Raoul Pal is one of the few figures in the cryptocurrency sector that is recognizable at both the institutional and retail levels. Once a hedge fund manager for GLG Partners (now Man GLG), Pal left traditional finance behind after making some early bets on the crypto market. He has since co-founded digital assets investor Exponential Age Asset Management, in addition to his roles as co-founder of the financial media company Real Vision and founder of the research publication Global Macro Investor.
Following a keynote speech at II’s West Coast Family Office Wealth Conference in Laguna Beach, California, last month, Pal spoke to II about the latest trends in the institutionalization of cryptocurrency and blockchain technology.
Tell us about your asset management firm and what it seeks to achieve.
The idea behind EXPAAM is to create an access point for family offices and institutional investors entering into the crypto space. Traditionally in the past they started with venture capital and then ended up wanting liquid investments, and if conditions were complicated, they would go to hedge funds or funds of funds. We saw a similar trend in the 90s and 2000s where it was too volatile to choose a single manager, so they opted for funds of funds.
So, I realized it’s exactly the same playbook now, just a new kind of asset class and opportunity set. Crypto is going from $4 trillion today to — if you project out the trend rate of growth — about $100 trillion by 2032. So how do you capture that trend? Bitcoin isn’t all of it, because bitcoin is just a part of the market. There’s also the technology side, smart contract platforms, and the applications layer that gets built on top of it.
A lot of that’s going to be captured by hedge funds in liquid markets. So the idea is to make it simple, one shot. So with EXPAAM you get exposure to 12 or 14 of the best crypto liquid hedge funds in the world and then we overlay with cycle risk management, because it’s a very cyclical market.
How do you analyze cryptocurrencies as a macro asset?
A lot of people don’t understand what moves bitcoin; they think it’s a diversified asset. But that is not really what it is. It is an asset driven by the business cycle which is driven by the debt refinancing cycle. Liquidity is the most dominant macro factor in investing history, so if everything is cyclical, then diversification is pretty much dead.
If there’s one dominant macro factor for everything, then you must ask what gives you the best risk-adjusted returns for that dominant macro factor. In my eyes that is crypto and technology — those are the two big bets.
There are only two sectors that beat debasement plus inflation, and it’s the NASDAQ and it’s crypto. If you look at most hedge funds, most blended portfolios, most endowments, almost none of them can beat crypto’s returns.
What about volatility risk?
Everybody’s very clear with the cyclicality of an asset this early in the adoption curve. We saw very similar movement with Amazon, Google, and Facebook; they all had like 90 percent drawdowns early after going public, and that’s very typical as network adoption starts to take hold and volatility falls over time. Crypto has had some big crashes: Last time we had an 86 percent drop; we had 70 percent in 2022. Next time around maybe it’s 50 percent — the volatility is real.
But crypto is not a cyclical asset that follows that pattern. It’s a log regression channel because it’s a network adoption model. Every time it goes up it goes to new highs; it’s exactly the same as Google and Facebook. People have to think of crypto like an early-stage technology investment with a volatility profile in portfolio terms and then size allocation accordingly. Now the markets generally thought about sizing it at about 2 percent of portfolios; personally I think that’s way underweighted. Something in the 5 percent order of magnitude in the portfolio drives significant outperformance of returns without undue risk and enhances returns over time.
There was a flash crash in crypto over the weekend. You mentioned the next crash could see the price go as far down as 50 percent. How would you explain such a huge drop in value to the investors that hold your fund?
It generally takes people by surprise the first time they have to deal with a crash, and you need to have a mental model ready about how to handle it. You can try and trade the cycle, which is possible but not easy, but most long-term asset allocators have to think of it in endowment terms and ask themselves if it is a 10-year bet or not. Do you think of it like a VC or are you more aggressive? If it does fall, you can just dollar cost average to keep the portfolio weighted; this simple trick to increase your portfolio weighting or bring it back in line as the market falls can help you compound massive returns over time.
How do you envisage the financial ecosystem working in harmony with cryptocurrencies in the future?
It seems that we can put anything on a blockchain. We’ve done it with cash in stable coins. That works phenomenally well, so I think we will see equity exchanges next.
The other is the ability to use NFTs (non-fungible tokens) or individual smart contracts for derivatives. A derivative is just an individual contract. All of this could be pre-programmed and put into an NFT contract. We’re going to see a lot of that in the insurance industry; it is very efficient.
On the flip side of that, the sheer amount of demand from retail investors is something that people did not expect — but this whole thing was bootstrapped by retail. So, what you get to create is new investment products, as we’ve seen. The success of the bitcoin ETF is staggering. We’ve never seen anything like it, and that kind of shows you that we’ve got different structures. The other side of the equation is that yes, we’ve seen corporations put it on the balance sheet as a kind of long duration asset, but more importantly the sovereign wealth funds are now heavily involved in this space. People are in search of assets that are independent of U.S. sanctions.
And how has big players like sovereign wealth funds getting involved in crypto changed things?
It is crucial that sovereign wealth funds are getting involved, because of the sheer size of the portfolios; they’re really the largest driver of portfolio flows. Blackrock is another great example. But really it’s a Trojan horse the other way around, because the moment you start seeing crypto returns, you end up becoming a direct crypto investor. So even when the sell side packages it up into an equity, people end up entering the crypto world. The financial system can’t take over a decentralized, distributed technology, but they will try to be gatekeepers, because they want gatekeeper fees at every point. But it’s hard when you’ve got stuff like defi spinning up so fast and becoming a larger and larger share. It just shows it's not easy to retain control over a system.
Do you think traditional and alternative finance can morph into each other?
Tokens have proven that you can store immense value in a single smart contract. The question is what that means for tokenized real estate or any other assets of huge value that can be stored securely on blockchain technologies to allow for instant capital formation.
And that means that in the world of AI, businesses will die and be born very fast. There is going to be a huge amount of competition for capital and gaining traction in this new world, and you need faster capital formation. You also democratize access to it, because right now 1 percent of people have access to venture capital early-stage returns. But in this new system the public doesn’t have to wait until everything goes public, so it really democratizes investing to the people.
And it is almost safer than normal private sector lending because it is on the chain and visible: People who can see which wallet holds what, when they sell it, and what they do.
There is an ability to monitor this; you just need the technology.
