What should we make of the recent crypto crash?  A sign this is all a scam? Or just another dip in the cycle? Gather round; you’re in for an interesting chat with the Church of the Flying Spaghetti Monster Disciple on Twitter @LDrogen. A Long Island surfer turned quant turned crypto fund manager who shows us how you have to be able to hold two separate thoughts in your head to succeed in the wild world of crypto. We’re hanging ten and talking Crypto with Starkiller Capital’s Leigh Drogen. In this episode, Jeff and Leigh bond over their love of skiing, the inception of Starkiller, how he’s doing trend-following on a portfolio of coins with dynamic yield farming.

Jeff gets Leigh to dive deep on the long list of warts in crypto: shadow banking, yield swaps, yolo trades, Ponzi schemes – but also wants to know what the real opportunities are. They then talk just how you can do trend following on assets so volatile, how you even start to go about doing due diligence in this space, and how to hedge the book. Plus, Leigh’s in the hot seat giving us his views for preparing for the next 10x cycle — SEND IT!

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Check out the complete Transcript from this week’s podcast below:

Trend Following Crypto with Leigh Drogen of Starkiller​

Jeff Malec  00:07

Welcome to The Derivative by our RCM Alternatives, where we dive into what makes alternative investments go analyze the strategies of unique hedge fund managers and chat with interesting guests from across the investment world. Happy July everyone, you made it sort of first half of the year done, but with a lot of carnage in tech and bonds and crypto Heck, even cotton was down 30% This week, which is interesting enough to get a cotton specialist I know on the pod. Stay tuned for that next week. Plus working to get an institutional vol Celeron soon see how the longer term big money thinks about all this volatility. On to this episode, I mentioned the crypto sell off and our guests Leigh Drogen of Starkiller Capital has some thoughts what a great firm named Star Killer. We talked about how he came up with that, how he’s doing trend following and a portfolio of coins and yield farming and living his best life surfing and skiing, which I may have spent too much time talking about. Sorry, it’s what I’m into. But this was a fun one where we see who can hold two separate thoughts in their head at the same time. Send it This episode brought to you by RCMs managed futures group and their newest white paper titled Your Guide to trend following. Our guest here today is trend following crypto. How do they do it? Why do they do it? When does it work? When doesn’t it? Ping the team at RCM to dig in. Check out everything RCM does plus that white paper at our cmos.com Now back to the show okay, I’m pumped to start talking surfing and skiing with Leigh Drogen. Did I get the last name right Drogen. Yep. Leigh Drogen of Star Killer. We gotta get into that name, too. So welcome, Lee. Thanks for having me. Yeah. So I get flack in the comments a lot when I spend too much talk time talking, skiing and such. So if that’s you right now, listener, fast forward 20 minutes or so because this is too good to pass up. Because I see your picture there. And you actually told me that you train for big wave surfing. What exactly does that mean?

 

Leigh Drogen  02:08

Yeah, so I grew up on Fire Island, which is a barrier island kind of about an hour and a half from New York City home Long Island, surfing and traveled around the world to serve as a kid a bit and then went out to University of San Diego, where during the winter, we get, you know, pretty big swell there and just a little south in Mexico. And there was actually a an elective course at University of San Diego called Big Wave surf survival. And it was a lot of fun that yeah, basically taught us to survive in kind of the biggest waves possible. And since then, I’ve you know, at the age of 19 kind of went on to serve you know, bigger and bigger waves all around the world. And yeah, a lot of fun.

 

Jeff Malec  02:59

So, turn to questions at one University of San Diego. This isn’t a question that terreros I think grant your arrows Yeah. All right. I used to know all the D one basketball school mascots was a little party trick. So terreros was a good one. The but Fire Island, how many people serve there? It’s cold as heck right? Well, so

 

Leigh Drogen  03:19

I’ll admit that I’m not much of a cold wave surfer. I’ll put on a three to suit but once we get to like, you know, gloves and booties, I’m, you know, I’m tapping out. So I don’t really serve on the east coast during the winter, but you know, once it hits, late May June, I’ll get in the water. Yeah.

 

Jeff Malec  03:37

And there’s like actual legit waves there.

 

Leigh Drogen  03:41

Yeah, there’s, I’d say, you know, from from that period until late October, when the water still real warm on the East Coast. There’s probably a good you know, two dozen surf days and probably a dozen really good surf days out there. Depending on how the sand is kind of structured and, you know, wind and swell, but yeah, it could.

 

Jeff Malec  04:05

And is this you on the picture over your shoulder?

 

Leigh Drogen  04:08

That’s That’s not me. That’s actually a famous surf photographer Aaron Chang, I believe. And that’s jaws that yeah, that’s pie he out in but I love I love the photo, and I have it in my office. Because it’s basically representative of the scramble when things go wrong out there. It’s basically just chaos and everybody’s just scratching to get over the set and not get cleaned up.

 

Jeff Malec  04:39

And is that Jaws pre tow in surfing? Like they’re all They’re all paddling I didn’t think no,

 

Leigh Drogen  04:44

no, that’s that’s post that’s post toe in So now, you’re actually kind of considered to be a bit of a worse if you’re towing into jaws on a day when it’s not when like super windy because they can basically paddle in it. Sighs now.

 

Jeff Malec  05:02

That’s awesome. So quick aside, on my honeymoon, we were in Maui. And I grew up on East Coast of Florida, Vero Beach. So we would serve what we thought were waves, but they were like, a foot to two feet high. Maybe. Kelly Slater grew up just up the coast there an Indian Atlantic about my butt. So I found myself as somewhat of a surfer. So we’re on our honeymoon. And I’m like, we gotta go see jobs. So we’re literally like driving through this pineapple field. And she’s like, What are we doing? There’s some burnt out cars on this. And I never found it. Like I couldn’t see it. It was getting dark. We abandoned but I wanted to see it. And my last bit there, did you watch the HBO series? I’m sure 100 foot way?

 

Leigh Drogen  05:46

I did. Yeah, it was pretty good. It was. It was entertaining. Although I’ll have to say that one of my like, are my only kind of, you know, hot take on on surfing is that Naza Ray is not a wave. It’s a swell. So it shouldn’t be counted. As you know that. That record, it doesn’t really break top to bottom like Jaws does. It’s kind of more like a rolling swell.

 

 

 

Jeff Malec  06:12

Yeah, that’s in that whole measurement thing. And so do you feel like those are accurate just from the photos?

 

Leigh Drogen  06:18

I mean, I’m sure they could figure it out from the photos. But it’s for me, it’s still at the maximum height of the wave. The Surfer is not in the dangerous part of the wave. They’re not kind of under the lip, like you are a Jaws where you may be writing a 50 foot wave of jaws and you’re literally in the tube like Kai Lenny. And that’s, that’s just Yeah, totally different thing. Yeah.

 

Jeff Malec  06:43

So what’s the biggest one you’ve written?

 

Leigh Drogen  06:46

Well, I was at Hanalei Bay in Hawaii probably five or six years ago. And it was a good, you know, well, for Hawaii, they would probably say it was like a 12 foot day, but for me, you know, it was more like a 20 foot day on the face, and that’s kind of where I tap out. Yeah.

 

Jeff Malec  07:07

That’s pretty big for a guy in Montana. So moving on, he moved to Montana, and white fish. I’ve never skied white fish skied Bridger Bowl first time this year. What’s it like up there? You just Oh, man. When we came on, it just started the summer.

 

Leigh Drogen  07:22

Yeah, white fish is amazing. You know, relatively small town. But we got the airport here. Just 15 minutes away, flies direct back to New York, LA San Diego, wherever. Great, great hockey town. I play a lot of hockey here. There’s a rink right in town. And then the mountain the powder is incredible. And I’ll admit, I don’t take as much advantage of it as I should just because I’m a more warm water sports guy. But you know, I’ll get up there a dozen times. A winter. And yeah, great community. Just a really, really fun place out west.

 

Jeff Malec  08:02

And right next to Glacier, right.

 

Leigh Drogen  08:04

We are Yeah, we’re like 25 minutes from Glacier. So we go hiking there all summer and we’re up there just riding bikes on going to the Sun road before it opens to the cars because not even plowed all the way up to the past. And just yeah, some amazing views. Like Switzerland in America.

 

Jeff Malec  08:23

Yeah, my it’s right up there with me. Gotta be a top three national park for sure. Yeah. And you see a lot of Grizzlies. We saw like, six when we were there.

 

Leigh Drogen  08:33

Yeah, we saw some bears the other day when we were there.

 

Jeff Malec  08:36

Which is hard for those guys in Glacier just eat berries and stuff, right?

 

Leigh Drogen  08:41

Yeah, I don’t think they’re fishing in the streams. Rivers.

 

Jeff Malec  08:45

Yeah. So that’s a hell of a lot of berries. I’m like, how do you get how did they get that big? Yeah. So and your name I mentioned real quick. My name my daughter’s late and so we got a Lea. GH similar name construction there. Where’d that one come from?

 

Leigh Drogen  09:02

Yeah, you know, I don’t know what my parents were thinking exactly. But I guess they didn’t want to know and they thought I was gonna be a girl. So I was supposed to be a layup and they just shortened it to Li i was actually playing around that that like kind of that site that shows how many people have your name by year you know, thing was going around couple of weeks. And I think I’m I’m one of five leaves with this spelling over a decade. So you know, I don’t know if my parents were trying to be kinda like counter trend, whatever, but it didn’t catch

 

Jeff Malec  09:41

catch on. I was joke of like kids names these days. Our friends are screwed, right? If I remember back to high school or college like John, Dave Bryan, right, all these normal names now that kids have to think of like Hunter and all these other names. So all right, if someone’s tuning back in from the And we’re done with our surf and ski combo. I’ll ask you one more surf my best favorite surf movie?

 

Leigh Drogen  10:08

Oh, gotta be September sessions, or sessions. Yeah. Which is it’s basically a trip that Kelly Slater and friends take to Enzo on a boat. I don’t know. Jack Johnson is on the trip. I think I’ve seen that. Yeah, it’s actually funny. So Jack Johnson, the music that he put into that surf film ended up being half of the songs from his first album. And that kind of launched his career. So great movie. Great music. Great surfing. Yeah. Yeah,

 

Jeff Malec  10:39

he seems like he’s got quite the lay right surfer songwriter gets out there.

 

Leigh Drogen  10:45

You got it dialed in.

 

Jeff Malec  10:45

Yeah. Let’s talk crypto a little bit. And I’ll preface by meeting. I’m a bit of a skeptic, sometimes professionally, on purpose just to make sure we’re not missing anything. But I invested for some education and fun back in 16. But like less than, less than 10,000 ish, but recently made a bet that we’ll never get back above 50,000 in Bitcoin. So I’m not sure where to start. So let’s start with what worries you most about everything that’s gone down these past few months. We’ll circle back to what gets you most excited. But let’s start with the in the War Department. What’s what’s most troubling from an investor’s standpoint?

 

Leigh Drogen  11:33

Oh, so many things. Great. Yeah, I guess I’ll

 

Jeff Malec  11:37

just moat not most, but let’s just go down the list. Yeah,

 

Leigh Drogen  11:40

I mean, so all of these things I put in the category of was very likely going to happen anyway, still troubling, still awful. And also, you need to hold these two concepts that are kind of posing in your mind, at the same time that all of these awful things are happening, and we’re likely to happen. And yet, it likely won’t matter anyway, to the long term growth of the asset class. So kind of trying to try and hold those two things the same time. So the awful things, let’s see, we we are literally going through the same shadow banking collapse as 1929, that all of our securities laws were written to avoid. And it’s most kind of annoying to me, because I’ve been screaming about the fact that this was going to happen for several years now. And that we have this whole thing called decentralized finance, which is great. And that relies on over collateralized loans that automatically liquidate when they become not over collateralized anymore. And that works out really well. Nothing near has really broken yet. But over the last couple of years, these kinds of centralized pools of risk and lending have popped up like Celsius and Voyager and there’s a there’s a lot of them now. And they made under collateralized or sometimes non collateralized loans, to funds and individuals. And of course, in a big, you know, price meltdown, all of these firms are now insolvent. And guess you know, really takes the brunt of it is the retail investors who basically gave them money as a yield swap trade, right? I give you my coins or my USDC you give me back 8% yield. And then of course, they went and gambled with the money, right? Making bad loans and whatever. Well, of course, this was gonna happen eventually. And I just all the laws are written to avoid shadow banking, and yet we did it again.

 

Jeff Malec  13:43

So it’s so important factor, it’s not necessarily the fact that they’re offering a yield. It’s what they’re doing with the money once they get it. It’s like, oh,

 

Leigh Drogen  13:53

no, look, I think the the concept of selling a yield swap to a retail consumer is already illegal, right? You can’t do that. So the SEC should have shut all of these things down from day one. My inclination is to believe that they didn’t because they kind of wanted this to blow up to say, Hey, I told you so. The thing is, like, they’re gonna use that to then go say all of crypto is whatever and we need to regulate it, whatever. But the thing is all the defy stuff, which is not this is all working perfectly fine. So we could have just stuck with defy but instead, these tech bros came in and said, Hey, give me your coins. I’ll give you 8% And, you know, but you have no recourse to it. There’s no FDIC insurance, there’s nothing

 

Jeff Malec  14:42

do you think it was the tech bros came in or the finance bros?

 

Leigh Drogen  14:47

Now these are tech bros, the Wall Street guys, the guys who were engineers at two sigma and Citadel and those places, they all built defy things. The tech bros built centralized C If I things and blew it up,

 

Jeff Malec  15:02

and they thought, Hey, I just created perpetual motion or something right like I’ve so would you would you go so far it’s called a Ponzi and some of those, right because they needed to pay the yield to get more investors in.

 

Leigh Drogen  15:13

Well, okay, so there’s two different things going on here. There are Ponzi ish schemes, right. And those were destined to fail. And there are some in defy to like that, like Terra. Terra was basically a Ponzi ish scheme, where they were subsidizing the yield that you were getting with investor money, basically. And what happens is when the desire for leverage decreases, and there’s nobody that’s borrowing from the system, well, then there’s no more money to pay the people who have deposits, right, and then the thing collapses, which is what happened. What’s happening in the Sci Fi shadow banks is a little bit different. What they did was they said, Okay, we’re gonna give you seven or 8%. And then they went out and made risky loans, whether it was in defy or whether it was direct lending. But the thing was, they weren’t really good at making the loans, and then they blew themselves up. So that wasn’t necessarily a Ponzi scheme. It was just like, they were bound to do it poorly, eventually. And they eventually did.

 

Jeff Malec  16:15

And what do you have insight into what some of those loans were, like, their loans? Like, what, what are some of the egregious examples?

 

Leigh Drogen  16:23

I mean, one of them was Tara, like, a lot of the Celsius stuff comes out of, you know, terror blowing up. But there are other things like terror that they’ve been blown up in as well, there are other lending protocols on chain, that, that haven’t gone well for them. And then in some cases, the yield on you know, stable coins is just dropped to kind of two or 3%. And so now you’ve got a mismatch between what they’re paying out and you know, what they’re getting, and they tried to lever it up. And you know, what happens when you use leverage in a bear market doesn’t doesn’t go so well.

 

Jeff Malec  17:00

So when you’re saying they were making bad loans, it was all still in the crypto arena, right? They were just saying, Hey, we’re gonna pay out for and we’re gonna go do it over here ourselves and get a good

 

 

 

Leigh Drogen  17:11

yeah,because they knew that just like Tara, if they dropped the yield that you were getting, there would be a run on their bank, just like their ones. But Tara, and they didn’t want to do that. So they tried to Yolo the trade. And it didn’t work out for

 

Jeff Malec  17:25

the traders here in Chicago back in the day called it the O’Hare spread. Yeah. In the pits here, you put on a big trade. You’d take the capital here, you’d call the clearing firm right before you’re playing board. Did I make money? No, you get on the plane? Did I? Did I make money? Yes. Okay, I’m coming back. All right. That’s one. So it’s 1929 style. shadow banking. Yep. What’s, what’s the next word?

 

Leigh Drogen  17:52

Yeah, I’d say number two, was this conversation around? Does web three really have any real world use cases to it? And, you know, I think there’s a lot of ways to have that discussion. But the way that I prefer to approach it is no, there really are no real world web three use cases today, right. But at the same time, we’re still really, really early in the development of this technology. None of these things scale, technically, right? They break all the time. There’s, you know, a limited number of people that are really attempting to use it for the actual utility of it versus the casino of it, right. So you have to look at it as a progression of utility, not Oh, there’s nothing here today, there will never be anything here tomorrow. What we’re basically seeing is the same progression that you saw on the internet from the late 80s, through the mid aughts, right, where you go from dial up where you really can’t do much of anything to DSL, where you can kind of do a little bit more stuff to, you know, broadband, and, you know, really good graphics cards, and memory where like, you can do all the things that you can do today. You can’t expect this stuff to do all of it from day one. But I think the difference between this and let’s say the late 80s, very early 90s in the internet is that wasn’t financialized at the time, you couldn’t own TCP IP, right? And so, in this world, we go through these big bubble and bust cycles that are basically hype cycles. And everybody screams Oh, well, it doesn’t do anything. Well, it’s because it’s still really early, but yet yeah, you can bet on it on like, you know, the early internet. So it’s it’s disappointing that we’re going to have to go through another one of these troughs, but it was it was inevitable,

 

Jeff Malec  19:57

but it it almost speaks to the Like if it’s going to be the next TCP IP or whatever a protocol and you’re investing in that protocol is that if that’s a single token or a single, is that, is that scalable enough? Is that legit enough to be able to be that for the whole web? 3.0? Right, that’s, that’s where I was getting a little hung up have like, almost seems like it needs to not be a singly single. I’m gonna use the word protocol again. But a single what do we call that a single coin protocol, whatever,

 

Leigh Drogen  20:29

level one chain? Yeah, I guess I think we’re still, I think we’re still before the consolidation of users onto one kind of platform or chain or, you know, whatever you want to call it. They’re still hashing this out. And the reason is, because none of these things are yet scalable. But the conceptual frameworks that they’ve built are very obviously the future of the entire financial and technology, you know, ecosystem. That that much I’m I’m 100% sure of, I’m also pretty certain that it’s likely that none of the things currently existing will win, it’s likely that there will be something else that, you know, comes along as we continue to develop that is the eventual big winner that consolidates

 

Jeff Malec  21:21

everything, and how to how do you think about why not just be a VC and own some of the companies not the coins? Right? Like so is the winner going to be a the next Microsoft or Google this space, like a company that does this? Or is it going to be a level one, which can’t level one

 

Leigh Drogen  21:41

level one chain or chain? Yeah, there are two reasons. One has to do with the investable aspects of a strategy. And the other one has to do with the scalability of and size of whatever is going to win, the thing that’s going to win here is going to be a decentralized chain or protocol. That much is sure it will be originally backed by a company, but then it will become something that looks more like Aetherium it will become a protocol that is d centrally owned, the more important piece of and I think VCs will do really well investing in picks and shovels around the ecosystem. But you’re seeing one of the big problems with that strategy right now, which is because this whole asset class is so bubble and bust driven. And we can get into the thesis of why that’s the case. But because it’s so bubble and bust driven, the VCs end up having to take a tremendous amount of vol inside of their portfolios by not being able to manage risk in those illiquid investments. And you know, Cliff Asness would say in a sense, they are volatility laundering, because they tell their pension fund LPS Well, you know, give us money for 10 years and you know, we’ll come back in 10 years, right. Don’t Don’t look at the vol during these 90%. drawdowns hence, the volatility laundering, you know, the

 

Jeff Malec  23:15

cliff and can use it with private equity. But yeah, applies there too. Even more?

 

Leigh Drogen  23:20

Exactly. In fact, they’re laundering even more volatility. Yeah, they are in PE in a sense. So my view is that if you believe in the beta of the assets, and the asset class over a long horizon as these VCs to do, that the liquid tokens are liquid enough that you can run trend following and momentum models to manage risk, get very similar beta characteristics on the way up, and then be able to extricate yourself from that beta, you know, when these bust cycles happen, and, you know, to me that just I think both strategies work in the long run. But for me, I would much rather be able to manage risk than have to hold through a 90 or 95% drawdown.

 

Jeff Malec  24:12

Or they’re, they’re saying, Hey, I’m gonna have 20 of these 19 of them are gonna lose 95% or 99%. And the one makes whatever 19,000,000% We’re all good.

 

Leigh Drogen  24:25

Well, there’s, well, there’s that there’s the portfolio theory of it, right, which also is difficult to swallow, if you’re, you comes from my background. But the other part of it is, even your big winners, like if you consider something like the VCs who invested in Solana very early on, right, they’ve in their coins are locked up. They’ve had a massive win. But if the coins are still locked up, they’ve just gone through a 90% drawdown in their most massive win, right? So like, how many people can stomach the biggest win that they’ve ever had drawn down 90% And still saying I believe in it.

 

Jeff Malec  25:05

Yeah, it’s hard. Well, but that’s what a lot of the believers right now, right if they bought back and pre 2016 Okay, I’m still massively up even though I’m also massively down, I can be both at the same time. Yep. You want to go into what exactly Starkiller does here or cover some more awards? We can come back to the Word.

 

Leigh Drogen  25:26

Um, yeah, we can we can get into well, okay. So here’s, here’s the other word, and it kind of leaves it. It leads into the the core thesis that we’ve got, which is, you know, when we look at firms, like three arrows capital, you know, which is one of, if not the biggest, you know, liquid crypto hedge fund that just blew up 19 billion under management.

 

Jeff Malec  25:51

Find those guys yet?

 

Leigh Drogen  25:52

I don’t think so. I think there’s still Mia. Yeah, unbelievable. And I don’t mean to pile on here. But it. And I think, again, you have to hold these two things in your mind at the same time. It’s very obvious that three arrows levered up in a lot of different ways, some of which were stupid. Others, which were relatively intelligent, but they were using a lot of leverage, whether it was simply a YOLO trade for them, or they didn’t believe what I’m about to say, I’m not sure it matters, because they were wrong. Anyway,

 

Jeff Malec  26:28

I’m gonna choose B, even though I don’t know what you’re gonna say.

 

Leigh Drogen  26:31

Likely. It’s B. Yeah. I think there’s a lot of people out there that didn’t believe that this asset class would ever draw down 80 or 90%. Again, right. And I, I’ve had a lot of conversations with very smart people who were not true crypto believers, who still thought because of the institutionalization of the asset class, that it wouldn’t do that again, right, that maybe that drawdown would be 60%, or 50%, or something like that. Right? Yeah. Our core assumption from the very beginning was that you cannot have the type of growth in the asset class that crypto exhibits without the associated vault, right. And because this market is incredibly driven by the actual underlying adoption rates, on chain transactions, total dollars of transactions, number of wallet addresses transacting, if you look at the price path over several cycles, it very much follows the growth in those underlying fundamentals. But what happens is because none of these technologies are mature enough to handle the demand, each cycle, we go through this process of maxing out the capacity, and then the flow of new people stops, and then the casino stops and the money stops. And then we collapse, right? Our main assumption was that we would have several more cycles of 80 or 90% draw downs between here and some eventual lowering of the growth rate, once the law of large numbers really kicked in as the whole world basically had an on chain wallet or was participating in crypto. It’s very obvious that three ACC and other funds did not expect this to be a, you know, a basic assumption of their investing. They obviously thought that this was a very big left tail event. It wasn’t right, right. And so almost mathematically,

 

Jeff Malec  28:36

so Right, like, yeah, given the volatility, you should expect this.

 

Leigh Drogen  28:41

Yeah. So I’m a little disappointed in, you know, who we’re supposed to be very intelligent investors, for not believing in this one very basic, very mathematically driven kind of baseline scenario.

 

Jeff Malec  28:58

But I can write, then I could go to the other side of like, well, that’s how you raise all those billions of dollars? Almost, if you purposely put the blinders on and say no, that those days are done. Give us your money. It’s true. Yeah. The it also reminds me of people were like, Oh, well, we’ll never have a Great Depression again. Right. Right. They’ll never be that type of drawdown in in the equity markets like never say never.

 

Leigh Drogen  29:25

It’s kind of what I was trying to tell, you know, our investors, from the very beginning was that look, the the core assumption in our models is that this will likely happen again. And yet we don’t run a long short book, we run a long biased momentum and trend following driven book that does go to cash and can be, you know, it can be slightly net short at times, but even given the assumption of 80% drawdowns, I still don’t believe that shorting is an incredibly good strategy in this market, because the growth rate the gains on just Getting the upside rate so far outweigh you know, tactically attempting to take 20 or 30% off the short side in a bear market that it’s just not worth it.

 

Jeff Malec  30:11

And I was gonna say like, all these words are narratives blowing up, like we didn’t even talk about it as an inflation hedge seems like that’s totally out the window.

 

Leigh Drogen  30:21

Oh no, yeah, so I’ll give you my really short kind of political philosophy of crypto, which is probably very different from a lot of other kind of true believers which is I don’t believe in like the libertarian like Goldbug fantasy of this stuff. Like this stuff is all high beta tech that’s what it is right? I tend to believe the Fed does a pretty good job most of the time you know dealing with money supply I’m not an inflation truther

 

Jeff Malec  30:52

and even though you’re there in your bunker in Montana

 

Leigh Drogen  30:56

I don’t think I don’t think they’re inflating away the value of your money or, or anything like that. Bitcoin is definitely not an inflation hedge never has been never will be none of this stuff. None of this stuff is. So yeah, it’s you got to treat it like a risk asset is the riskiest of risk assets.

 

Jeff Malec  31:15

And then my question, somewhere buried in there was gonna say like, even all these narratives were sort of debunking? Err, you don’t care because you’re systematic. So right, like buy it up? Because of this reason? I don’t care sales off because of that reason, I don’t care. So is would it be fair to say your trend following the coins? Yes.

 

Leigh Drogen  31:39

So we run basically a liquid portfolio, no more than 20 positions at any given time. Our universe of coins today is well, it’s, it’s, it’s smaller today than it was four months ago, let’s say that but it’s roughly 400 coins that have enough liquidity for us to participate in. And we mostly use trend following and momentum models to govern the beta of the portfolio. And then we use cross sectional momentum models to govern the asset selection within that beta and and then we look at all of the on chain fundamentals and all sorts of other kind of quantitative variables that have to do with attention and leverage and basically everything having to do with the casino like how is it going in the casino and and that works really well to keep you out of these massive bear markets and then push the gas when it’s really time to make money and the market is telling you it’s time to make money.

 

Jeff Malec  32:44

So a lot of trend follower, peeps, listen here. So how do you do trend find when it’s that volatile? Right. So a lot of the I would imagine you’re gonna get whipsawed like crazy if you use some of the standard techniques. So what are some of the without giving away all the secret sauce? How do you approach that with it being so bald?

 

Leigh Drogen  33:04

No, we kind of pride ourselves on being very AQR like in the fact that we’re glad to share our research. None of it is super rocket science. It’s just all of the research that cliff and I and many others have done in equities over the years applied to crypto, but used in a slightly different way. And you kind of you gotta hit it right? You need to adjust your models for the ball. And I like to say to people, crypto is just like any other market, but more so in every way. There’s, there’s more involved, there’s more returns, there’s more fat finger shenanigans, there’s more insider trading, there’s more stupid actors. There’s, it’s just it’s markets, but more so. So in our strategy, because we are kind of a mid to long horizon book, we have to expand the parameters for the timeframes for some of those trend following models. So one of the very basic naive models that we build on top of is a 550 Exponential Moving Average crossover model tends to work really well in crypto, but even with that, the expectation of max drawdown in the portfolio is about 30%. So you have to be willing to take a significant hit to stay in the primary trend of these bull markets. If you really want these big 678 100% you know, kind of gain moves, you know, during these cycles. We also use more kind of don’t change channel you know, type things. The other kind of more interesting thing that we do is we

 

Jeff Malec  34:56

I always come Dunkin is a dancin or dunk You know, your question? Tomato tomahto

 

 

Leigh Drogen  35:04

Yeah, um, we we have to kind of volume and volatility weight our moving averages as well, because whereas in equities, you’re dealing with kind of five days a week mostly where there’s not necessarily an equal amount of activity taking place, there’s obviously more activity at the open in the close than in the middle of the day, but you’re roughly getting the same amount of information each day, you know, as you are the next. But in crypto, because it’s seven days a week and 24 hours a day, you really have to, you have to wait, that that moving average for the information which does not take place, you know, equally in the market, and that’s an important part of what we do.

 

Jeff Malec  35:51

So that’s interesting. I hadn’t thought about that. I’m like, yeah, what’s, what’s the day? Yeah, where do you How does your model when does it calculate? Just yeah,

 

Leigh Drogen  35:58

everybody goes off of UTC. So it’s, it’s midnight UTC, which I don’t know why we’re still using that. But everybody still does.

 

Jeff Malec  36:07

Got it, but you’re not. And then did this require big tech investment too. So you’re having to crunch all this data are you it’s relatively easy to get? No, like

 

Leigh Drogen  36:14

AWS is pretty cheap at this point. These are in you know, massive, massive, massive datasets, they’re, you know, they’re manageable. But we excuse me, we do have a really good team on the research side. And definitely took a while mostly, the problem in crypto is that there really isn’t great, easily off the shelf accessible pricing data and in volume data, because the market is so fragmented between on chain indexes and off chain sci fi exchanges. And so it took us a long time to basically be able to combine all the things that we needed for all the different markets and all the different places for all the different coins into a unified, you know, pricing feed so that we could have a, you know, a reliable data set to both back test and go forward on

 

Jeff Malec  37:12

and then. So 20 coins and portfolio. So what you mentioned the liquidity, how liquid? What does that mean? How liquid do they have to be? And how do you measure that?

 

Leigh Drogen  37:21

Yeah, we need a certain amount of dollar traded volume a day that we can actually access on the exchanges that we can trade on. And that’s relative to the size of our book. And basically, we want to be able to get out of anything, within about six hours without moving the market too much. So you’re never gonna find us being you know, 15% of the book in a, you know, 100 million dollar token just never gonna happen. But you may find us, you know, having a 15 or 20% position and a big L one that’s, you know, worth, you know, $20 billion and trades, you know, a billion dollars a day in liquidity.

 

 

Jeff Malec  38:08

What, what’s an example of one of those costs Solana

 

Leigh Drogen  38:10

or Aetherium? Or I mean, those those are theories much bigger now. But

 

Jeff Malec  38:15

yeah, yeah. And so who’s, who do you feel is on the other side of those trades when you’re doing? Is it retail? Is it Dr. W is at the prop shops?

 

Leigh Drogen  38:25

That’s a good question. depends on kind of what timeframes you’re, you’re doing them on. So in kind of classic trend, following, you know, strategy, we pyramid up into trades. So we’re not taking full positions from day one. You know, we believe in buy high and buy higher and buy more higher and sell higher. Today, the liquidity coming from market makers is way better than it was two years ago. And Ken Griffin at Citadel is entering now. And so two years from now, the liquidity will be even better, and I will probably be trading against Ken or Yeah, they’ll probably be the counterparty to most trades that will make it two years. But today, it’s still I would say a handful of kind of more crypto market makers like Wintermute and others. And then yeah, during the bull phase is definitely very price insensitive retail that is throwing market orders at this thing all day. Yeah.

 

Jeff Malec  39:32

Please take one of those. Take one of those. You just triggered me of like if you’re trying to get at what you said you don’t do. But imagine some fun trying to get out of that 15% and $100 million coin right. And the market makers on the other side, just hands in their pockets. Oh, yeah. Which I think is some of what we’ve seen recently, right?

 

Leigh Drogen  39:49

That is exactly what’s going on right now is they’ve basically turned the computers off and the liquidity in the market has dropped by almost an order of magnitude for A lot of the long tail of stuff. And, you know, one of my kind of favorite theses about markets. And it goes back to, you know, very classic research in equities is if more analysts cover a small cap equity, there ends up being more liquidity. And that raises the multiple and there’s a feedback loop there a positive feedback loop, right? Yeah. So there’s a classic kind of, you know, alternative data, stat ARB strategy, right is kind of trend falling off of analysts coverage lists and things like that. In crypto, it’s the same thing, right? It’s when liquidity goes up, prices go up, multiples go up, when liquidity goes down, this stuff is worthless.

 

Jeff Malec  40:46

And how do you measure that liquidity that’s the size of the order book are

 

Leigh Drogen  40:51

mostly just dollar volume traded per day? You could look at the order book. But we keep it even more simple than that.

 

Jeff Malec  40:58

And that’s been going down over how long the last three months, six months? Oh, yeah.

 

Leigh Drogen  41:05

I’d say it really started to decline in late January. And it has significantly accelerated in the last month and a half or so.

 

Jeff Malec  41:17

Which leads me to my We’re never getting back about 50,000 bet, right? Because like, what, how, what faith do you have that it’s going to come back? Yeah.

 

Leigh Drogen  41:26

So so this is where again, you know, hold two things in your mind at one time. I have 100%, you know, undying faith that the total market cap of crypto will come back above $3 trillion? For sure. No doubt about it. Will Bitcoin end up back above 50? I would say there’s a very, very high probability because I think at least for one more cycle, the correlation between everything else and Bitcoin is still going to be pretty significant. At some point that correlation will break Bitcoin will fade into the background and this asset class will move on without it likely. I think we probably still have one more cycle, which probably puts Bitcoin back above 50k. Yeah.

 

Jeff Malec  42:13

But I’m saying more from the liquidity standpoint, like, have a bunch of software players got blown out that we’re on Quiddity. And now, so it’ll take a while. That’s your thesis, I guess. But like it’ll take a while to build that. Yep. Infrastructure backup, and then you can get another leg higher.

 

Leigh Drogen  42:28

Yeah, look, bear markets end in one of two ways. It either ends in an apathy phase or it ends in a you know, kind of superior capitulation congratulatory event, that capitulo Ettore event could then kind of coincide with some macroeconomic shift. The Fed could be done raising rates or something else could happen that was positive for risk assets. But yes, most of the time, we do go through an apathy phase and and then it takes a while to build back up the type of institutional leverage that’s needed to really set us off on another one of those rounds.

 

Jeff Malec  43:07

You do shorts, but very minimal amount of shorts. So talk about that from it because, right, a lot of classic trend followers would be rolling over in their graves if like, we don’t take the short side like curve fitting Yeah, that’s no good, right.

 

Leigh Drogen  43:20

So there are times when we use shorter term mean reversion models to hedge the book. This will either happen kind of within a raging bull market where we just think things are super overcooked, and we’ve made a ton of money. And you know, we want to hedge the book will hedge the book with mostly just super liquid perpetual futures contracts on a theory and Bitcoin, you know, the biggest, you know, kind of stuff. And we try and match the beta of the portfolio with that stuff. There are other times like in December and early January, where the market starts to roll over in our models, or, you know, mid and long horizon momentum will start to roll over, where we will hedge the book for longer periods of time. And we will believe, and this did work pretty well in kind of late November to early January, that our asset selection will outperform our hedges, and that was the case. And then during parts of a bear market where we are mostly in cash, we will take very selective event driven kind of short positions within that downtrend, and it’s usually it usually coincides with some structural arbitrage that we believe we’re seeing. And man in this bear market. There have been so many of those, and we’ve been pretty conservative. We’ve made some money but we’ve been pretty conservative with taking a lot of risk there. Terror was obviously one of them. You know, there’s a bunch of other errors that have played out and they mostly have to do with just really poor tokenomics design that there would be to go short those Yeah, to go short, it basically produces massive inflationary effects within the underlying number of tokens of the project. And that produces a death spiral in the price. So yeah,

 

Jeff Malec  45:20

but how what’s it look like? Even you have to borrow those to go short? What’s that look like?

 

Leigh Drogen  45:25

No, we’re mostly using perpetual futures contracts where we just have to pay the funding rate on, on on that. And, you know, sometimes those funding rates are five 10% annually. And sometimes, you know, when everybody really is pretty sure that this thing’s broken, it’s 200%. It’s, we don’t want to stick around for a year, right? We’re sticking around for a week or two to really get some kind of, you know, flush.

 

Jeff Malec  45:50

And have you if it was just pure data driven? Does it hold up the the trend models on both sides?

 

Leigh Drogen  45:58

It it does, but it it reduces. It reduces the returns on the way up. So the it you’re making, you’re making money more consistently, obviously. But the total return is actually lower, the drawdown is also lower, but the total return is lower. And our point is to make as much money as we possibly can, while stomaching, the kind of ball that we’re willing to stomach. And what we really don’t want to do is be losing money while other people are making money. That’s the worst thing. And your investors really hate that when that’s the case.

 

Jeff Malec  46:45

Right? If my mind is like, well, I want some exposure to if the Etherium goes to 50,000, I want that exposure. But I also want to step aside when when things don’t look so good. And you find most investors are like that they want the right, do you get some that are just hey, I don’t care what you’re doing. I don’t care if you’re trading Beanie Babies, like as long as they give me that absolute return, I’m happy. Are they mostly like, No, I want exposure to crypto. That’s why I’m here. Yeah, so

 

Leigh Drogen  47:13

we told our investors from day one that this, this vehicle was a lot more of the latter than the former, that we may in the future run a vehicle that is more, you know, market neutral, long, short, really high Sharpe. But that this was the vehicle that they should want for I believe in the beta of the asset class long term, I am not willing to hodl you know, through a 90% drawdown, and it’s very unlikely that they are going to pick assets correctly themselves. So we are the solution to that problem. And during the points in time, when we step out of that beta exposure, we are farming stable coins, basically. And so we’re still producing kind of, let’s call it a 15 or 20% return, you know, annually on our capital during the points in time where we don’t have any beta exposure in a basically a market neutral way. But you’re never going to find a swinging hard on the like long short side at like holding a lot of beta exposure on either side.

 

Jeff Malec  48:31

So help me keep those two thoughts in my head. You were Pooh poohing farming before. No just the illegitimate farming.

 

Leigh Drogen  48:40

No look. So

 

Jeff Malec  48:41

I think we understand those. Yeah, like now I’m before these guys were doing weird stuff when they’re trying to get you know, now this is okay, yield over.

 

Leigh Drogen  48:48

This is a perfect example. Yeah, in November and December, we were in the territory, we not only owned Luna, but we were also collecting that 22% yield in in turn, right? There are times when you want to own the Ponzi schemes, right? Yeah, and it doesn’t matter if it’s a Ponzi, or if it’s what we call kind of a subsidized yield, you know, company or scheme. But when all of the other variables roll over, that make those things risky to own, you want to get the hell out of the way of them right and which we did. So what we do is, even when we own a lot of beta assets, we take those beta assets and we liquidity mine and farm all of them at all times. So we are pairing them up inside of indexes. We are lending them out on lending protocols. And then or we’re using them as collateral on lending protocols to then take out stable coins and farm the stable coins for extra yield. So we’re always producing extra yield on top of the book, but this is most important when you know we have no pay and exposure and we’re still producing returns, you know, like this in a bear market. Now, the way that I explained kind of yield farming and liquidity mining to people is, yes, a lot of these protocols are unsustainable, right? They’re basically giving you equity in their project for simply providing liquidity. And most of the tokenomics for most of these projects are not sustainable. I don’t want to own their governance token, right. I want to liquidate that every single day, I want to, you know, I want to I want to grab it and liquidity every single day for the yield, right and move on. And a lot of those things will collapse over time. I don’t really care. I made money from it, right? Yeah. But you definitely don’t want to own the beta of some of those projects. It makes

 

Jeff Malec  50:47

me think we’re in the golden age of sports betting apps, right? And so you like sign up? Get a free $500? Right, yeah, hey, there’s 30 of those. I just got 15 If you’re willing to

 

Leigh Drogen  50:58

pay me to nominally participate at no risk, except for hacking risk, because there’s there’s on chain hacking, or that’s really the risk? If you’re willing to pay me to participate in your thing? And I don’t really have to do much. I’m going to take that money all day. Yeah.

 

Jeff Malec  51:13

But help me understand that, because I’m still thinking there’s the risk that it turns into Luna and goes to zero? Yes. So yeah, so the risk is, yeah, just explain how you view that risk.

 

Leigh Drogen  51:24

Yeah, so the the main risk is hacking risk. And then the second risk is protocol design. So what we do is we score every protocol that we provide liquidity to, or that we farm, on eight different variables, on a one to 10 basis, and then we basically add up that risk score, and then we look at the yield that we should be getting, and we look at a risk adjusted yield. And then we position size into those protocols on a risk adjusted basis. And one of the main things that we have to look at is, what percentage of the liquidity pool are you, you never want to be bigger than 10%? Because you don’t want to be the liquidity of last resort in a run book, right? We have to monitor for the withdraw of other people’s liquidity so that we’re not in the runbook. And then you have to really understand the tokenomics and the dynamics of the system, right? So if Tara is subsidizing the yield, that they’re giving out in an unsustainable way, you just have to know when it becomes unsustainable, and when it’s still sustainable, and there are, you know, variables that we looked at, which have to do with the size of the size of the reserves that they had, and the number of people that were borrowing, so paying into the system. And when those things break, you just got to be ready to get the hell out of there.

 

Jeff Malec  52:56

And would you equate it to just like a long short fund that’s loaning out their long but right to get a little extra young.

 

Leigh Drogen  53:03

I see it’s a little bit more sophisticated than that, because we’re a little bit further out on the curve there in looking for protocols that are new, that we’ve read the code, we’ve read the audits of the code, maybe we know the founders, maybe we know that it’s a fork of another protocol that we know on another chain that we think is really safe. And we are looking to capture the rewards tokens from maybe an initial three or four month launch where they’re really trying to gather users. And so there’s a little bit more work that goes into it than just shoving money into Ave and getting, you know, seven or 8%. Yeah.

 

Jeff Malec  53:47

And how do you think about like the longevity of that whole ecosystem, right? We’re like, so for early days and grab the money in these first few years or whatnot? Like, how will you know, and me, I guess you’ll stop seeing new tokens with rewards. Right?

 

 

 

Leigh Drogen  54:04

Right. So I guess we have two really big like philosophical theses about defy, I guess you would say, right, one of them is the casino is the boot program for the real utility in the act, right? You need the casino in order to get the liquidity and the people into the system so that you can actually build real utility eventually, for everybody use in real world stuff. Right, which is the complaint right now that went through doesn’t actually do anything except for enable the casino. The other big thesis is that the ability to bootstrap a decentralized system with these rewards is not a big thing in this whole system. It is nothing right? Like it is a really important piece of why this whole thing works long term. In a sense, you’re going from Uber having to raise enormous amount To VC money, right? To then throw it advertising to get people under their system and fight a land grab war, to, instead of raising money from the VCs, you’re giving the money to your users, right. And just like venture backed tech companies, many will fail, most will fail. But some will attain escape velocity to the point where the system becomes liquid enough that they no longer have to give out the rewards. And there’s real utility in their protocol. This is something like uniswap, right, which has become big enough that they no longer have to give out those rewards. So I think that this is not only going to be around, but this is going to be a bigger piece of how companies actually bootstrap themselves in the future. And so I think as we go forward, you’re gonna see more and more protocols doing this and more and more money to be grabbed. At the same time, we’re gonna have more competition at the far end of the spectrum for grabbing those really good rewards from other intelligent institutional investors.

 

Jeff Malec  55:56

And so if I think of it like that, of like, okay, I’m investing in all these private companies, and they’re paying me to give them money, which seems weird, but yeah, but I guess it’s right. It’s like, Hey, I’m giving you

 

Leigh Drogen  56:06

a CD, maybe the great way to rent them.

 

Jeff Malec  56:09

Yeah, well, I’m not just giving you money. I’m, you’re selling me a bond, right? I’m giving you money, and you’re giving me a yield. But the kicker here is you can pull it at any time. Which leads me to like, won’t they eventually start coming up with like, Hey, you get a better yield, if you keep it in there longer, or like, I don’t want the money to be pulled right away. So what does that look like?

 

Leigh Drogen  56:32

That has already happened. So we call it the V model, which actually makes no sense vote escrow, which comes from a different thing. But it’s, it’s still the same concept where you’re giving different amounts of yield to people who have had the money in the liquidity pool for different amounts of time. And it kind of brings me to the concept of, I think we’re really, really, really early in the development of all these tokenomics systems. And we’ve been through a couple different cycles now defy 1.0, defy 2.0 defy three, we’re on three now. Right, like, and it just shows how early we are in the whole thing that we’re still in the very early experimentation stage of figuring out what incensed the right behavior on all sides of the system to build these networks into what they should eventually be.

 

Jeff Malec  57:22

I feel like that goes against the libertarian ethos, right? Like no one gets a special deal. Right? Everyone gets

 

Leigh Drogen  57:29

that that’s the thing about crypto is they say it’s this like libertarian thing, but at the end of the day, it is it is it’s it’s weighted, and it’s like there are philosophical views on all sides. It’s It’s nothing. It’s not one thing, it’s everything.

 

Jeff Malec  57:55

How do you feel about like all the retail that got killed and Solana and and all these coins, but Right? Are you feel like? Is this any different than any other thing of like, Hey, I was selling Gamestop into them buying it up? And it’s just how I do my business? And they know the risks? And

 

Leigh Drogen  58:13

yeah, I mean, I think in every single asset bubble, retail is going to behave poorly. Because to be really honest, I don’t believe that individuals should be playing around in pools like this. If they get screwed every single time, and they shouldn’t do it yet. Our society believes that they should have the ability to do it. Personally, I believe that they should have the ability to do it. I don’t think they should, but they should have the right to do it. And it’s kind of inevitable. It’s it’s just like any other asset class where, you know, look, you wouldn’t walk into an operating room and do brain surgery right without being a brain surgeon. Nor should you be playing in 100 Vol asset right without being without being somebody who understands how to manage risk. But that’s the story of markets since the beginning of time.

 

Jeff Malec  59:12

The grants almost the same thing of like you put money in your buddy’s restaurant and you did all this, like people just jump into risky things all the time. The Do you think when so are you big on like institutions will come and it’ll save the day and all this stuff? And if so, once the institutional money I think institutional money is usually just as dumb as retail, they just have more money.

 

Leigh Drogen  59:36

Well, we just saw that. Yeah, so

 

Jeff Malec  59:38

right, basically, well, those even if the retail slows down, well, the institutional just be a never ending stream of there’s a question here somewhere, do you think the institutional money will come and just get the beta or they do beta plus, kind of like the stuff you’re doing?

 

Leigh Drogen  59:53

Um, the institutions are definitely going to do beta plus eventually I think we’re probably on the bleeding edge of that the pure beta has been a pretty naive set, you know, up until now there’s, there’s some coming like us. Look, I think retail will be involved in every additional cycle, right. And this whole thing requires retail, it cannot be driven by institutions because it requires the actual users in the protocols, right. So for example, there is a company in a protocol, it’s going to be launching, I’m forgetting the name of Ira now, but it’s basically you buy a $500 dashcam, for your car, you stick it to the car, and you drive around, and it maps the road, and then sends it up into the cloud, right, and you get paid in their cryptocurrency based on all the different variables of your mapping, right? That requires consumers, you know, retail to be a part of it, right. And so this market cannot go forward without retail. And institutions will not be the driving factor in it. And as you said, institutions are just as dumb as retail, but in different ways, right? They tend to take too much leverage at the wrong times. And, you know, they tend it, they’re just, they’re just as dumb, but in very different ways.

 

Jeff Malec  1:01:23

No offense to all our institutional investors that are listening. And what