A Conversation with Michael Sonnenshein, Managing Director at Grayscale

The following transcript is taken from episode twenty four of The Scoop, The Block’s flagship podcast. Listen below, and subscribe to The Scoop on Apple, Spotify, Google Play, Stitcher, or wherever you listen to podcasts. Email feedback and revision requests to [email protected]. This transcript has been edited for clarity and length.

Frank Chaparro Ladies and gentlemen thank you so much for tuning in for what is an incredibly exciting episode of The Scoop because there is an actual scoop tied to it. We're joined by Michael Sonnenshein , the managing director at Grayscale -- one of the largest asset managers, probably the largest asset manager -- a couple billion dollars under their helm here in New York City and I am of course joined by Ryan Todd my very special co-host and and an analyst at The Block. Michael is joining us to share news of a record breaking number of inflows into the firm's many different crypto asset funds. Michael's been with the firm since 2014 I believe, he's risen through the ranks. He's got a small but gritty team over there sitting alongside our other friend Michael Mauro. Michael thank you so much for joining us. Please, I guess the best place to start if we're gonna start anywhere is with this quarter three report. It's a record breaking quarter. What's behind it?

Michael Sonnenshein Well first of all thanks for having me.

Frank Chaparro I'm sorry for being late.

Michael Sonnenshein Well the public apology is is really, I gotta say I really appreciate it. But let's dive into the numbers. This was an amazing quarter for Grayscale. We raised just shy of $250 million in the third quarter of 2019 which breaks every preceding quarter we've had in the six year history of the Grayscale business. The flows were mostly dominated by institutional investors which is probably one of the most important things for us to talk about Frank. Whether it's you guys or other folks in the press, you're always asking us, where are the institutions? And why aren't the institutions coming into digital currencies yet? And I would argue that they've been not only showing up to Grayscale but they've actually been showing up in droves.

Frank Chaparro It's interesting. You make a good point, there is this dichotomy that I'm seeing as well. You have certain players that are doing better than others. When we look at companies like Fidelity that's off to a slow and steady pace. Bakkt -- the volumes aren't quite where we would want them to be perhaps. There aren't that many headlines about larger hedge funds and larger pension funds entering the market or entering the fray. But we do have these numbers at the same time so is it... Are they quieter firms that maybe don't want the press attention? What is Grayscale's quote unquote secret? If they're attracting these inflows that other firms might not necessarily be seeing?

Michael Sonnenshein By and large it's difficult if you're a hedge fund or an institution or even as an individual to get exposure to digital currency. Folks have got to figure out where they're gonna buy it, how they're going to transfer it, how they're going to store it, how they're going to safekeep it and that's challenging because it's definitely not the same as going into your brokerage account, punching in some stock symbol and just clicking buy and then all the settlement and payment kind of happens in the background for you automatically. Digital currencies are totally different from that. And so the secret of what or not so secret sauce at Grayscale is the fact that we have packaged digital currency exposure into a security so if you're a hedge fund, if you're a high net worth investor you can buy into any one of our private placements any day of the week. We have 10 different funds and that lets you do something that feels very familiar to any of the other investments you make. It's a security with a CUSIP and has audited financial statements and produces tax documents. It's what investors want to see.

Frank Chaparro So let's break it down why would I as an investor of a large, say manage hundreds of millions of dollars. Break down for me why it's better or more familiar to invest via these private placements? This is a security as opposed to onboarding through the... a lot of these crypto exchanges have institutional offerings. Why is it better to get the exposure via private placement as a hedge fund versus just opening up an account with white glove services on Coinbase?

Michael Sonnenshein A lot of hedge funds just by mandate can't hold a digital asset. It needs to be held either with a qualified custodian or be something that they're easily able to have on their books and records. And so for a lot of folks when we start talking to not just the CIO but when they're ready to invest and we start talking with the legal teams and the auditors and the risk teams the fact that they have something that is a security that has a CUSIP and that's audited is exactly the same thing as any other instrument or derivative that any of these funds use when they're looking to gain exposure to something. If they're to buy digital currency directly they have to figure out who at the firm is going to have access to the private keys. They're going to have to determine what's the appropriate cadence of checking the balances of the digital assets et cetera. And quite honestly investors are really more so and should be more so focused on when's the right time to gain and take off exposure to certain assets, not necessarily worrying about the security and safekeeping of an asset they're invested in.

Ryan Todd I get that argument, something I'm always curious about is how do you compare that versus say the regulated futures that are now starting to come out. Whether that's Bakkt's physically delivered product or even CME's bitcoin futures product. Hedgefunds do have familiarity with those types of products, what's the value add with Bitcoin Trust?

Michael Sonnenshein We have a lot of our clients using futures to hedge. No question about it but there are some of them that are either looking at capital requirements related to using some of those products and when they look at the transactional costs they would actually deduce that it is more cost effective to gain exposure to Bitcoin through Grayscale Bitcoin Trust than it would be for them to either use futures or even buy these assets directly if they had the legal framework that allowed them to buy and hold directly which most institutions unfortunately don't.

Frank Chaparro Bottom line is you're saying it's cheaper to buy GBTC as opposed to...

Ryan Todd Even with the premium, do you guys take that into account as well?

Michael Sonnenshein So where are institutions are getting involved is through our private placement. So any of our institutions can come to Grayscale directly buy an NAV on a daily basis and that way they're actually getting exposure to digital currency directly at a price that reflects where it is on a given day when they're investing.

Frank Chaparro So let's focus in on that for one second because it has been a topic of conversation which is the premium that sometimes occurs with this product. Sometimes hundreds of percentage points in some cases with certain products. Is that something that you guys can remedy? And in conversations with clients when they bring this up how do you sort of walk them through the understanding of it?

Michael Sonnenshein So if you're an accredited investor, high networth individual, family office, hedge fund other type of institution you can buy into the private placement for Grayscale Bitcoin Trust or any of our other products you're subject to a one year holding period at which point you're able to get liquidity on your investment by selling your shares into the public market. So for Grayscale Bitcoin Trust that is symbol GBTC and as you guys suggested that does historically and currently trade at a premium to the fund's net asset value. That is primarily a function we believe of supply and demand in the market. There is more demand than there is supply of shares available because this is the only security available in the US that lets investors gain exposure to Bitcoin right alongside any of the other assets they may own in their brokerage accounts or retirement accounts et cetera. And so it is not something that we can directly remedy so much as the price is really dictated by the market on a day to day basis.

Ryan Todd Do you guys get excited when well maybe not excited, I don't know but it's favorable when ETF's on bitcoin don't get passed for your product? Just in general, it's still the only avenue for these types of investors to get exposure into this product. How would that change if there was an ETF?

Michael Sonnenshein So we actually spent 2017 working on registering our product as a 33 act ETF and ultimately pulled out of the process just citing that the market wasn't ready for it nor were really regulators and so when we have conversations down in D.C. folks have generally been pretty proactive about the space. The level of understanding that they have when we're there has ramped up so substantially over the last few years and an ETF is really more of a matter of when not so much a matter of if.

Frank Chaparro Specifically does it impact your business in any meaningful way whether one gets approved or not?

Michael Sonnenshein We're in favor of seeing any additional onramp into the asset class so whether we now have an additional derivative using Bakkt as opposed to only having CME or seeing exchanges have better KYC & AML or even seeing additional access products get launched -- the more avenues there are for capital to flow into the asset class from our standpoint the better the asset class will be overall.

Frank Chaparro So Grayscale has made some waves, has gotten some attention for their recent drop gold campaign. It's been a couple of months in the making. You guys put a lot of resources... I actually see the commercial pretty frequently on YouTube and other business shows or CNBC. What has the success of that product looked like? And has it played into this pretty significant uptick of non Bitcoin trust inflows since a few months ago?

Michael Sonnenshein Sure. Well so Drop Gold #DropGold. We launched in the beginning of May of this year and so the idea behind the campaign has been and continues to be a call to action for the investment community. It is now nearly 2020 and we're starting to task investors with this question which is, what constitutes a store of value? It historically has been gold but that may have made more sense for a physical age. As we are in fully immersing ourselves now in this digital age perhaps gold doesn't hold up as much as it once did as that store of value and perhaps investors need to think about a digital store of value such as Bitcoin and the campaign has been really the core of that question for the investment community. Dropgold.com -- we created to kind of house a bunch of educational content for investors thinking through this question. And as Frank said the campaign has taken the form of even a TV ad that's been playing on CNBC and other outlets throughout the year. What we've learned through the campaign is this is not only a narrative that is resonated with the investment community. Zero question about that but more so that it is driven awareness around Grayscale and driven awareness around the product offering. We'd certainly attribute some of the success of the campaign back to a record breaking quarter for us on the asset raising front.

Ryan Todd Outside of the campaign. What other types of getting out there in front of investors... Like what's that process look like? I in person? frequet meetings? How do you actually bring in actively?

Michael Sonnenshein Sure it's it's important for us to be out in front of investors. While most investors these days we encounter have that kind of preliminary 101 digital currency education it is still interesting to see in the age that we're in that handshakes and face to face interactions and giving investors the opportunity to ask questions that they may not otherwise ask through a phone call or over email is something that we do in person. So our team is out on the road quite a bit with investors and will descend on a city -- call it Chicago or we were just in Vancouver a couple of days ago and what's been interesting to see is that even though we only give ourselves two or three days in a given place we're actuall