, you have to start to partition things based on the entities that participate. Galaxy can face certain people, retail can face certain people. So, you start to make each pool smaller based on the rules and regulations of the road. And then you have a question of actually, the product exchange is liquidity, right?

Michael (28:20):

So, you’ve seen BATS and all these other ATS, these new exchanges launch and they say, “We have better technology. We have fair execution. We have fundamentally a better platform from a technology perspective.” What they don’t have is liquidity price discovery and easy to use, plus credentialing. If you go public on NASDAQ, that says a certain signal to a certain set of investors that say, “Hey, you can call interactive brokers. You can buy every single type of share class in this asset you want.” So, what crypto is going to need to do is start to solve those problems, which is it needs brand name like durability. It needs to exist for a while and people need to feel comfortable that Uniswap will be there in five years, because this is a pretty classical thing.

Michael (29:11):

The longer it exists, the more likely it is to exist. This is something we talk about all the time. So, we have seen a lot more consternation on Wall Street around Defi and asset issuance and price discovery than we saw in Bitcoin, because they understand what Bitcoin is. They understand how to package it and sell it. It fits in their traditional model. This idea of, “What is internet native issuance, price discovery, and secondary transaction?”, that is something that scares them, because they understand that the most important thing in the world is providing a price for an asset. Because once you have a reference rate for an asset, you unlock trillions of dollars of value that you can do really profound interesting things with it. So, they start to realize that and they’re very interested.

Tom (29:58):

Damn, incredible answer. Definitely, going to have to rewind that. Let’s do it again. I love that take. Switching gears completely, because we have 20 minutes left, I want to switch to founding teams, how you get comfortable investing. What’s the spectrum of due diligence you do on a founder? If you could compare that to the due diligence you would do within your personal account in crypto to paint the picture for a retail user, that’d be really helpful.

Michael (30:26):

Yeah, so first thing we ask is, “Is this a newt new concept, or is it an expression of a concept people already understand?” So, a net new concept would be like when Phil dropped the Flash Boys 2.0 paper. It was understood, Flash Boys, the book, paper, but the whole idea of transaction, ordering and inclusion, everyone read that and said, “Shoot, I need to pause and learn because this is a new concept,” right? Versus when it’s an expression of an understood concept like C.R.E.A.M and Compound, we had already done the work the first time that we saw on chain money markets.

Michael (31:00):

So, whenever we see something, the first thing we do, we start to partition it. Is it a new concept? And then we do a lot of work. We say, “How does this work? What are the macro factors that drive it? How many people in the world know how to do this?” So, let’s say it’s a zero knowledge proof for example. We would talk to our references that say, “This is a really vanilla proof. There’s a lot of people that understand it. An undergrad comp scie person could probably build a deliverable version with not a ton of risk,” or “This is Halo or Sonic or one of these very new cartographies. You’re going to have to have a really world class team. Everyone should know their name, because there’s so few people in the world.”

Michael (31:37):

So, that’s how we start to go down this decision tree. Once we understand it’s a net new concept, we go down one decision tree. If it’s an expression of a concept we understand, then we go down a different tree, which is like, “Okay, well, what are the competitive pressures? What’s the moat? How do they think about it differently? Why does anybody care? Is the founder someone that people should believe in and start to work with? How much code have they shipped? Is this something that it’s Defi, you can launch with a 100K? Why haven’t they launched already?” So those are how we start to think about diligence. They’re very different qualitatively, but there are these two tracks that we pursue when we look at projects.

Tom (32:16):

How do you diligence founders on the qualitative basis? Does you not liking a founder personally sway your decision on whether or not to invest, or what kind of depths do you go to to look for passion, to look for buy in beyond money, beyond token incentives, beyond equity incentives?

Michael (32:31):

Oddly, our biggest mistakes have been where we just had personality conflicts with founders. There’s a fine line between conviction and naivete and insane, which is you are doing a really hard thing. The default is not for it not to work. So, you need this a little bit of cognitive dissonance to say, “I’m going to push through and I’m going to be the one that makes it work,” because the probability is often, that comes across harshly or false bravado or a lack of real communication skills.

Michael (33:02):

That has turned us off sometimes or what feels a little bit dishonest, where they disqualify all existing technologies and partners and ideas and say, “We are the only one that matters.” It’s like, “Well, you haven’t done anything yet.” So, where we’ve made big mistakes, is making investment decisions based on personality conflicts. I can tell you, we’ve done it two or three times and we regret it all three times. That’s a difference between integrity. Integrity is an automatic disqualifier and we just are okay losing money if we don’t trust the founder.

Tom (33:35):

Doesn’t the whole idea of investors investing in passionate founders… Doesn’t that conflict a bit with having personality conflicts? Because the way I judge passion is probably different from the way you judge passion on a personal level. So, it just seems just very subjective, right?

Michael (33:53):

It’s extremely subjective. The earlier it is, the more subjective this business is. We have very little to go off of. It’s one of these things that I wish I could put better language to it, because it’s the thing that after a while, you get muscle memory. You start to understand what a real passionate founder looks like. You can’t put them on a scoreboard, but you can ask very specific questions and understand the depth of thought and the experimentation and the amount of exposure their thought has to the world. They say, “Well, we tried this and we got this feedback. This is why this doesn’t work.” They’ve really taken the problem and put it around their head and got a really highly qualified answer.

Michael (34:34):

So, even if I don’t like their personality and they’re abrasive, if they’ve done that, I say, “Okay, maybe this is the right founder.” But the other thing is we’re going to work with them a lot, right? You’re going to spend the next 3 to 10 years depending on the duration of the project with this person. There’s a quality of life question. I really like to spend time with my founders. I’ve lunch and dinner. We go out. We’re all personal close friends, which actually maybe to an extreme too far. They cloud your judgment at some point. If you’re too good of personal friends, you got to be careful. But generally, we were friends for a long time. It’s a real investment. So, for us, we’re okay missing some if we don’t want to spend some time with this person.

Tom (35:14):

For the retail side of things, a lot of people in crypto will look at a founder and they’ll say, “Hey, they ship really quick. Hey, they’re nice on Twitter. They’re well known. They’re on Discord. They’re doing ops while they’re shipping code,” all the normal things to judge passion, but it seems like all the founders are doing that today. If you’re a retail investor, let’s say within Galaxy, how would you diligence a founder when you might not have the resources that a Galaxy has and you have to judge everything from the outside?

Michael (35:41):

Yeah. So, the first question is, “Where are you?” The great thing is that we’re based in New York and go to meetups. The meetups are awesome places to understand that you’ll see the founders come out of them. So, it takes a while, but most of my great investments come out of physical meetups, which is such a funny thing for crypto, whether it’s based in New York or San Francisco. If you’re not in one of those places, go to a place where people meet online and you’ll see the quality and quickness. One thing I really personally like is people who respond quickly, because it suggests that they’re in control of their life. I don’t mean, they actually have it all figured out, but that they are able to act, which is the most important thing.

Michael (36:20):

Crypto, you can’t just plan. You have to constantly be reacting to new crises and figure this out. So, I love that as a very simple way. How quickly do they respond when I ask them a question? There’s plenty of appropriateness of they don’t need to respond to an investor instantly, but after a while, you start to figure out, what’s their mean and what’s their median.

Tom (36:39):

No, the predisposition for action and understanding the level of depth that somebody should have an answer when you’re on the receiving side is important. So, if I have all day to get you an answer, obviously, it’s going to be gold. If I respond in two seconds, it’s obviously going to be less, but understanding the other side is very important. Switching gears a little bit, what do you think is the most important sector within crypto to invest in? It is a tough question, because it’s not like you can be a generalist anymore. You have to be an expert on AMMs, lending, layer 1s, new layer 1s. Being a generalist, diving in, having a team, how do you do all that?

Michael (37:17):

Are you asking from a fund perspective or a retail? Because I think they’re very different.

Tom (37:21):

That’s a good question. I would probably ask from a retail perspective, because I guess, it’s better for the listener base, but either way you want to take it is fine with me.

Michael (37:29):

Yeah, the amazing thing about retail is retail gets the stuff up before we do all the time, because they have so many more interest than we do. It’s impossible. Our team unfortunately can’t look at it as much. We’re overwhelmed with things and we have to investigate things we’re not intrinsically interested in, because that’s a bit of our job. Most of us follow our interest in investing things we really believe in, but a lot of my time is spent learning about things that aren’t just necessarily my core competency.

Michael (37:59):

So, the advantage that retail really has is they can spend time in smaller, earlier, more interesting out there things and get real edge over the bigger institutional investors, because they’re passionate about it, they can participate. Putting $10,000 to them is the real amount of risk. For us, we just can’t spend that much time there yet. So, the advice that we always recommend people is nobody will ever beat me at my game, because I wake up Saturday morning at 8:00 and just start reading about crypto.

Tom (38:29):

I know you do.

Michael (38:34):

Everyone does this. This is the game you have to play. It candidly would be exhausting if you didn’t love it. So, you are competing with people that really love this. This is what they want to do. I believe retail has an opportunity, which is you can find what you love, you can participate. The community loves to work with people that love this stuff, right? Whenever you go to a really good community meetup, everyone’s so passionate about it. So, that’s where the edge comes from, which is going out to community, being active, and expressing your passion for it.

Tom (39:00):

I wouldn’t be working 18 hours a day if I didn’t love it. I totally vibe with that answer. Mike, we have five minutes left. Two quick questions for you, diversification versus concentration. I know at the fund level for Galaxy, that’s impossible given the size of rounds and how diversified you have to be. Again, going back to the retail level, what advice would you give people on diversification versus concentration and then also, not being an idiot about concentrating, actually, knowing stuff you’re messing up?

Michael (39:29):

That’s a personality question in my opinion. So, our team has different personalities. I’m a concentrated investor. I make fewer investments a year than my investment partner. He is much more able to digest ideas quickly, put risk in a bunch of baskets. He’s able to pay attention to 15 things at a given time. So, the first thing is you have to know yourself. You have to know whether you’re the type of person who can really pay attention to a lot of things and make sure that there aren’t any loose threads hanging because that’s how you’ll start to lose money.

Michael (40:00):

I personally make much fewer investments and I’m okay with concentration. But for my personal risk management, that’s an entirely different situational question. It’s a question of, “Is your full time job trading crypto? Do you have an income source? How are you appropriately sized?” These are things that everybody needs to manage. We’re not the right people to comment, because we work in crypto, right?

Michael (40:22):

Everything we do is a diversification within the same subset of a correlation, right? They may have a job in an equity’s hedge fund. So, there’s correlation. There may be really long queues or some emerging cloud index. There’s already long tech. What’s the relationship there? All these are so context and situation specific that I can’t really provide actual advice for a general audience.

Tom (40:44):

No, no, knowing yourself is the right answer. Two rapid fire questions, but mental health breaks. Obviously, we’re both working 18 hours a day, but we’re not robots. How do you get away? How do you take breaks? How do you not burnout?

Michael (40:57):

That is something you learn with practice in terms of the cyclicality of crypto. It can always feel extremely, extremely overwhelming, right? It feels like there’s always something to do, the markets are always trading. But what I always recommend to people is you do get downtimes. Right now, we’re in a bit of a downtime, right? The markets are flat. It’s summer. You’re seeing a lot of range bound trading. Take the time. For me, it’s surfing and reading. They’re the two things that help to steady my mind, but also just find something else you’re interested in.

Michael (41:36):

Find a new thing that you’re really excited about and give your brain a chance to refresh, because you’re looking at the same problem with a stale brain, which is bad for you. Stale brains are the worst way to look at problems. They get caught in traps. They’re too reflexive to the local things. So, get yourself a fresh brain, come back in the fall really be excited about what’s happening.

Tom (41:54):

I love having an outside activity. Last question for you, what’s the best advice you’ve ever gotten? And then I’d love to hear the best advice that you give people.

Michael (42:03):

Oh, man. The best advice I ever got was about how to think about risk oddly. I think most people think of risk as this linear value, where there’s not risk on this side and super risky on this side. One thing we’ve learned or I have learned from a personal perspective and our projects we invest in is not taking enough risk is an extremely risky activity. So, risk is really shaped maybe a sphere or hyperbola, where in the middle is maybe the appropriate amount for you. Too much can get scary and too little is also not the optimum value. So, thinking about the shape of risk for you and your investments has really transformed the way I think about career, decisions, relationships, all of those things. It is a really underlying theme in my life. That was very helpful.

Michael (42:54):

Mike like things about risk in a very different way than I do. I’m very analytical, engineering brain, focus mind. Mike’s animal spirits think of it that way. So, he gave me that advice. I’ve taken it everywhere with me. The second one, what advice that I’ve given that really helped people, don’t listen to VCs. A lot of the time our founders ask us, “What should do they do?” It’s like, “Look, the answer’s in your head and in your heart. My job is to help you get it out of you. I don’t know your business as well as you do. I promise that I’m here for you. Whatever is right, we support you.”

Michael (43:28):

That’s the advice we try to get people. Everybody that’s listening to this probably knows the right answer for themselves. It’s your friend’s and family’s job to help you get it out of you and become that full version of yourself.

Tom (43:42):

I love how you think about risk. I love that your disposition for the founders is to listen and to talk to them, instead of just automatically giving advice. Mike, I know we have to wrap up right now. It was such a killer episode, man. When you opened with responding quickly, you respond quickly with so much depth. It’s incredible. So, I really appreciate you coming on.

Michael (44:03):

Awesome. Thanks for having me, Tom.