Bakkt, Inc. (BKKT) Earnings Call Transcript & Summary

Welcome to the Water Tower Hour. I am your host, Tim Regan, head of Business Development at Water Tower Research. In today's episode, we're going to talk about a company called Bakkt Holdings, which build solutions that enable their clients to grow with the crypto economy through institutional-grade custody, trading and on-ramp capabilities their clients leverage technology that's built for sustainable long-term involvement in crypto. The stock trades on the New York Stock Exchange under the ticker BKKT. You can learn more about the company at bakkt.com. You can also find our coverage on the company at watertowerresearch.com. Look on the company's tab and scroll down to Bakkt Inc. Our research content, as always, is open access and freely available to all investors. To dive into the company today, I have 2 special guests. First, a Managing Director of Technology at Water Tower Research, Dr. John Roy. John, welcome back to the show.

Great. Good to speak with you, Tim.

Thanks, John. We also have Dan O'Prey, Chief Product Officer of Bakkt. Dan, thank you for being here today.

Thanks so much for having me on, Tim and great to see you, John.

Likewise. So Dan, I think maybe a good place to start for our listeners is why don't you tell us a little bit about your background and what attracted you to Bakkt.

Sounds good, yes. So it's been a long journey into the sort of crypto, Bitcoin, blockchain space. About 10 years ago -- coming up on 10 years in January, actually, I just left my last start up, and I was looking for what I was going to do next and came across the Bitcoin white paper. About 10 years ago, for a little too early to be doing a Bitcoin startup. I was actually living in China at the time and trying to figure out how we could be in around the space without necessarily doing something directly in Bitcoin at that time. So explore the wider blockchain space for about 8 years or so before joining Bakkt just over 2.

Great. So Dan, I mean, you were saying you read the research paper. I know a lot of people may not know what that is. Maybe you could give a little bit of what really got you excited about crypto, what elements of it do you really think are the most interesting?

Yes. It's a short white paper, it's not super technical. So it's only about 9 pages, I think. So anyone can give it a good read. But really, the headline peer-to-peer electronic cash caught my attention, was very interested in technology and distributed systems and in money, not just making it, but what does it mean? And so the combination of those 2 things really clicked for me straight away and started sort of diving deeper and deeper into a rabbit hole and really getting blown away by the potential of what this simple, elegant, beautiful design could mean for the world. And having spent a lot of my background in the Internet, technology-related companies and cloud computing, find it fascinating what the Internet can do for information. This technology can also do for value. And that just seemed like there wasn't a clear and tangible -- this is what we're going to do with it then. But it just seems like such a massive generational sea change in what is the Internet can do now that it has a native form of value.

Interesting. So do you see it more of a store value or transactional? Or what's your kind of thinking there? Or has it evolved?

I think it evolves, right, and it goes through different phases, different times and different use cases. So Bitcoin, given that it's limited to just 21 million coins, many people look at it as just a digital gold, a store of value that can't be inflated away. That's one-use case. But again, the headline of the white paper was peer-to-peer electronic cash for actually using as a way to transact value and not just bought it and store it. So there certainly is a gold bug style, inflation hedge, limited number of coins that can never exist part of the story. But to me, the far more interesting piece is how you can transfer it instantly across the world and programmatically without needing -- without meeting intermediaries and without a single government being behind it. And to many people that probably doesn't matter. To people in developing countries or countries where they've experienced hyperinflation, obviously, it does. But I think more importantly, even just for developed countries with stable currencies, having a neutral store -- a neutral piece of value that can be transferred that isn't beyond the control of a single country means that multiple countries can participate in it without the fear of giving one an advantage over the other. And so that neutrality and accessibility means that we can all tap into it just like we do with the Internet and leverage it and have a single, probably settlement layer to start with. I don't see people pricing things in Bitcoin and paying for their coffee in Bitcoin day 1. It will likely be dollars to euros but behind the scenes, you can leverage it as a settlement piece to transfer value that maybe every day consumers don't necessarily see.

Interesting. I've heard you in the past you mentioned that not all crypto currencies, especially are created equal. So let's dive into this a little bit deeper. Can you tell me what really distinguishes Bitcoin and all the others [indiscernible], et cetera.

Sure. Yes. I think people tend to look at crypto as a singular asset class, then within it, which are the different coins and this does that, and this does this, and this is faster, and this is cheaper. But really, that -- there's always trade-offs with each of these. Bitcoin was the first. It doesn't have a central company behind it. No one knows who Satoshi Nakamoto, the synonymous founder or group of founders is. There's no central points of influence that can be controlled or changed or it's very decentralized and decentralization gives you many things, but the main property that I think is valuable as it gives you predictability. You know that what it is today, it's likely to be very similar 5 years, 10 years, 20 years from now versus other coins that have foundations or founders or even companies and CEOs behind them and that gives them the ability to much more easily change the rules and change future issuance or distribute coins in different ways. And that has a lot of impact to businesses and ultimately consumers as well. And it also has, as we've seen in the U.S., in particular, a lot of regulatory potential implications and challenges.

Interesting. So now getting to the company. What do you think really distinguishes Bakkt from its peers?

Yes. So I'd say -- speaking very broadly, there's kind of 2 camps. There's the crypto native startups, the disruptors who are new to financial services and are trying to rebuild or replace or disintermediate traditional financial institutions. And then there are those traditional financial institutions who are trying to update or join or participate in the new crypto economy in some capacity. To me, Bakkt is kind of unique and that is an interesting hybrid of those 2. We were started under the Intercontinental Exchange, ICE, who own many different exchange groups, even in the New York Stock Exchange and then spun out as an independent crypto company. So we've still got that institutional [indiscernible] heritage, that understanding of what it means to build critical market infrastructure, comply with regulations but also we're small enough and nimble enough to act and build like a crypto-native company. So for us, we're one of the few crypto public companies, publicly traded on NYSE, as Tim mentioned. We have money transmission licenses in every state in the U.S. that requires, I mean including a Bit license in New York. We also have a trust license for custody. So we've got all the benefits of being our publicly traded, audited financials and fully regulated and licensed company while still having many of the benefits of being that smaller, more nimble crypto company as well.

So you mentioned custody there. I mean, Bakkt is very focused on that. Isn't that a commoditized facility? I mean, what does it really take to do custody well? And what do we look for?

In some ways, it's commoditized. It's a competitive space. But actually, over the last couple of years, I've probably come to the view that it's less commoditized than maybe I did used to think. Crypto is very different from traditional financial instruments. We're not talking about paper stock certificates or database entries where things can be reversed if something goes wrong. These are better instruments where whoever owns and controls them, you can't get them back if they're taken. And so really, the level of security, the operational processes that go around securing the private key material, which is ultimately what is used to sign these transactions is very stringent process that requires very, very deep understanding of the technology and deep, secure regulated processes around how you safe keep those assets. And we've seen over the last year, multiple custodians have issues with that. So we saw with FTX primarily in exchange, but you had to move your coins to the exchange in order to trade there. So they were also the custodian. And of course, I think many people are familiar with how that story ended with those funds being misappropriated and used for other purposes. We've more recently seen a smaller company in the space, Prime Trust be hacked and have funds stolen and other instances of this at some of the smaller custodians as well. So it is not just on the security front. Having a team that knows, having stock to compliance, being audited, being regulated and making sure the funds are not re-hypothecated or used for any other purpose than remaining customer funds, is turns out not as commonplace as it should be. And we and others are making sure that we change that. But not all -- as not all coins are created equal, not all custodians are created equal as well.

Interesting. So if you look at the crypto markets right now, obviously, there's been a little bit of a lull here, to say it one way. What do you think is the catalyst that will help the crypto markets recover and then eventually take off, if that's what you think?

Yes. I mean, my general opinion there has been that in 2021, prices were going up, everyone was making money, everyone was happy. And so people weren't may be paying as much attention or taking as much of a nuance to view as typically should be done, right? So coins that ended up like Luna and Terra and taking a lot of money but really won't fundamentally sound business models and companies that didn't have boards or didn't have governance structures in place that ultimately -- or did very risky business practices. While times were good, people didn't mind as much. They were prepared to take that risk or overlook it. And now that there has been some issues with some of the riskier practices. I view that overall as a -- obviously, it's never good when people lose money but it's good to have for the industry to have a clear out of some of those practices and to have those companies that did it the right way and sometimes that's the slower hard away, but that's what you need to do when -- to prepare for some of the tougher times. And I believe that those companies that take that approach will come out stronger at the other end. And as the product person at banks, it's also -- selfishly, it's nice to have some quiet time to build and to focus. Again, like when times are good, there's a lot of distractions, a lot of shiny trends and hypes that are necessarily there long term and sustainable. And when the tide comes out, you can focus a little bit more on where the true value is and building for the long term, not just the next hype cycle.

So to kind of follow on that, if looking at Bitcoin specifically, what do you think it will take to get in the Bitcoin price back up to where it was?

I -- yes, I can't speculate on price. I have no insight there relative to anyone else. But I mean, ultimately, long term, I think, we've been in a bear market for a little while now. Those cycles do tend to repeat. We have the halving coming up next year, which is when the issuance of -- or the rate of issuance of Bitcoin is halved. So that will be 50% less created that commonly is seen as a potential inflection point for the markets. But really, for me, long term, what's happening now is people are speculating on the prices of these assets but they have to speculate on it, having value and having utility. Otherwise, it's speculation for speculation sake. So really, I think that the key driver, maybe this isn't the next cycle but the one after, who knows. The key driver is when are people actually going to be using this for productive use cases that current technology cannot enable and that may be them directly using Bitcoin or other cryptos for new use cases that they get value from or it may be that they don't even know they're using it under the hood. And as mentioned earlier, they're just sending dollars or receiving euros. And ultimately, it is going in and out of Bitcoin temporarily. And I actually think -- that's really when you've got the best product market fit is when you don't even know you're necessarily using a technology to get the value from it.

If you look at crypto, what do you think is the biggest misconception that people have about crypto? Investors and the general public.

I think the -- yes, the primary one we've touched on a little bit, right? A lot of people made money on some of the long tail of coins, new ACOs where smaller coins have the potential to appreciate very quickly but likewise, the potential to depreciate very quickly. And so really looking at what is that long-term value, what are people actually using it for? Where is the utility going to come from? There's a lot of debate about whether we'll end up with 100, 1,000, 10 or 1 different platforms in the future. And so I think the biggest misconception is just looking at it as a single plus, kind of like people looked at the dot-com companies as a single group of companies, whereas in reality, you had e-commerce companies and social media companies and different types of companies within that. I'd say the market still tends to broadly paint broad brushes over the entire space. And associate things like we saw with FGX or like we saw at Terra and Luna with the entire space whereas in practice, there's very little in common between an FGX company and a well-regulated well-run company and it's a little in common with Luna as there is with Bitcoin. So these headlines don't help the industry, these practices and core practices or legal practices can hold back the space. But really, there's very little in common other than the fact that they both touch crypto.

So when you look at that future, what are you most excited about? What is its largest opportunity? Is it custody? I mean, what is it?

Yes. I mean we're a platform company, right? So we're not direct-to-consumer. We try to help companies that want to participate in the crypto economy that don't have the skill sets, the regulatory licensing or just the operational capacity to really jump in deeply. So we look rather than sort of being end-to-end vertically integrated as a single company, we help serve many different types of companies. That starts with custody, right? Number one piece that you need is to be able to ensure that assets are safe and can be held conveniently. Then moving up the stack, enabling trading, enabling liquidity, whether that is for traders or for people who look to get in and out of the coins for utility purposes. Earlier this year, we acquired a company called Apex Crypto that power of the largest fintechs for the retail embedded trading in the U.S. Again, I won't see their name or our name necessarily when you're in the trading app but behind the scenes, we're onboarding those users through our fintech partners to facilitate that for them. And then -- so once you have those pieces and keeping assets safe and providing liquidity to go between fiat currency and cryptocurrency, then there's a host of different solutions that you can build on top of those and enable -- one longer term, I'm very passionate about, and I think comes back to that utility point is cross-border international remittances, where still high friction, very difficult and often very, very expensive to move money between different countries. But really, that's -- we're trying to be the enabler to build these capabilities that our partners can combine in different ways and being a platform company. One of the most exciting things there is seeing what people come up with and what they build, combining our different services for their users and their use cases.

So you have mentioned regulations a couple of times here. Where are we with the crypto regulations in terms of where do we need to get to, how long will it take, et cetera?

Yes. I mean again, I'd say there's different segments that are in different stages with different agencies. So in the U.S. given it is, in a way, quite decentralized between different departments and different states, even different sectors of the crypto economy are at different stages of regulatory clarity. So take -- from the SEC's point of view, Bitcoin is a commodity and not regulated by the Securities and Exchange Commission. Stablecoins are another area that have got a lot of interest and getting a lot of usage. And I think the different various regulatory bodies are looking at how they can provide more clarity on that front. And then you have NFTs or DeFi and very different areas within the space that are probably a lot further behind. So our goal is to be as compliant. We want to be compliant. We want the clarity to know how to be compliant and in the interim, we do our best to make sure that we can be as compliant as we can for the laws that we understand that are today. But certainly more clarity around those various different areas would enable us to operate in a way that is compliant and it is in the interest of ultimately the end consumers that the regulators want to protect and we want to make sure we are protected as well.

Now, ETFs -- Bitcoin ETFs, I mean what are your views there? Could we see them go live fairly soon? Is that something that's going to happen? What is Bakkt going to do here?

Yes. It's a super interesting space in that. Bitcoin ETFs have been approved based on cash settled futures. So for the audience who aren't super familiar with those, they are financial derivatives where you can get exposure to the price without actually touching the underlying or needing to even hold the underlying asset. There's been a ton of talk about spot ETFs, which are actually the ETF holding the equivalent amount of Bitcoin under the hood. That's where regulators have -- particularly the SEC, have some concerns and rejected some applications on -- primarily on the grounds that the spot markets, the trading of actual Bitcoin is not a highly regulated market in terms of price discovery. I think with large companies, large financial institutions, right, we've seen BlackRock, some in an application, we've seen NASDAQ and others actually participate in surveilling these markets to ensure that pricing is there. Those arguments are getting harder and harder to make. But that said, it's still very mixed opinions or mix predictions on whether we will see those spot ETFs get approved in the near term. I definitely -- it was mentioned in the case is getting harder to reject them, and we will see them eventually in the medium term, whether we'll see it improved in Q1 or not, is to be determined. But our role there really would be, right, these -- for the spot ETFs, again, the Bitcoin that is being held in those funds needs to be secured. And ideally, I'd love to say they should all be secured in one place, and that place is Bakkt Trust but in practice, good practice is to diversify your risk and to use multiple different custodians that are all qualified custodians, all regulated, all trust companies, all fully in control of all the private key material needed. And so Bakkt being one of the few New York Department of Financial Services, trust chartered companies with an independent Board of Directors for our Trust company, are one of the few highly regulated, qualified custodians that can play that role.

So maybe one last question. In an ideal world, how would you envision crypto being used by both consumers and institutions. And when do you think we might be able to get there?

Yes. I mean I think to an earlier question, it is being used today as a store of value, there are many people who are buying it just to hold it long term. And even in the U.S. have concerns about inflation and the value of the currency and where they can park and put their savings. People around the world are, particularly in Lat Am and Africa, using it on Stablecoins and Bitcoin through a new piece of technology called the Lightning Network, which is a layer 2 built on top of Bitcoin to enable fast, free and instant transfer. So it is happening today. It's just not happening in the mainstream or particularly the very developed financial markets, which have these very efficient payment systems domestically already in place, but it is happening across the world. But yes, I think the next stage really is the -- what are the products and services that a good test of technology is when -- let's take NFTs, right? People looked at NFTs and they wanted to participate in NFTs because they're NFTs and they're shiny and they're new and they're interesting rather than necessarily what is the actual value that NFTs provide versus traditional technology. And that line, I think, was very blurry and led to a lot of people perhaps overinvesting in things they could have already done in many cases. Whereas when you're abstracting away the technology and from the consumer's point of view, they're moving money, they're making a payment. They're getting a loan, whatever normal everyday use case they're doing. The technology just happens to make that 10x faster, 10x cheaper, 10x easier. That's when we will really, really see a huge spike. And I believe that will happen first in remittances, just because that is the low-hanging fruit and the highest paying use case that the tech can solve.

Great. Thanks a lot, Dan. It's super helpful for us to understand as you look at the market coming forward. It's been really exciting over the next 6, 12 months. We'll definitely keep up and checking with you again for another update when we have the time.

Awesome. Thank you so much for having me. Been a real pleasure.

Yes. That's been a great introduction for the firm and to [indiscernible] from Bakkt. Listeners, thank you again. Special thanks to the producers of the podcast, Joy Malone, Jesse Redmond, and Nick Ford, [indiscernible] Nick Ford and [ Mohamad Abdud ]. Thanks for listening. Don't forget to subscribe and we'll see you next week for a very exciting special episode where Jesse and I will be recording live from the Benzinga Cannabis Capital Conference in Chicago. Definitely don't want to miss that one as well. The views expressed in this podcast may not necessarily reflect the views of Water Tower Research LLC aka WTR and are provided for information purposes only. The Water Tower Hour may not be distributed or reproduced without the written consent of Water Tower Research and should not be considered a research nor recommendation. WTR is an Investor Relations firm, not a licensed broker, broker-dealer, market maker, investment bank, underwriter or investment adviser. Additional disclaimers should be found at watertowerresearch.com.