Behind the Hype podcast: Publicly listed companies using blockchain

00:10

Invesco: Welcome to the Beyond the Hype podcast. My name is Alex Olivares from the Invesco EMEA Marketing team, and today I'm joined by Alex Schmidt from CoinShares.

00:23

Invesco: Hi, welcome everybody and welcome to Alex Schmidt from CoinShares who's joining us today for a conversation on publicly listed companies with exposure to blockchain. Alex welcome. Could you maybe tell our audience a little bit about yourself?

00:37

Alex Schmidt - CoinShares: Hi yes, thank you for for having me. It’s a pleasure. Yeah so I work at currently at work at CoinShares UK in the equity index team where we manage the index with companies exposed to blockchain technology and cryptocurrencies. My background is I have a finance background starting in the City in 2013 where I covered a variety of sectors ranging from utilities, mining, that is hardrock mining and technology, and I think that's what made me well suited to to join Ellwood, which has been acquired by CoinShares in July this year.

01:22

Invesco: Super well, thanks again for joining us and diving right into the questions here.

01:27

Schmidt: Yeah.

01:27

Invesco: So what are some of the market trends for publicly traded companies utilizing blockchain?

01:32

Schmidt: Yeah, we have seen quite a big phenomenon in this area to be honest, uhm? To speak for myself, for example, when I when I joined Ellwood in September 2019, two years ago, we barely had any companies to invest in, in terms of pure players in this space. There there were very few exchanges, very few miners and um there were there was a big number of companies with some crypto and blockchain businesses.

I know for example Monex in Japan. They they have a big crypto currency exchange there, but obviously they cannot be considered pureplay because they have, you know, an FX broker in Japan and that's quite quite a big business as well.

However, going towards 2020 and especially the beginning of this year. You're seeing quite a lot of quite a lot of companies becoming listed. Uh, as pure place and the reasons why this is why this happened is, well, there's one of them is A) companies seeking capital for investment for growth. This is quite a quite let's say, relevant to the miners, which are capital hungry. And then there's been some growing investor appetite for blockchain. Especially because there's still lots of investors who cannot invest in cryptocurrencies themselves, so they have to go via the equity market via these proceeds, if you may, and and yeah, so this has been spurring quite a lot of growth in this sector.

03:30

Invesco: That's really interesting and and you've recently put together some research about publicly listed companies that have pure exposure to cryptocurrencies. Can you explain what that means?

03:40

Schmidt: Yeah, so these are companies whose core business is related to cryptocurrencies or blockchain technologies. We have split them into four categories in the report and if I may, I can go into a little bit of detail in each of them.

Uhm, so yeah, the first of them is cryptocurrency miners, which I think is perhaps the most obvious pure play company. They were one of the earliest coming to the market. They basically buy hardware, put them into some containers and start mining and make money out of it.

And then they we have the financial services companies in which we have a split. We made a let's say an umbrella term for banking services and consulting companies. You have, you know the likes of Silvergate, Galaxy. These guys are providing almost like investment banking services to companies like you know to some of these blockchain companies as well but also to other people involved with cryptos.

Then you have the exchanges which are quite obvious as well. More likely that people you and I are dealing with buying and selling cryptocurrencies.

Then you have the hardware companies which are the ones that make the mining rigs. Right now we could only identify two companies in this space, which are Canaan, Ebang and the let's say the two biggest ones, which are Bitmain and MicroBT, which produces most miners? They are still private. But yeah, I think Bitmain a few years ago I filed a prospectus to list but never in Hong Kong. But they never went ahead. But yeah, so initially it started with miners and financial services and now the exchanges make up the third largest groups in terms of number of companies. And then yeah, the hardware is still so quite small.

06:05

Invesco: Yeah, and you mentioned a lot of the functions there. Are there some kind of broader sectors that provide the exposure to cryptocurrencies and how are these firms concentrated in terms of geography?

06:18

Schmidt: Uh, do you mean broader in terms of other companies like I mentioned in the beginning, which have different exposures as well?

06:29

Invesco: Yeah, would you extend it more

06:31

Schmidt: Yeah, yeah.

06:32

Invesco: beyond beyond just you know, technology and financial services per say

06:35

Schmidt: Ah. I would say that the vast majority would be financial services and you know the if you take into account in the GICS, financials and technology like the vast majority of these companies.

There will be some companies that are in the media business as well that do provide some. We have some in South Korea that are, you know, Naver um, which is like, you know, kind of the Google or South Korea. So again, technology, but they are far more focused on media and they do also own bits in exchanges and stuff so you can find that it's also quite related. But yeah, I think it will struggle to find something outside those two or three.

07:31

In terms of listed ones, it's very, very dominant North America at the moment. US making up for like 44%, Canada 24% of companies listed companies. Then you have Europe, which Sweden, Germany with absent of identifying of 9% of each and the UK with 7%. There's some companies listed, pure players listed in Hong Kong as well.

And yeah, we didn't look into China mainland China because lots of these equities are off limits for most investors. You know the A-Shares is so very hard to to have a, you know, accurate view on that. But yeah, North American dominant actually US in terms of market caps. More than 80% of all companies so we very big dominance of North America there.

08:24

Invesco: Yeah, and could you talk a little bit more about the timing of, you know why we're seeing some of these firms list to market right now?

08:32

Schmidt: Yeah, uhm, actually in the beginning of the year was far more friendly than it is right now, but yeah. In terms of timing, I would say well initially the rally that you saw in the last quarter of last year, first quarter of this year, in terms of cryptocurrency prices, Bitcoin and Ethereum rallying quite a lot. A lot of these companies come to market right after these phenomenon phenomena happens, and actually in the report we have a chart showing that there's quite a big correlation.

It did happen as well in 2018 after the big rally in 2017, but also you're seeing a lot of capital hungry companies tapping into the market, and it's quite interesting. For example, NASDAQ makes it quite easy for companies to to file for they can file for um listing securities in advance of doing them so they can do as they require. Um, and they call it ATM financing, so that's that's extremely helpful for these companies. Lots of companies are enjoying the fact that, you know, market that does find a big premium and there’s quite a high valuations in the market, especially at the beginning of the year. And they decided to go to go public, then.

And then, finally you saw lots of SPACS. That also was a phenomenon in the beginning of the year. They were looking for targets. Lots of that has subsided now, but you're still seeing companies coming to market as well.

10:33

Invesco: Yeah, and could you add some a little bit more color on that so you know you started to discuss different types of companies? But how big are they generally and are they revenue making or loss making and what's the investor appetite for these types of equities?

10:47

Schmidt: Yeah, uhm, many of these companies um. They are revenue making. If you think if you break down into the categories I mentioned, you know the miners are inherently going to make revenue just because that's how their operations go, right? And financial services also. These companies that have come to market they are quite established in a way I would say it would be quite hard to IPO a company in this sector without any revenues at the moment, just because investors might be very skeptical in terms of that. Exchanges again are quite, you know, they make some good money.

However there are. There will be some companies which are still in project stage coming into the market still waiting to launch their their main product waiting to be regulated. They might not have that many meaningful revenues.

And then in terms of profitability it's a mixed bag to be honest. You will have many loss making companies. I think it's predominantly loss-making at the moment. And I I can actually relate to the beginning of my time at Elwood, in which you know, for example, miners were exclusively lossmaking because, you know, it's such a capital hungry industry and and and prices were really not very good back in those days.

However, if you look at them now. And with Bitcoin, even you know right now which some people might see those a bit depressed at 45K US. These companies are quite healthy in terms of profitability because their costs have not gone up so much. Actually they're finding power quite cheaply in North America right now. And so they can make some quite good money there and exchanges they did very well both

13:00

in the cryptocurrency rally that we saw in Q4 and Q1, but also on the way down because they don't depend on prices, they are really volume businesses, right. So they will make money when there's a lot of trading activity and depend on you know deltas, big deltas or lots of volatility in the market.

13:29

So yeah, they they still mainly loss making up. I would say 2021 will see quite a lot of improvement in for these companies and another point is difficulty hasn't gone up because you know, there's been so many backlog in the semiconductor industry and also the whole phenomenon with China banning cryptocurrency mining within the country.

So you would you know when conditions are so favorable for mining would expect lots of people to come into the market and difficulty to go up. But this has not happened. It has recovered a little bit in the last couple of months but hasn't gone back stratospherically like you would expect.

In terms of size in terms of market cap they are usually you know what you would call small to mid-cap. Lots of companies in the single hundreds to you know five/six million dollars market caps. And then you would see teams mostly under 100 employees. Now this can vary quite a quite a bit. Miners are companies that will have small management team and then, you know, maybe a few companies, two of them to overlook containers and you know supervised those operations, but really not that many because this is very automated.

Exchanges and financial services, you would see a little bit more because it would need developers to be adding features and maintaining those platforms.

And in hardware, you would see bigger teams because you need a lot of R&D and some manufacturing those companies.

I didn't address the last bit. In terms of investor appetite for the equities. I've mentioned before, that lots of people are trying to jump into cryptocurrencies, but they some of them are not allowed. And you saw in the beginning of the year, with all of these listings also there were lots of secondary listings as well and they were all amazingly, you know, over over subscribed and you know 1234x times, so there's this quite a lot of appetite for for companies getting to this Despite that they have to evaluations.

16:15

Invesco: That's really interesting about the investor appetite Alex. And could you maybe talk a little bit why investors would want to target equities as opposed to directly investing in the crypto currencies themselves? What are the advantages and disadvantages of equities?

16:29

Schmidt: Yeah, uh, I will start the advantages and I think the first mean of main one would be well, just because they can. You know some because there's so many restrictions you know these guys become a vehicle to emulate a similar performance as you will have with with Bitcoin or you know any other cryptocurrency.

But yeah, some of the other advantages is that you know these equity businesses are usually regulated and audited, meaning that you know that the figures that they present are reliable and you know, they are more solid businesses. That you would expect.

Also you have access to management teams and you can assess whether management teams are good or not. And you can choose to invest or not in those companies, and I think there's a lot of transparency going on with this.

And finally, you can. It's a way of acquiring crypto for for less money, especially in terms of when you look into mining, because you know, at Bitcoin at 45 and a mining business mining one Bitcoin for like $7000 or $8000. You were indirectly buying a big big discount.

17:55

Obviously these companies themselves traded valuation premiums, but that's one of the rationales for investing in these companies.

In terms of disadvantages. One of the things I could say about these companies as intermediaries, why add a layer somewhere that you know you could just go directly. And if you're looking at a portfolio and want to add crypto exposure to it, you may not get exactly the same performance as the underlying crypto you're looking at. So that there could be some noise in there.

And as I said before, this sector. Is insanely valued. The valuations are insane. And yeah, so people can be. People need to be very careful when they invest there.

18:52

Invesco: And Alex, a lot of our conversation has been focused on companies that have exposure to cryptocurrency. But what about those other companies that have exposure to kind of broader blockchain technology?

19:05

Schmidt: Do not have exposure to cryptocurrencies and you're talking about broader blockchain technologies, I would say A) they are rarer you don't find so much of that in the markets and B) it's a bet, right? You need to understand very well what they're doing. You need to investigate. Talk to them quite a lot.

We talked to some companies that we're doing something very interesting in terms of proxy voting, and they were using crypto blockchain. Sorry blockchain to make those ledges and mutable, and you know, for people to be able to do online voting and that eventually took off and became a very interesting business. But you're not finding so much of that.

I would also like to talk about companies that are not pure place so and advantages of investing them is that you have a whole other side business to support all that that whole operation. But the big disadvantage with that is that you don't get. The exposure that you might be looking for, so you might be you may end up with a lot of noise. And let's say you know Bitcoin goes up by 50% that business which is so diluted might go up by just you know 10 or 15%.

20:36

Invesco: Yeah, thanks for that answer and kind of. Shifting on tangents here, energy consumption has been a major headline for crypto currencies in particular, but one could even argue blockchain more broadly. And in a previous podcast we linked up with some colleagues at Cambridge who were able to shed light on the nuances of blockchain energy consumption. But what are you seeing on this issue in particular?

21:05

Schmidt: Yeah, so we talk a lot with cryptocurrency miners. I think we have talked to pretty much all of the listed ones there and also to other investors. So what's happening? What we're seeing is that a A) miners are seeking greener sources of energy. You see, there's a lot of miners based in, especially in Quebec, where they have a lot of hydropower capacity, some of them are based in Iceland, Sweden also hydro geothermal, so they're quite good.

Some of them are looking for excess for carbon capture, flare gas, and other sources which are not 100% green, but let's say better than, uh, you know, pure coal or pure gas, even an.

Also, you're seeing green energy mining pools. Where some miners are joining up together so that they can strengthen their ESG profiles. And you know, if you see a miner in that pool, that can mean that they will be, you know, using those greener sources of energy.

And then yeah, when you talk about energy usage itself, then there's a discussion between baseload and peak load power. So if they are, you know, if they are only using peak load you can see that they are having quite a quite a big burden on the system and you could you could you could say that you know they are A) taking

23:01

the place of someone who would be consuming that power, and B) usually peak load is far less environmentally friendly energy. So so there's that discussion.

But on the other hand you could also say that these companies are helping make projects viable because if you are taking, for example, intermittent sources of power.

You know, let's say a wind turbine is producing a lot of wind at 3:00 o'clock in the morning, and if you have a miner that's willing to take that power for for cheap, it makes you know A) the miner find a cheap source of energy and B) the wind turbine operator they get revenue at that point in which they wouldn't. So that's how they they can fill those gaps and help those increase the revenues of those projects.

And finally, you see some miners also who are offsetting to the carbon footprint with carbon credit and stuff. Now there are some some people who might see that as you know, hey, great and some others might see that you know it's not the way to go, but they're trying to certainly try to reduce their footprint.

24:25

Invesco: That's really interesting, and it adds a lot of nuances of the conversation because the headlines could sometimes be so, so distracting.

24:32

Schmidt: Absolutely, and I mean I think people like to jump into into those big headlines and see know the what Elon Musk says and take that at face value, but it's not black and white. There is a lot of things going on in the background and people need to take that into account. We also do that.

24:53

Invesco: Definitely, and along those lines, maybe there's some nuance to be said around the governance for companies that utilize blockchain or that have exposure to cryptocurrencies. Could you talk a little bit there about what you see is the major issues?

25:10

Schmidt: Yeah, well as you mentioned, yeah, we look into into equities more than the protocols themselves. Our focus is on the companies and I think, one of the going back to advantage incentives advantages, but one of the advantages is that. The level of scrutiny of on these listed companies is far bigger than than around crypto themselves. You know we have the SEC looking at these businesses and making sure that they have boards that are, you know, on top of things with management and and the businesses.

And shareholders are far more able to voice their concerns then you know in relation to companies than crypto users. Just think about Ichan or you know the elite funds these companies have been able to charge quite a lot whilst. Uhm, in crypto currencies and block some company some some users, you know the decentralized nature of them makes it very hard for users to have a meaningful voice, and sometimes they end up at the developers themselves have a bigger say. And it's almost like you know the community is to shareholders and the developers are management as a bit of a comparison. But I think in terms of equities. There's a whole legal framework that supports shareholders there.

26:51

Invesco: Great thank you. And finally, what's the outlook for blockchain, especially for publicly traded companies that utilize the blockchain as we were discussing?

27:03

Schmidt: The number of companies listing has been very high and you know, like I said, people are choosing to list after price rallies and and you have seen that happen this year an and you're seeing these companies mature. You're seeing them having hiring former people from Wall Street, former people from you know, mining businesses like you know, traditional mining businesses, from traditional other companies.

And that's very good, because you can see that both boards and all are taking this seriously. And also the CEOs believe in this company. And I think that helps the whole investment community around there.

I would say that you know the only negative I could see there is that the increased regulation around cryptos, they could make cryptos more appealing to investors and reduce some of the appetite towards the equities involved in that, but I don't think there's going to be any cannibalism there. I think both sides are able to grow, and actually increased regulation around cryptos could be beneficial to companies dealing with them because you know they could see higher volumes and and higher individual interest going into that space. So I think everybody is likely to win there.

28:36

Invesco: Great, thanks very much for sharing your outlook there and if people want more information on some of the research pieces that you mentioned, they should visit the CoinShares website. Or they could also look at etf.invesco.com where we have other research pieces on blockchain.

Well Alex thank you so much for a really fascinating discussion and sharing your thoughts, especially given your insights and where you sit in terms of the blockchain investing universe so thank you for joining us.

29:04

Schmidt: Thank you very much as being that big pleasure.