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- [00:01]
A
All right everybody, hello and welcome to Bits and Bips, where we explore how crypto and macro collide one basis point at a time. We're going to start today with the latest stories in the worlds of crypto and macro.
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- [00:42]
A
all right everybody, I'm your host Austin Campbell, now equipped with Water High Scholar of Zero Knowledge Group. And I'm here with my co hosts Ram Alawalia, Maester of Wealth leader of Lumina, Chris Perkins, the golden hand of 250 digital asset management, and our guest Gordon Liao, Master of Coin at Circle, who I'm particularly excited to have on today given what's going on in both the news and the rates market. So if you're not familiar with Gordon, trust me, you're going to enjoy this one. Now let's start actually specifically with Circle today because news came out that Coinbase and Circle have essentially eaten usdh. And what I mean by that is that USDH is being sunset. USDC will be enthroned as hyper liquids aligned quote asset. So native markets, which had won the governance bake off eight months ago is being acquired by Coinbase. I will remind everybody that there is a long standing and existing relationship between Coinbase and usdc. So what will happen is USDH holders will redeem for USDC during the migration. Coinbase is going to become the treasury deployer, Circle is going to become the technical deployer and is staking, I believe, 500k hype to move toward validator status. 90% of the reserve revenue will flow back to hyper liquid. I believe it will fund hype buybacks through the Assyrian Distance Fund. And what this ultimately means is a significantly greater structural tie between Hyperliquid and the Coinbase and USDC ecosystem. Right now in round numbers, 5 billion. USDC at a little under a 4% yield is just under $200 million a year. Some of that will be captured by Coinbase. Most of that will go to hyper liquid so circle will get another outpost in order to deploy USDC on chain and continue expanding volumes as they chase tether. So I'm going to give the bull case, I'm going to give the critics and then Chris, I want to start with you as someone who's been an investor in this space. But the bull case deeper books, less conversion, easier deposits, faster exits, better market maker support, hype tied to usage fees, staking builder activity and stablecoin liquidity. Now per our Aries Bitwise is also launching a spot Hype etf. At the same time we're seeing hype starting to move more into the mainstream. On the other hand you have people like Zach XBT arguing that sort of USDC concerns around ruggability in his words are unresolved. And some questions around the native markets going governance however the structure publicly I think is one worth laying out here. So Chris, let me start with you. As an investor in this space, how do you think about this whole transaction?
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C
Look, I think this is one of many that you're going to see when it comes to capturing what I like to call net interest income. And so if you step back and you look at the traditional model for exchanges, you make ticket fees, so when there's transactions you make a little fee. You don't usually make money on liquidations. Maybe that's a new innovation in our space as much as you hate innovations. But that's another business line, I guess sometimes you make money on data, but you make a lot of money on net interest income. And the way it works in traditional finance is somebody gives you dollars as collateral. You take those dollars, you give them to the clearinghouse, they invest them, they keep a bunch of it, they give you a little bit back. That's your net interest income or your nim as some people call it. That is a fundamental part of any exchange business model and a lot of them just ignored it for a long time. Not really decentralized guys, but a lot of these apps and they were letting that beautiful revenue go to waste but now they're taking charge of it. They're saying listen, I should be capturing the vast preponderance of that float that's going to contribute to my business model. I I'm here to tell you that every single place that traps any kind of tvl, whether it's an exchange, whether it's a other sorts of apps, prediction markets, they're all going to look to monetize that float because why would you give it to a third party no offense, Gordon, like circle, when you can internalize it yourself. And so that's the bull case. If you're looking at the exchange, the exchange, the lights gone on. I think hyperliquid rallied on the news because now, like, now the circle's complete again, no pun intended. But you've now solved for net interest income, which is very important, and that's going back to the shareholders. If you're circle slash coinbase, you also have a win here because, and again, I think the devil's always in the details on like, you know, how long is the hookup, you know, what are the, you know, how often can the rates be negotiated? I don't know if Gordon's able to share that or not. But what you get is you get ubiquity, which, with your stablecoin, you, you, you have more. And generally speaking, USDC is fungible. And so the more you flood the market with it, the more it's going to be accepted by end users as a form of payment. So I do think that USDC wins as well, and then maybe in time there'll be a difference in, and maybe they, they, they change the balance. I don't know. Again, the, the economic terms, but hyper liquid, big win, softer net interest income, Circle gets more ubiquity, you know, bigger size, more distribution power law and obviously, hopefully incremental utility. I think it's pretty much a win win. So congratulations.
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A
Yeah, Gordon, I actually, so I want to lob this one up. Being, you know, familiar with Circle myself, I think there are a lot of different angles to USDC as it exists in the market right now. Looking at this as a market participant from a market structure standpoint, in the US we're used to thinking of money as being pretty segmented. What you use to buy a coffee is not what you use to settle a derivatives trade. But here we're starting to see increasing fungibility as USDC is used for a lot of things. How are you thinking about this from the circle side, but also like zooming out to your economics background from a market structure side as well.
- [07:11]
D
Thanks for setting that up. Yeah, I think there's a couple of things to recognize. One is we're seeing a broad maturation of platform of infrastructure, you know, hyper liquid being the dominant per deck today. And that have grown quite a bit in size. And along with it, the USDC balance on the platform has grown roughly doubled year over year. Right. And while eight months ago and nine months ago there was a vote and the governance at the time chose a different reference asset. I think as the growth and maturation of platform become evident that they need to also engage with more traditional institutions using high quality institutional grade quality collateral asset is also a key part of that. So the choice of using USCC is a testament of the underlying security, underlying promise of one to one backing of usdc. And as Chris mentioned, I think this is also a point in which it's a win win because it is a liquidity supernova event. Being the dominant perp on chain, that means the collateral asset that's being used for the perp is also being used and radiated out to the rest of the on chain economy, whether it's other Dexes, other type of platforms, as Babai says, centralized platforms. So it's a very big liquidity event for encouraging the usage and functionality of USCC and also by association other infrastructure for no we deployed USCC on hyperliquid last September along with cctp. So it's been there for a while but it's a good recognization. Yvonne and as you mentioned there has been this debate about what is a stablecoin more broadly, is it a medium of exchange, is it a store of value? And we're seeing that it could be multiple things at the same time. It is certainly used in some contexts as a medium of exchange for payments, but in other contexts in this context for capital mobility, for collateral mobility. And that will increasingly become more and more important as the system scales as they become more institutional grade. And similar to that trend, we're seeing a lot of sediment values. As we reported in our earnings recently, we saw $21 trillion of on chain settlement in USDC in the first quarter alone. That speaks to how the infrastructure expanding and how liquidity is improving along with the largest platforms, whether it's centralized or decentralized.
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A
All right, so pulling on that thread a little bit, if we zoom out and look at the ecosystem, a lot of USDC flows also integrate quite tightly with Coinbase. Right? Like reminding all the listeners, some of whom are not Americans, Coinbase has a huge number of products that bootstrap off the back of USDC debit cards, you can pay credit cards, you can use Coinbase for business payments. Now we're also using it as like a central asset for exchanges like hyper Liquid. Rahm, let me actually throw this ball to you on the market side of things. Does this make you more or less bullish on Coinbase on Circle in terms of the stocks and on the deployment of stablecoins vs banks overall it's a
- [10:44]
E
win for all of them. It's an especially big win for Hyper Liquid. For Coinbase and Circle, they were able to neutralize an emerging competitor. Very strategic move to get USCC involved. And with Coinbase as essentially this collateral manager, installing themselves at a very key point in this new infrastructure for hyperliquid, it's a major win, 90% of the revenue here. So that's the toll that they exact for having accomplished a tremendous amount over the last several years. We talked about HyperLiquid, I think three or four weeks ago. This is one of the assets that you want to own this cycle. And it was very prophylactic of Coinbase to get ahead of that because Hyper Liquid is emerging as a decentralized trading venue. Obviously Circle generates a material amount of recurring revenue, net interest income. So it's a win for everybody. But it's especially a big win for hyperliquid.
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A
I think it goes back to another point we've discussed too, which is that distribution is ultimately going to drive a lot of the gains in this system. Like Gordon, you were just saying Hyper Liquid is like the perps decks emerging in the crypto space now. So I think all of the parties sort of aligning together are recognition of you're following where the distribution and where the users are. I think that's a thread we're going to continue to follow throughout a number of these sort of situations as we look at who are the winners and losers going to be. So speaking of winners and losers and somebody with quite a bit of users today we got news that Elon Musk lost and Sam Altman won, at least in round one. So an Oakland federal jury unanimously rejected all of Elon Musk's claims, deliberating for under two hours in the OpenAI versus Musk case. The ruling however, turned on the three year statute of limitations allegedly or at least in the eyes of the jury. Musk knew of the for profit shift by 2021. He sued in February of 2024. The judge said she'd accept it as her own verdict. She dismissed the case. Musk had been seeking 134 billion in quote Ill gotten gains and Altman and Brockman removed from leadership based around the 2025 for profit restructuring. Now the merits of this case were never settled. They did not rule on breach of charitable trust. They did not rule on unjust enrichment. None of that was adjudicated. Musk's team has already said they will appeal on this point. And Wired hilariously said the closing arguments made everyone look terrible. That both Musk and Altman were painted as self serving by the other side. However, the read through here is that it could be very possible, at least in the interim, for OpenAI to go to an IPO. So I want to read a few X reactions and then I'm going to let all of you guys fight about who the winners are here. Chris, we'll start with you. I know you have a related rooting interest here, but structured Skeptic on Twitter. Legally this is a major win for OpenAI. But politically and institutionally, the bigger question remains untouched. What happens when an organization builds public legitimacy on a nonprofit humanity first mission and then becomes one of the most valuable commercial platforms in the world? The News24.com, a nonprofit machine founded to benefit humanity, pivoted hard into a closed Microsoft backed profit machine. The trial did fundamentally expose broken promises around openness and safety. So I'm going to start with you Chris. Did they win on a technicality? Do you expect this to stand up? But also equally so, what does this say in our modern world about what is possible with foundation models? Models?
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C
Yeah, it looks like the statute of limitations was exceeded. It was very cut and dry. I don't know how Elon's attorneys plan to appeal, but they're very, very smart and I'm sure they'll figure out how to do it. Just want to point out that this is the time of the episode where Rob is going to say something bad about OpenAI and he's going to say nothing Burger. But before we get to him, I think the bigger question now is in crypto land you have a lot of challenges because due to regulatory scrutiny over the last four years, we have these situations now where many of the foundations were structured as nonprofits and you also have labs. And so I think I would love to get some closure here and hopefully that this doesn't delay, which I think is perhaps more natural structures. Amongst many of these protocols that have the foundation labs. Everyone's confused who does what, what does who. I would like to see that streamlined in the future across the board. And I'm not saying that there's no need or use for foundations. There absolutely is. And I think that there are a number of nonprofit ideals that they could advance for their ecosystems, whether it's cross with Ethereum or otherwise. But I think many of these foundations were set up maybe because they were a way to protect against a very aggressive regulator. So I think this case will have some far reaching consequences in the crypto space as well. And Sam is know increasingly involved in that space. So I don't know. Rob, your turn, buddy.
- [16:24]
E
Look, you read me right down the fairway. Chris Marcus did not expect anything to come of this. So nothing really happened. It is a nothing burden. So. So there's. There's one for two.
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C
There you go.
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E
These are two for two. A lot of heroes and villains coming out of the tech sector. Okay? I put Elon on the hero side. I put Sam Alma on the villain side. Doesn't mean that they haven't created a lot of value, but I think a lot of that's playing out here, right? He's got a history and a reputation now of cutting deals that are illegal under contract law. He even did that with Microsoft when he cut the deal with Amazon, which led to a renegotiate with Microsoft. And Microsoft exacted highly favorable terms
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A
as
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E
a concession so that OpenAI could get the funding they need. And of course, Microsoft wants that so they can liquefy their 10x investment in OpenAI by funding its capital. Right. So Sam is one of these guys who's, I think, clearly a villain. He's fired by a board that he appointed. He has accidentally seated his primary competitors. He's got an employee that died under his watch under questionable circumstances.
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C
Oh, come on, man. You're getting a little bit. You're going a little extreme.
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E
No, no, no, that's a fact. He had someone die in his watch under questionable circumstances. Is that not a. That's an accurate statement? Those circumstances are questionable, okay? I mean, that's just a fact. But look, yeah, I think they're heroes and villains in this. In this category, and I put them in the villain bucket. That's it.
- [18:16]
C
Does Gordon have a view?
- [18:18]
D
Look, I think if you zoom, the AI space is super competitive at every single level, at the foundation model level, at the application level, and this is playing out in court. But if you think about where the opportunity is for this audience of combination of blockchain and AI, I think building the Rails for tomorrow for agents, for AI, is very important. And frankly, that's a bit of what we have been building at CIRCLE with our agentic stack release with also arc, which is what we call the economic OS that we're trying to build for AI agents. I think that will have enduring network effect and value, just like USCC have very strong network effect, as we've seen. So, you know, while there is competition at these foundation model level, I think that shouldn't from a business angle, there's plenty of opportunities elsewhere.
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C
I think the competition's excellent. And we need more of it. And I think that's very, very healthy for what we're getting into. Look, none of these guys are perfect. I'm not perfect. And it's a vicious, vicious race out there. I'm hopeful that they continue to innovate, they continue to drive value, and I hope that the free markets prevail.
- [19:37]
A
I'll hop in here to pull on a thread we were just talking about from a previous conversation, which is we're having a huge fight in court right now over OpenAI because the market, well, let's be specific. Private markets are saying that OpenAI is extremely valuable as one of the foundation model companies. But let me stress test this. I'll steal a term from Rahm here and say, in the long run, will this trial potentially be remembered as a nothing burger? And the reason that I ask that is if the thesis is right that distribution is where a lot of the market value ultimately accrues. Do we think the value is going to eventually reside in a company like OpenAI or Anthropic, or is the value going to reside in the platforms that bring those models to people and can take a toll from them? So I want to lob that ball up. Is are what we watching here a fist fight over something perceived as valuable, but it won't stand the test of time? Well, Rom, you had your hand.
- [20:41]
E
I'm definitely all over this. It's really the latter. There's very limited value capture at the LLM layer. They're doing public good service for the rest of us by investing tens and tens of billions of dollars to get more free services. But Microsoft has their IP and after they liquidate their stock in six years, they have all of their ip. They can do whatever they want with it. They can even deploy the Internet. I'm not saying they would do that. But the value of an LLM is the model weights that that's called ip. They've got. They will have it in the hands of a direct competitor, will not have this unaligned interest. So I'm rooting for the AI labs to raise more money and invest more in the future of humanity. But there's no value capture in those kinds of business models. Now you've got Meta. So Meta brought in like the A team for Those that have 80s movie references like Airwolf and 18, but they're rolling out new models, are quite compelling, they're powerful and they are spending a lot of Nvidia GPUs. So it's still early days in this race And Quad is in pole position, growing revenue substantially. I also read today that Dell, Michael Dell shared that signed up a thousand new enterprise customers. How amazing is that? So we've gone from a world where it was the hyperscaler, spending a lot on GPUs and the AI labs to real commercial adoption and it's still early days. So pretty exciting. Pretty exciting. I think it is the whoever owns the end customer and delivers the most value primarily going to be the application layer and these cloud businesses and other AI enablement service providers like the Accentures of the world that are going to do really well.
- [22:31]
C
Yeah, I think it's maybe a barbell. I agree with you on distribution, but I think the other end of the barbell is energy. You know, he who has access to unlimited energy and effectively cheap compute probably get a win. And I think it's pretty fair to say that Elon has an edge there. I know that we were talking about it this morning, the physics, the science of getting your energy pretty much for free in space ain't easy. But if anyone can do it, it's the guy who has the, you know, I don't want to say the M word, but he has a very, very robust capability across the globe in getting things into outer space. So I think that's Elon's unfair advantage, you know, at the very back of the stack. But yeah, in the front distribution wins. We also, Rob, haven't seen Apple really come forth with its plan and how often have we seen Apple come, come in out of the top ropes really late and dominate and so, you know, obviously there's been a bit of a shake up there. That's the other one that we need to watch.
- [23:34]
A
I'll hop in and say I think Apple is a very interesting story in this space because as most of their competitors in the MAG7 have started to earn a huge amount of money on capex and building the models. Back to our discussion about is the model layer where you capture value Apple appears to be sitting on. We are a vertically integrated hardware company, right like from front to back we can build everything from an iPhone and a MacBook Neo all the way to like servers. Mac Studios, we could distribute. We are going to be the end point for you to distribute your models and we're going to take a toll. You can look at the same thing they've done with the App Store. You can look at the same thing they've done with ecosystem tie ins. By the way, Chris, to another topic near and dear to your heart about identity. They're one of the few companies that's done at least an adequate job of that in privacy. Right. Of the big tech companies. So they might be more trusted about some of these things. I think one of the things I'm watching is an increasing divergence between am I trying to build AI myself or am I trying to implement other people's AI and charge a toll for that, which means you're going to be a distributor. And so with that comment, I actually want to throw the ball back to Gordon on that and ask. You're obviously currently at a company that does a lot of work with a form of money at Circle and you've been watching not just agentic commerce, but call it finance companies writ large tangling with the AI side of things. I want to ask how you think that plays in with the modernization of the US financial system writ large and adoption of these new products. Because you know, for those again who are looking only at the United States, I will remind everybody that Asia has had real time gross payment 247 systems since like the late 90s and early 2000s. So we're currently two decades out of date. And I'm curious if you think this will accelerate other parts of the financial economy, not just essentially the AI sector.
- [25:34]
D
Yeah, absolutely. I think look, currently most of the transactions are human mediated and there's no surprise by many predictions that machine to machine or machine initiated payments will dominate. And while today these large LM models and companies are quite large and important, as others pointed out, that these models are changing really quickly and even the open source models are not so far behind. So more and more will accrue. The value would accrue to I would believe both the commodities and hardware, but also the rail on which these agentic commerce happens. So for instance, what type of agent commerce, nano payments is something that we have done some work on. We released our nano payment protocol having agentic marketplace where agents could scroll through and find the other agents even without human being around using the best tools. That is also something that's deeply valuable for just more machine based commerce. And all of that I believe will be built on the blockchain rail. This is what we have done quite a bit recently with Ark with our agentic stock. And I think that would be a huge growth area and that will integrate very closely with finance, which I know we'll talk in a little bit about clarity and all those stuff. I think it actually quite closely relates to, you know, activities that are being discussed versus more traditional balance sheet based intermediation.
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A
All right. So I want to give a counterpoint there on that one. So I have heard often the agentic payment thing going through blockchain Rails, I also think they're just going to use traditional Rails. And what I mean by that is it's pretty easy to have the agent have a credit card. And I think the winner of this space will actually be the one that can flow between systems. So going back to like the Coinbase Circle partnership at the center of things, or if you look at some of the announcements starting to come out of companies like Fidelity, where they're building money market funds, they already have a brokerage cash management product. They're going to have a stablecoin. Agents seem to demonstrate so far less, call it loyalty than human consumers, but they seem to be good at optimizing through flows. And not all flows have the same framework. So sometimes you want a blockchain payment, sometimes you want to pay with the card, sometimes you might want to pay with bank details. I'm going to hypothesize that the winners there for agentic commerce are the ones that make it easy to flow between all of those in integrated fashion. So I think things that are trapped either purely on chain or purely off chain potentially lose to things that are very good at spanning both of those as a theory. But that also does lead us towards having a discussion about potentially clarity and what the rules for these sorts of things are. So before we go to that next segment, because I know we're going to talk about that for a bit, let's go ahead with our second commercial break and we will
- [28:59]
B
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- [30:44]
A
All right everybody, welcome back. We are going to be hopping momentarily into clarity and then interest rates. But before we go, Chris, you wanted the baton next, so go for it.
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C
Yeah, you're, I mean you're talking Austin, and you're talking about how agents hyper optimize. And that's one thing that we've, we've learned. If there's anything that they're awesome at, they almost over optimize. And I guess my question would be in that world, and I think you alluded to it, do money markets win? And the reason why I'm asking that is because if I'm an agent, I want that, I want that interest to come to me, not to go to the stablecoin issuer. And do they start, what prevents that? And then I guess the second question is, what's the freaking difference between a money market fund and a stable coin? When you step back for a second and you ignore wrappers and other stuff and you say fundamentally, if it's the same risk and I get interest in one, I don't get in the other, why would any agent go into the stablecoin space?
- [31:41]
A
All right, so I'm going to pile in on that one and say this is something that clarity is actually quite important for, Chris because the distinction between payments products and investment products has a lot to do with the legal structure in the United States. Right. So like rewinding the clock for people you know and putting on my business school professor hat for a moment here. We had the 1933 Banking act, we had the 34 and 40 act in the security space. We subsequently had the BSA which is technically handled by banking regulators, not the securities regulators. And we have the proliferation of agencies in the United States. If you're in a place like Japan where they have the fsa and you go over there and explain to them we have somewhere around 19 regulators who touch all this stuff. They look at you like you've grown a second head, because it sounds kind of crazy, but here in the United States, we do have like this divide in our regulatory apparatus. You have the SEC and CFTC on the investment side, which helpfully aren't even the same agency and often don't agree with each other. Then you have all the banking regulators who don't agree with each other or the SEC or cftc, and vice versa. So, Chris, I think we've had this market fragmentation because of the structure that Congress has created. And one of the interesting parts about clarity to me, and we'll talk about whether it's going to pass or not, is as we're having the discussion around digital assets, as we're having a compromise around yield. And Gordon, I would love to get your opinion on that in a moment. One thing that I'm seeing about this whole thing is that inadvertently we're probably highlighting how weird the US Framework is and giving a big advantage to the people who can move between the different aspects. Because here's the honest answer. An agent probably wants a money market fund that pays incrementally if the money is at rest. But the moment it wants to pay somebody, it wants that thing wrapped into a stable coin to make a payment easy just because if nothing else, the paperwork implications of paying for things with securities and who can receive them is awful. So because we have this weird fragmentation, I actually think it's going to be the people who are transformers, AKA people who can move between one state to another. Like now I'm a stable coin. Now I'm a money market market fund. Now I'm a bank deposit. Wait, I'm a money market fund. Again, no, I'm a stablecoin who will ultimately be the winners here because you can optimize across all of those channels, which is why I'm paying increasing attention to integrated stacks like say on one hand to go crypto native circling coinbase, and on the other hand say, what's JP Morgan going to do? So, Gordon, let me throw that ball to you. I know you have some.
- [34:25]
D
Yeah, I think you're doing the selling for Circle almost. You know, we have the largest regulated stablecoin, but we also have a the largest tokenized mind market found usyc, and people could go between them. And you know, I see you rightly pointed out, one is a payment instrument, other one is if you want to get the Money market yield and you go through the, the, the typical type of requirements, then you get the USYC yield and moving in between them. We offer a seamless process and perhaps aging some days will make that even easier. But there is also some friction at the end of the day. Why is there $3 trillion of physical cash in the world? Why is there non interest bearing deposit accounts alongside with savings accounts? There's always some type of delimination, even if it's offered by the same institution. And I think you're always going to have both, not just one versus the other.
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A
Chris, what do you think? To throw that ball right back to.
- [35:40]
C
No, I think you're right. I think you're going to see an interoperable capability. I do think you'll see there's a love of, there's a network effect when enough people have accounts with money market funds that you'll see more, I guess, ability to, I don't say pay, but exchange them for value and goods or whatever. But yeah, I think that intersection is going to be very important going forward and the agents are going to be very good at it.
- [36:09]
A
All right, so let's talk about clarity then, which is part of the key to unlocking this. Senate Banking Advanced the Digital Asset Market Clarity act to the floor on a 15 to 9 bipartisan vote. It would need 60 votes on the floor to proceed. Also an open question on if we're going to get more amendments as we land on the floor. There are many core mechanics in here. We've talked about this before. Decentralization tests, assigning duties to the SEC and cftc, what tokens or what kinds of entities. I think everybody has agreed that this bill is not perfect, but it is at least decently good. And I want to throw two things out here to discuss for the group. Let's start with the first one. There's still an ongoing fight around stablecoin yields, which I think consumers, retailers and the crypto industry are calling working as intended. The bank lobby is still calling a loophole, but Senators Tillis and also Brooks have cut a compromise where strictly passive yield is banned, but activity based rewards are allowed. The ABA is upset about this, but several others seem relatively happy with it. And the Senators have indicated, quote, we're not open for renegotiation. So I want to start with that issue, which is what do we think of where it's landed? Let's assume that what Senator Tillis and also Brooks said is correct. There will not be renegotiation. How do we feel about where that is, if the bill passes with the
- [37:42]
D
exact language in it, I can jump in there. You know, I think the Tillis and also broke compromise is actually, you know, it has a academic nature in it, right. At least from an economist perspective. There is multiple facets of money. As I mentioned, it's a settlement instrument, but it's also store value in some ways. This is separating the store of value component from the settlement value and from the from the unit account. And it also speak to a larger, I think movement about how intermediation happens in finance. Traditionally we think about intermediation being very balance sheet heavy, right. That that's why we have all the banking rules that is focused on stress testing the balance sheets of banks in that world. It is about growing the size of the balance sheet and making it as big as possible and having the right regulatory structure around it. But if you look at how even just decentralized finance have evolved on chain finance have evolved, quite a bit of it is activity based. It is not necessarily about having a largest balance sheet but having the set of intermediaries sometimes are mediated by smart contracts. That's a set of activities. So I think this compromise is actually speaking very well to that divide between the old and the new. The tri fi view of balance sheet heavy intermediation to the newer world of smart contract agentic mediated intermediation in finance. And I think there's tremendous opportunities for those who want to focus on the activity based type of rewards, activity based services, newer form of intermediation that will take over the older form.
- [39:35]
C
Let me start by saying Senator Tim Scott, Senator Loomis, Republican side leadership's been amazing. And I also wanted to give a special shout out to Senator Gallego and also Brooks of course. But Senator Gallego is a Marine and dude fought in Haditha when I was in Ramadi. The guy has some courage. I just thought it was awesome for him to make it bipartisan coming out of committee. I see that we're now like you ever climb Everest, Austin and Rom Gordon. It's like we're approaching Hillary Step on this bill, right? We're approaching Hillary Step. You still got commissioner issue. I'm sure you're going to talk about that. Austin, you've got ethics which is going to be really hard to overcome. And then you've got the interesting where the banks aren't really happy. So what's going to happen? Like the banking lobby was pulling on the national security string today because maybe they're not happy about other aspects. So it gets really weird towards the end. I'm still in the camp that it gets done. I would love to know where you guys are, because I think we've been diverging for a while. I think it gets done barely. It gets really weird between now and when it gets done. But I still think it gets done. Because when Epic Fury started and the bullets were flying, what did Trump do? He tweeted out about the Clarity act, saying he's going to put the chips on the table to get this thing done. I also think as midterms approach, there's not a lot of upside for not making this happen. There's more downside than upside. Right. And I still think it squeezes by.
- [41:09]
A
So I guess I would say I remain more skeptical than average, though I'll say, obviously, getting to the floor is a very positive sign. Whatever your previous estimate of it was a probability. You need to have moved it up based on that happening to me. Chris, the one that I have not heard somebody give me a truly credible solution to yet is the ethics part. And I think there's two potential ways that that ends up. One, which is probably a temporary good, but extremely long term bad, is you would not want Clarity passing on a purely partisan vote in the House and the Senate. And that is possible with the current framework if you can get to a vote. But I think if it's Republican only, this probably ages, like the Affordable Care act, where the other side just takes it apart over time. When you jam through something transformative on purely partisan lines, the history in United States legislation is pretty poor. Now the other hand is, do we just crash on the Ethics rocks? Completely. Completely. If it dies, that's where it's dying. I think every single other issue we have, there's a solution to. And many of the arguments being made, like with the bank lobby around, yield or quite frankly, special pleading by industries, it's not in good faith for the average consumer, the American economy, the national security apparatus, who is growing more and more interested and positive on digital assets as they see the capabilities. The ethics part is the one that, as I've talked to people on both sides, I still have some doubts about. So I guess that's why I keep pumping the brakes.
- [42:45]
E
Austin, what, what are the specific issues on the ethics side that you're alluding to?
- [42:49]
A
I. I think basically here's the question. Are the Democrats going to vote for something that doesn't force Trump's family to divest world liberty, the meme coin, et cetera, and would the Republicans send a bill to the President that forces him to do all of that. That to me is like the break point right in the middle. I don't see a great answer. But also as Chris said, now that it's on the floor, things get weird at the finish line. Like there is a non zero chance that it does move one of the.
- [43:20]
C
It can compromise some way like totally away from, from crypto.
- [43:24]
E
Right.
- [43:24]
C
Long roll, there's chips.
- [43:26]
E
That makes sense. The distinction between paying interest and activity is a very clever distinction. It's a good principle. I like the principle. The question is going to be like how many edge cases come out of activity based regulation. It looks like a duck, it cracks like a duck. Well, it starts looking at interest again.
- [43:46]
C
So this is the problem. So what we're living now is we're living in a post Chevron deference world. And so in the past it'd be like hey, you know, Ty goes to the regulator, regulator, you figure it out. We're going to give you a little bit more leeway to kind of fill in the gaps. Right now you have legislation has to be much more rigid and prescriptive which makes the legislation worse frankly. So it's going to be. And then it just goes to the court and like so that you know, in a way we needed the Chevron deference to come away but there were some benefits to it. I'm not saying it's time to bring it back. By all means, yeah. But it's some of the complexity we're dealing too overreach.
- [44:27]
A
I'll go back the other way though and say the original problem with this is the call it Gordian not of financial regulation writ large. Because if you want to prevent money market funds from paying yield, you're going to have to rewrite the 40 act because I will remind everybody they are legally obligated to pay people yield right now you can't hold that money inside of the vehicle and just compound. So as long as we have tokenized securities on one side and stablecoins on the other side and reserves that look like the tokenized securities, there's kind of no way to close this door. It's more a question of form over function. Otherwise you're rewriting the Banking act and the 40 Act. And I don't think Congress has the appetite or willingness to do that right now. I mean they could barely confirm wash, right. And that's like getting a guy in a seat to do one specific job. And we think they're going to rewrite the fundamental structure of U.S. securities regulation. No. So this is Part of why I thought this fight was quicksonic for the banks in the first place is like what do you guys get out of this? Like, are you handing essentially a giant wind to asset managers by stabbing each other to death? You might have done that, yeah.
- [45:36]
C
I think Senator Gillibrand is probably one of the most important people to watch right now. She's pro crypto, she's very involved in the formation of legislation from the very beginning. But she's also been adamant against ethics. So I'm watching her and I think if there's a way that folks can reach a deal with her, I think it's going to be really impactful.
- [45:58]
A
All right. So I would be remiss not to talk about a segment we've titled Bond Vigilantes Box Wash if we have Gordon here and the reason I say that is Wash was confirmed so 54 to 45 vote the closest Fed chair vote in the modern era. The only Democrat to cross the line was Senator Federmick on this one. So not the people crossing the line around clarity. The first FOMC is in middle of June but hours after his confirmation the 25 billion 30 year auction broke 5%. We had 30 year yield hit 5.12 at the high the first 5 handle since before or the financial crisis of 2008. The 10 year is currently sitting at 4.59. The 2 year is at 4.08. CME FedWatch has 50% odds of a hike by later in the year which is a complete inversion of the cut narrative. Though I think there is a lot to be said about how to interpret that data that we can get into. It is not purely one linear cut. So let's talk about commentary. So Ed Yardeni, the man who coined the phrase bond vigilantes I believe said they are now setting policy and the Fed may be forced to raise in July to appease the long end. Vincent Ahn of Wisdom Fixed Income said Wash wanted the option to cut on day one. The bond market just took that option off the table. Morgan Stanley is saying rate cuts are off the table until 2027 and Ryan Swift of BCA is saying if Warsh pushes dovish during this bloodbath and inflation expectations will break out and the Fed loses control of the long end. There are some who view this as a good thing. Phil Blacanto Reuters Breaking views basically saying vanishing cuts by time and that stripping power from an over interventionist fad might be a good thing. But this is a very complex space like interest rates are a very misunderstood thing in traditional markets and there's a lot of complexity to these dynamics. So I want to lob the ball up. Gordon, first, just as an economist, a market observer, somebody who obviously has deep experience with the Fed, what do you make of what the market is saying about US interest rates right now?
- [48:25]
D
Sure, I'll give you answer from my background. I used to work at the fed board in D.C. and you know one of the first things you look at in those positions is what has driven the interest rate move. Is it the term premium or is it the expected rate change? If you look at, if you take the iconic ACM model and break it down, Most of the 30 year rise in yield is driven by the term premium. Term premium right now is I think it's like in the 80bps or or so which is quite high relative to a couple years ago as it's negative. What does it mean? It means that the term premium is basically reflecting supply demand whereas the expected short rate is market expectation of how much a Fed is actually going to hike or not over time. So much of the increase in the yield being reflected in term premium means that what we're observing is a market reflection of perhaps a few things with regards to supply and demand. One is continued fiscal issues, continued expansion in fiscal aspect and perhaps over a long term loose of credibility of the ability to control inflation and also perhaps some lack of foreign demand as it was. I think if you look at just the balance of payment has changed quite a bit over the last year or so. So that's on the kind of the demand side and in terms of supply side this is where it's also quite interesting. Soon to be governor Walsh has also been a proponent of actually shrinking the Fed balance sheet, meaning that kind of reversing QE which essentially since 2008 has been an expansion in balance sheet otherwise ebb and flows in overall size. That comes at a time when you know you're getting this pressure on the long term yield as well. This narrative that others have put out, I think that even the US treasure has mentioned in the past of stablecoin being the marginal buyer of Treasury I think actually has a bit more meat than you know, people give gratitude not only because the stablecoin circulation is increasing but also because of the maturity aspect. Stablecoin maturity is the asset that's held is generally very short. Short term T bills and reverse repos which free up the opportunity, give up the opportunity for the US treasury to issue more in the shorter term versus longer term. Now if you actually do the duration weighting that actually could mean a significant shift in the dollar duration. Kind of reduce the supply of long dated dollar duration in the market and hence perhaps help moderate the the current rate pressure upwards. So in a way it's all kind of linked together but I think it's not to think about the rates in itself as a single number but you should break it down into two. But also think about the balance sheet aspect, how they're playing with the expected changes in the both the Fed balance sheet but also the private sector demand.
- [51:46]
A
I think an important part of that that people often don't think about is exactly what you said, which is not just who is buying Treasuries but asking the next more granular question of who is buying which type of treasury specifically because exactly as you just said, stablecoins are going to have a preference for T bills thanks to the Genius act and the restrictions there. But also even if they're not, they're doing reverse repo which is a form of funding that can take Treasuries as collateral but you have larger haircuts on longer dated versus shorter dated. So there's some preferencing there as well. The same time that's going on back from my days on the street, some of the biggest buyers at the 30 year point are both insurance companies and sovereigns and the preferences of those are shifting over time sovereigns just towards holding less long dated US debt of geopolitical concerns potentially moving around in there. But also insurance companies roll with the call it demographic profile of the country that they're serving. So as the boomers age out and the next largest group of people is probably millennials and we see sort of like a curve transformation for insurance, we could see less demand for the 30 year. So I'm watching Term Premium. Gordon, it's funny to hear you say hey, term premium at 80bps is pretty high compared to recent because conversely it's pretty low compared to at least some truly historical measures where you could see like 1.5 or more. So I think the curve itself changing shape is part of the story here that people should not miss. So Rahm, I want to ask you that on an investing standpoint, how are you feeling about the long bond right now?
- [53:29]
E
Yeah, a few things. First off, yeah I agree it's supply demand driven. Investors are saying I need more compensation for greater inflation risk. That's it. And they know the Fed isn't biased to cut rates so they're saying something's got to give. And what's Going to give is rates are going to go up. That's what's happening. So you see it because of oil impacting memory prices, gasoline, oil, a lot of different areas. You're seeing inflation like a comeback. I did find it kind of ironic that Wash was approved in such a lopsided manner. Elizabeth Warren, her litmus test is will you cut rates? This guy wants to cut rates like he should be issuing. So he, he, he fit the profile perfectly, which is kind of uncanny. It's more about sending a political message more than anything else. Overall though, I would say I expect that the rates are topping out right around here. And if that's the case, then rate sensitive names which have been hammered. You mentioned insurers, Austin, for example. Right. Insurers are a balance sheet business like a bank. So when rates go up, the value of their holdings drop, the value of their bonds drop drop. The value that asks us to fund their future liabilities drop. Right. So they've been hard. But what we're starting to see in the most recent, even two or three days is that long duration, high free cash flow assets have rallied. There's been a, a pullback of over a point in the major indices the last two days. Pick an index. All of them except these long duration, high free cash flow assets have been rallying. So the equity markets are saying that they believe the long rates are going to come in, which is kind of funny because usually think of the bond market being smart on the equity market. I think the equity market actually is right here. I think Kevin Warsh, his confirmation was a kind of a capitulatory event. The only thing we haven't seen here is a Ray Dalio video that's gone viral talking about the end times missing around the bottom.
- [55:41]
C
It.
- [55:42]
A
So let me say we'll, we'll know.
- [55:50]
C
Yeah, let me, let me chime in. I think long term there's a number of very deflationary pressures coming to hit the economy, starting with AI and then on top of that, energy prices, the amount of investment going into cheap energy is profound right now. Elon's going to channel it in space. You're going to get compute coming out of that that you've never seen before. So I feel like in the long term that's going to be quite deflationary. And Warsh talks about that, particularly around AI. It's the near term that's the problem. You've got sovereigns selling treasuries. Why? Because in certain cases they want to decouple. In other cases they need the money. Oil prices are high and we know why there. Now, the difference with this administration in the post war era is number one, he's reevaluating how we should be looking at inflation in the first place. We've spoken to the truflation guys in the past. I think we're going to get much more thoughtful on what inflation is. Second, the cooperation between treasury and the Fed is going to be like you've never seen before with Besson. And I think that coordination should help arrive at better just holistic policy responses. And that doesn't mean that Wash isn't going to be independent. I think coordination, you can be independent and be coordinated at the same time. And I think you should be. So I'm very positive there. So the last thing is like this geopolitical stuff, it can get worse very quickly or it can get better very quickly. My sense is that it's going to get better because midterms are coming. The American people don't love it. And it's a matter of it's a tough, tough problem. But I think Trump is asked to de escalate, not escalate, if he can.
- [57:32]
E
Agreed.
- [57:34]
A
All right. Well, we're right up on time, so I'm going to leave it right there. First, I wanted to say in particular, Gordon, thank you for joining us today. The timing here was excellent to talk about these particular subjects, so I hope our viewers benefited from your knowledge. Thank you for watching and hope you enjoyed this episode of Bits and bips. Just remember, nothing we say here is investment advice. And please check unchained crypto.com bitsandbips for more disclosures.