Fintech Digest - How to Set Up a Crypto Fund; World's Largest Botnet Born from Minecraft; Raisin and Lemonade Raising Raises (via Autonomous ?NEXT)

Hi fellow futurists -- here are our top 3 favorite thoughts. No more talking about Bitcoin's price -- if that's still of interest, see last week's newsletter.

How to Set Up a Crypto Fund  

We don't do this often, but we'd like to give a major shout-out to HFM Week by summarizing their excellent webinar on Demystifying Cryptocurrency: Best practices for trading digital assets. Go listen to the replay now -- featuring a crypto focused lawyer, a crypto hedge fund operator,a CPA who audits crypto funds, and the president of Gemini Hedge Fund Services, which provides back-office support to hedge funds (can you tell we love financial infrastructure). So how similar or different are crypto vs. conventional fiat hedge funds? 

In many ways similar. First, human psychology is always the driving force in the markets, which we’re seeing it play out “in overdrive” right now. Second, when setting up a crypto fund, as with a fiat fund, service provider diligence is key. Find an auditor, attorney, and other partners who truly understand crypto. The market for such providers is expanding dramatically, and there are too many faux "experts". As with any investment fund, carefully describing the fund’s strategy and paying close attention to disclosures (and making sure they evolve with the asset class) is paramount. Tax considerations are similar to those for fiat funds, at least in the US. Fee structure is also shaping up to be similar, with a 2/20 structure becoming most common. On liquidity, many crypto funds are aiming to be fairly liquid with side-pockets for investing in less liquid assets. As a side note, we know that about a third of the funds are traders, a third are venture investors, and the rest are indexes and quants.

As far as differences, the main one is that crypto has yet to find a formal custodian mechanism. The few attempts out there are small and not suitable for a large market. This is a problem that will need to be solved, especially if the instruments are deemed securities, as it makes a fund unable to comply with the custody rule. Following on this, how can an auditor verify the existence of assets without a reputable custodian? Blockchain-based transactions allow for transparency and record but not necessarily validation of control (although there are third-party confirmation of wallet services that are helping solve this problem). Solutions to these problems are evolving, and it’s reminiscent of the 1994 internet, which also created questions around accounting and auditing. 

Some of the other outstanding questions without answers: (1) Tax treatment: Crypto currency is treated as property by the IRS (so if you sell, you incur a capital gain or loss). But if you use crypto to buy into crypto denominated share class and never touch fiat, what is the tax treatment? (2) What type of insurance is available for the sector? Right now, there’s no mass market product. (3) With no central clearing of pricing, how should mark to market be handled? (4) When does an ICO have market depth to be priced and to be marked to market? And the question we have is how long do these funds have in the market before ICOs are heavily regulated and a large asset manager vacuums up assets with an ETF!

Source: SEC Action against Munchee deeming it an investment contract

World's Largest Botnet Born from Minecraft

This is a lego piece for the future. On the Internet (we're there right now!), a distributed denial-of-service attack ("DDoS") is when a group of computers access a server so many times that traffic spikes and the server crashes, taking down whatever it is hosting. So for example, if you don't like the NY Times, just overwhelm it with robots and bring the site offline. These robots, collectively a botnet, don't have to be particularly good computers -- one could for example hack into thousands of baby monitors over WiFi and then point them at a target.

In 2016, a tremendously powerful botnet attacked the internet infrastructure of the United States, like never before. It used 600,000 Internet of Things devices. Where did this weapon come from? The answer is the video game Minecraft. In 2014, the virtual sandbox had 100 million registered players and a GDP of $400 million. Part of these economics is hosting Minecraft servers for local communities, and the corrollary of that is that executing a DDoS attack against a competitor makes you a modern-day Minecraft mafia monopoly. The 21-year old creators of this infamous botnet built it to snipe out other video game tycoons and make more money on their Minecraft servers. Later, they used the same botnet to defraud advertisers (selling hundreds of thousands of clicks and traffic that came from robots, not humans).

At some point, the creators open sourced the software and it spread through the dark web. That means any black hat hacker can get the code, change it up, and try to create its own infection of IoT devices. We know that, for example, North Korea is pretty good at cyber attacks and is now hacking crypto currency infrastructure. The links between 21-year old computer savants, video games, Internet money, and international geopolitical power struggles are here to stay. Which world is more powerful?

Source: Minecraft

Raisin and Lemonade Raising Raises

This week, Softbank and PayPal are competing for the B2C future of finance. PayPal put an undisclosed amount into German neobank Raisin. We use the term neobank loosely. Raisin helps customers comparison shop for the highest deposit rate across 40 European banks. Once PSD2 rolls out (i.e., in Jan of 2018), auto-switching between banks could be a trivial virtual assistant task. That makes Raisin a better Amazon Alexa skill than, let's say, UBS. PayPal has just announced an Acorns partnership in the US, so they seem to be moving from money in motion (payments) to money at rest (savings and investments).

Second, Softbank is splurging its $100 billion fund on Fintechunicorns across categories. Remember it owns some SoFi and Kabbage. And now it has put $120 million into the freshest of Insurtech startups for renter's insurance, Lemonade. According to a back of the envelope from Coverager, the startup would need to sell 2.5 million policies to return the investment in 3 years, a far cry from its current 70,000. That makes the likelihood of cashflow economics working out pretty low. And this is exactly the same thing people say about Betterment, Acorns, N26, Revolut, et cetera et cetera.

Our usual refrain to this is (1) many of these companies are attention economy companies with winner-take-all dynamics for the next generation, and overinvesting in them means building brands that work for the future, (2) demand generation and monetization are separate things, and this is why many of the million-use-base companies are diversifying across products, and (3) what's expensive to acquire for traditional finance incumbents is cheap for Facebook, or, maybe an Ethereum billionaire. We'll call that trend "Vitalik goes shopping". But better yet, let's look at this from Softbank's point of view. A portfolio of millions of American financial services companies with modern technology stacks and cool brands, spread across different verticals. You only need one of them to be Goldman Sachs.

Source: Lemonade's Renter's Coverage

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