Galaxy Digital Inc. (GLXY) Earnings Call Transcript & Summary

All right, everyone. We're about to get started. Welcome to this year's Digital Currency Panel for the 2021 Financial Services Conference. I'm Will Nance. I cover Payments and Digital Assets out of research here at Goldman, and we're delighted to have a great lineup of panelists today to discuss some of the trends in the crypto space. So let me introduce some of the panelists today. First, we have Mike Novogratz, CEO of Galaxy Digital. Galaxy calls itself the bridge between crypto and the institutional world. And Galaxy makes direct investments in companies in the crypto space and offers crypto trading and prime brokerage services, advisory services and has its own proprietary crypto mining operations. I think Galaxy also has the distinction of being the second largest publicly traded crypto company with a market cap of $8 billion. Next, we have Mike Levitt, CEO of Core Scientific. Core Scientific is one of the largest crypto mining operations. And I think one of the only ones that can claim to be 100% carbon neutral. Core Scientific announced its plans to go public for a destack process this year in a transaction that valued the company worth $4.3 billion. And then last but not least, we have Oli Harris, who's Head of North American Digital Assets here at Goldman Sachs. Oli touches on numerous areas of the firm in the digital assets practice and has been involved in several of the firm's investments in the digital asset space. And prior to coming here, Oli was Head of Digital Assets and Strategy at JPMorgan. So I want to thank everyone for being here and looking forward to the conversation today.

Thanks for having us.

So maybe I'll kick it off with a high-level question. I think each of you touches on part of the market that underwent significant changes over the course of the year. What do you think have been the biggest changes in your business over 2021? And how has that kind of impacted your day-to-day?

Maybe I'll go first just because I'm younger than Michael.

Oh man.

We're the jewel disguised in crypto in the key moments. Listen, the whole year was a paradigm shift. Crypto went from wanting to be an asset class to being an asset class. 2 major stories, right? The adoption of Bitcoin as a hard asset inflation hedge, hedge against debasement of fiat. Guys like Paul Jones and Stan Druckenmiller are credentializing in the hedge fund bucket, but it really being credentialized in every asset bucket, hedge funds, wealth channels, insurance companies, college endowments and now big state pensions. And so that adoption has picked up kind of critical velocity, and it feels like it's going to continue to go. And now it's just a macro asset. It's on people's screens next to the 10-year in crude and oil and gold. So that was story one. Story 2, which is probably a bigger story, is Web3, the internet of value transfer. And it wasn't really until the NFT craze, where the world woke up and said, oh, this is not just crypto people playing with each other, which DeFi often felt like, this is real-world companies now using Blockchains to do really cool things. And so if it was the NBA selling video highlights through Top Shot or the whole new generation of generative artists, selling things online and selling things at Christies. It was the wake up that the future of consumerism, the future of finance is going to be built on Blockchains. And so we had this explosion of Level 1 Blockchains. Ethereum is -- was a far, far better bet this year than Bitcoins.

Yes. I'll just second that entirely. I think, yes, the year became real. Obviously, we think about cryptocurrencies, stable coins and tokenized assets. And I'd say the balance of these 3 things, I'll say, this year is the year that crypto became mainstream and significant. And obviously, from our end, starting the year as an adviser to coin base's direct listing, rebooting and setting up our crypto trading desk earlier in May and then setting up our PWM team. So I'd say just like tangibly from our end, there was also like going live with real products and teams actually service cryptocurrencies.

And I would echo Oli and Mike's comments with regard, especially to the institutionalization purely, the adoption, acceptance and engagement and interest that is -- as Mike said, it's accelerating. It's growing. Every month, we seem to end up in discussions with more institutional folks in financial services and investing, et cetera. Also the globalization. The China shutdown, if you will, probably had 2 general impacts: one, which is the obvious one, which is redeployment, if you will, and the source of the Bitcoin network geographically shifting such that United States is now probably host to the most substantial percentage of the Bitcoin network. But probably more importantly, what that has led to, I think we would say that that's part of the reason for this institutional acceptance for this engagement and for broader based more global interest in and around digital assets. The principal digital asset is now viewed, frankly, as the network is not controlled in China. It's much more democratized, it resides in other places. And it's fair to say that, that's given people a lot of comfort to engage. So it really had implications 2 ways.

Makes a lot of sense. I guess all of you touched on the increasing institutional adoption in the space. Obviously, that accelerated over the course of the year. People talk about institutions in crypto as kind of a monolith when there's actually a lot of different institutions that Mike Novogratz has talked about. But maybe each of you could kind of spend a little bit of time talking about the types of institutional engagement that you're seeing in the market. And for those that haven't chosen to engage yet, what are the biggest pain points or hurdles preventing them from doing so.

Sure. Yes, happy to take it as a first go. I'd say, super interesting year. I'd say at the beginning it was very much around like macro focused hedge funds. I think to Mike's earlier point, looking at like directional long-term exposure or the basis trade around Bitcoin. And I think we're seeing 2 fundamental shifts over the course of the year. I'd say, one, broader engagement in terms of client types through to pension funds and corporates inquiry alongside real money? And then secondly, the types of assets. The conversations have moved on from Bitcoin to Bitcoin and EVE and then of course, given NFT Summer, conversations around like NFT, the metaverse and the broader basket of the other ones as Mike mentioned. So I think that's been super interesting as we're moving into 2 dimensions, different types of clients alongside different types of assets. And then from a from a product perspective, I'd say the difference has been like cash settled products and the underlying, and that's why I think there's still work to be done in terms of institutional adoption on the underlying, given some unique characteristics around actually accessing the physical, whether it's like custody, execution and like regulatory uncertainty.

Makes sense. You want to take it, Michael?

Sure. Well, yes, I would comment that there's both the institutional adoption, but there's also, call it, the institutionalization of the industry and Mike and Galaxy, if you will, leading the way on bringing real financial services to the asset class, right? The fact that we engage in conversations with Galaxy about what -- how we can optimize our assets, right, that there are, in fact, there now is the ability to trade to utilize derivatives -- institutional quality financial products. And with Mike and Galaxy kind of leading the way, bringing those to participants in the industry like us, right? To me, that's institutionalization, right, that we should be able to do with our assets, what we could otherwise do with gold or with stocks or with bonds or with loans. That -- first of all, that's an advancement. Second, to me, it's that in addition to the fact that Goldman Sachs actually invites Mike and I to talk at a fintech conference, right? So it's both this institutional adoption, but it's also, like I said, I don't want to over credit, but Galaxy informs like Galaxy, although I don't really know of another way, are bringing that to bear in our industry is a big difference. It's a big difference from past years.

I'm going to answer it just so I'm not repetitive in a different way. I look at the talent that's come in. We recently announced that Neal Katyal had joined as our senior advisor on an advisory board we set up, which roughly means he's going to work a quarter of his time for us. Neal is probably in a handful of most prominent lawyers in America. He's tried more Supreme Court cases than any minority lawyer in history in any living way. He is a senior partner at Hogan Lovells, the kind of key new DC law firm. And so he's been the Solicitor General under Obama. For a guy like him to take his reputation and say, I believe in this crypto revolution is a huge statement. We're flattered. It's most flattering thing that he actually joined us at Galaxy. But I can look at our senior people, Michael Daffey coming from Goldman as our Chairman. So at the very top we're getting people that had awesome careers in other parts of industry. But I look at our junior guys. We're recruiting kids from Stanford that are staggering. We're recruiting kids off Twitter. These crypto de-gens that have learned more about trading crypto than I can imagine. And so both from the bottom and the top, the quality of human capital, our combined company as we close with BitGo is over 530 people. We were probably -- Galaxy alone 62 years ago. And so there is a flood of human capital coming into the space, which is allowing this institutionalization in lots of ways. Sandrock [indiscernible] used to tell me, follow the smart engineers out of Stanford, and they're all going into our space now. And so I look at our asset management business, it's got 10 straight months of positive inflows. I look at our banking business, the -- all the KPIs in our business are coming up, and we didn't do retail, right? We were either B2B2C or institutional. And I waited a long time ago. I had this bold call in 2016 that the herd was coming. The institutions were coming. And it really wasn't until COVID, where they started, and now it's a stampede. I was just in the Mid-East. Places that looked to me like I had 3 eyes 2 years ago are now engaging, they're engaging in mining, they're engaging in venture. I mean, it's shocking that we've got major state pension funds who are now putting big allocations in the crypto or planning that. And so I do think there's a lot of work to do still, but we're an asset class.

Makes sense. One of the things that kind of dominated the conversation earlier in the year were ESG concerns around crypto, particularly Bitcoin. And I think that was a big driver of some of the volatility that we saw. I'll throw this out to the entire panel, what's the conversation and approach like for ESG issues in the crypto space more broadly? And then maybe for Mike Novogratz and Michael Levitt, maybe for the mining space specifically?

Michael is part of -- setting up a more part of it -- the Bitcoin Mining Council. I think that's what it's called, right, Michael?

Yes.

And when I look at this, we lost the narrative early about how much electricity Bitcoin use, and it was a false narrative. The facts really are not nearly as bad as the story was. Most companies, like Core Scientific and ourselves are going to fully green mining for lots of reasons. But that Bitcoin uses as much electricity as Denmark, kind of who cares Denmark doesn't use a lot of electricity. And so when you look at the overall power of the world and the electricity users in the world, Bitcoin is infinitesimal. It gets bigger as the network grows. But I think it was like a fall story, but it was such a powerful story. We all had to address it.

I think Mike is right. The narrative needed to be addressed. Forming the North America Bitcoin Mining Council has certainly helped to release stats. I mean, right now in North America, the Bitcoin mining uses -- the clean energy utilization is high 60%. By the way, the United States in total is 40%. So well above, if you will the average in the U.S. and to Mike's earlier point, the raw numbers or that the Bitcoin network globally uses, I believe, it's 188 terawatt hours of power a year. The world produces 155,000 terawatt hours of power. So to Mike's point, the narrative sounded much worse than the reality, but it's incumbent upon us to make sure we educate with facts. And so that had to happen. The second aspect of the ESG thing that we should comment on is the S -- is the S. I mean, many of us in the industry have -- we're creating jobs. We are reopening formerly shuttered facilities and plants, industrial facilities that have been closed down. And the S doesn't get, in our view, enough narrative. I mean, Mike talked about they're up to 600 people. We're creating jobs. Core Scientific didn't exist 6 years ago. We have a few hundred people, now a couple of hundred people in our company. These are all -- they're good jobs. They're growing jobs. They're well-paying jobs. So repurposing formerly bladed areas. Helping with, in fact, providing load for the build-out of renewable energy sources, which we also work with the utilities on. All of those, we need to get -- we need to get the message out in a clear, factual way. And I think that that's -- I think it's -- we've been -- as an industry, we've been doing a better job of that of late.

Makes sense. Maybe -- so just for, I guess, for the benefit of some of the people on the line. So I guess the economic model for mining is you earn Bitcoin by running cryptographic calculations, the amount that you earn is proportionate to your market share for the computing power. Crypto mining has just been really profitable this year with a triple whammy of higher crypto prices, China mining capacity coming offline, and I'm guessing some supply chain disruptions that's stopping new capacity from coming online. How do you guys see the mining profitability trending over time? Are we at peak mining profitability right now? How does the industry evolve from here?

I mean, the -- it's so profitable right now. It's hard to think it gets more profitable. My instinct is like any commodity cycle, when something gets real profitable, people plant a lot of corn, if corn is really expensive and in the next cycle, it's less profitable. And Michael is much more of an expert on mining than I am. I see the cash rate going straight up, but not as fast because of the supply chain stuff, right? It's tough to get the chips. It's tough to build the data centers. They are all full. And so my guess is there's probably 12 to 24 months of good sunshine ahead. And then it's going to get more expensive. The ones who are going to win are the places with cheap electricity, who understand how to mine and how to keep the machines running efficiently, who are sophisticated around hedging. And so what happens is in the down cycles of mining, the better miners push out all the weaker miners. They become less profitable. And so the other thing that I think has changed. If you look at mining 3 years ago, and again, I'm going to have Michael address it. The chips had a pretty short half-life. And the ability to extend that life of a chip dramatically improves the economics of being a miner. How did I do, Michael?

That's fantastic, actually, by the way, and I'd like to take you on our roadshow with us when we get this destack done. Mike's absolutely right, in probably all of Mike's years in my years of investing when profit margins are too high it attracts capital. And our industry, the mining industry has attracted a tremendous amount of capital and interest. Now that said, supply chain issues are absolutely, absolutely coming into play. And I would bet any amount of money that taking the under on announced infrastructure build in the United States. There is just no chance that all of that infrastructure that has been announced can get build in the timeframe that has been stated. But it's also true that margins will come down to more reasonable levels over the course of time because that's the way every business works. It just flat out is. That said, we certainly think that it will continue to be a good business, and there will be winners and there will be losers, for sure, especially as we go through the next [ carbon ] cycle in 2024, that's probably when we'll see the winners and the losers. They'll -- it's like there's sometimes -- in businesses, there's chapter 7s and sometimes there's chapter 11s and we're going to see some of both through the next cycle. But we do think that it will continue to be a good business, but it's not going to be as profitable a business as it is sitting here today, you're right, the triple whammy, if you will, you say? It was real, and it has been a gift to mining companies.

Makes a lot of sense. Regulation has been a really hot topic this year. I think everyone here probably touches on that and knows now that crypto has become too big for regulators to ignore. I guess what do each of you think are the key regulatory issues that need addressing? And how would you kind of stack rank them in terms of priorities? Maybe in terms of your prioritization and then how you feel they're being prioritized?

Oli, why don't you start?

Yes. I'll take that one. There's significant regulatory uncertainty. Obviously, especially from a U.S. perspective, I think next year is going to be key especially for institutional adoption. And the 23rd of November, the Federal Reserve, the FDIC and the OCC released a joint statement saying that they're going to be looking at a wide variety of factors relating to the crypto state. And I think personally, increased clarity is welcome and will further encourage an institutional adoption. In my opinion, I think there's 2 key areas that need to be addressed, let's say. One is like custody and execution together, especially from a buy-side perspective, the ability to ensure that you're working with a qualified custodian. And as part of your fund mandate, you can actually invest in cryptocurrencies. And I'd say the second piece, which obviously, as discussed a lot is like the absolute definition and taxonomy of certain digital assets. And there's a lot of uncertainty around the treatment of certain cryptocurrencies, namely like stable point for example. And I think progress on both those dimensions, I think, will definitely help continue to accelerate the adoption and institutionalization of this space.

Yes. I think, Will -- I mean, Oli, you're right. I think the focus principally is on stable coins and consumer protection.

Yes.

And where it seems to be -- I think we all would like clarity, right? We can all operate in almost any environment, but we need clarity. And so that, I guess, is the hope that we have is that we get the clarity so that we can operate.

Makes sense.

So 2 things I'd point out just to hit a tangent. There was a hearing yesterday in D.C. 5 Crypto CEOs, Congress asking questions, Maxine Waters set it up. And the tone was much more friendly than everybody expected. And it's not that -- and it was more sophisticated than everyone expected. And so something really special happened around the Infrastructure Bill, right? The administration jammed, a pretty aggressive, I want to control crypto. I would guess it came from Gary Gensler and into the Infrastructure Bill. And it was -- they thought no big deal, who cares, and DC was shocked by the response of our community. From Tweets and phone calls from guys like Jack Dorsey, Elon Musk, Pete Briger and lots of others, myself included on the phones with lots of senators to a groundswell online of the 60 million, 70 million Americans that care a lot about crypto. And I think the politicians realized, oh, these guys can they have a big voice. They care deeply about this, and they can mobilize faster than just about anyone we've seen. And that changed the tone of DC immensely. We became a force literally over that weekend. The next thing I'd say is 2, 3 weeks ago, you had tons of Americans willing to contribute $200 each to come up with $43 million to buy the constitution, right, ConstitutionDAO, might have been the coolest thing that happened all year-long in crypto because it was the pure essence of here we are, we're doing it for the people, we're buying one of the founding documents, one of 13 constitutions, and we're going to give it back to the people. Unfortunately, Ken Griffin played the Grinch, a rich billionaire coming in to kind of spoil the party. And what I would call a tone death move. Listen, Ken's going to put it on display and whatnot. But DC noticed that as well. There is power in networks. And the crypto network is willing to do a lot of good. If you see the ethos around the NFT communities, it's a very positive ethos. And so I think it's changing the way crypto is perceived in DC, right? You can't just come out and say, I don't like crypto without facing consequences.

I guess one of the things that's also picked up steam this year has been the proliferation of DeFi protocols, I think, grew to over $100 billion, as measured by Total Value Locked this year, which is the amount of crypto that's sitting in decentralized protocols. I know it's a big topic to talk about in a 35 minute panel. But I guess what do each of you see as maybe some of the risks and opportunities for DeFi and how you see it evolving?

Sure. Let me go first. So DeFi had an exciting early part of the year, and then the tokens have really wildly underperformed everything else. But the ecosystems have it. I think 2022 is going to be a year of DeFi. And I would tell you the reason why. What DeFi really is, is driverless banks and driverless insurance companies, driverless fixed income markets. What prevents most institutions from using them is a fear that if I trade with a smart contract, and I don't know who's on the other side of the smart contract, the regulators might dig me for AML KYC, right? Individuals are all trading and saying, I'm trading with a smart contract, and the regulators aren't going to go after individuals. But if you're a regulated entity like ourselves, we're very careful not to break the rules. And so because DeFi is just code, there's nothing to regulate other than who uses it. And so as soon as the KYC AML piece is solved as soon as I feel comfortable using it because I either, A, either have a real high confidence level around the person on the other side; or B, there's a blue check system. He's been KYC by someone else in the network. And therefore, I can trade even I don't know who he is. One of those 2 things is going to work in this last year. I mean, we actually went to FinCEN with an Analytics AI process, and they gave us the thumbs up to try it and report back. We take that as we can use it for proprietary, but we're not going to roll it out to customers until we get a full opinion there. But there's willingness to go forward. The moment that gets solved, DeFi is going to eat the lunch of these places. And I tell you why, it's a better product. It settles atomically, you're in a settlement risk. It's composable. I can build on top of each other's protocol and because of that, you see unbelievably quick innovation, but most importantly, it's transparent, right? Sam Bankman-Fried, yesterday, he said, and his is in a DeFi exchange. But he says our entire exchange is transparent. It's all up there free to see, right? TradeFi can't say that. We wouldn't have the Bear Stearns crisis or the Merrill Lynch mortgage debacle, if all participants could look at their portfolio. And so this transparency will win over regulators as soon as they get comfortable with the KYC stuff. And I think, again, it's a 2022 or 2023, it's coming, and you're going to see the explosion of DeFi.

Yes. I definitely agree, and I -- it's like super interesting. I'd probably just add 2 other points. I think one is the technology itself. And I think, unfortunately, we do need more sort of smart contract auditing and formal verification, the ways to actually ensure that the smart contracts are fit-for-purpose to minimize hacking because I think year-to-date, I think it's something like $12 billion worth of tax in DeFi, which depending on when you cover data, it's roughly like 5% of the total value locked in. So there's still what I would call like technology risk but is being addressed and will be. And I think on the KYC AML piece, secondly, agree, there's a ton of like really interesting companies and protocols being created basically embed identity and KYC into DeFi that will help solve that. And I think the third thing, just very quickly, like who are you facing and a bit of like legal maturity and some evolution there, again, like for TradeFi and incumbents like us, are we facing a company or are we facing a Dow? And if they recourse these entities, and I think there's going to be continued growth on that space. And if you solve those 3 agreed, like it's composable, transparent and 24x7, and I think there's a lot of promise.

And Will, if you wrap kind of all of these thoughts together, thematically, what you also pick up is the more we educate people, right, about what DeFi really is about the transparency aspects, about the benefits to everyone, including those that are unbanked, right? As we have been able to and been given the opportunity to educate, whether its government or just people participants, it gets better and better and more accepted and more accepted. And so to Mike and all these points on DeFi, it's about people understanding what it really is, right? It's the only problem with acronyms. Acronyms, forever, it seems, at least since the GFC have been suspicious, right? And so really, what I think we're seeing is as we educate, as people become more informed, they are less afraid and as they're less afraid, there is more acceptance.

I think everyone on this panel has invested in private companies before, a lot of, I think, Mike and Oli have invested in private crypto companies before. There's a lot of investors on the phone, probably a lot of public side investors who -- I'm guessing you're anticipating more crypto paper coming to public markets and looking for a framework to evaluate crypto companies. I'm curious to hear your perspective. What do you think investors should look for when evaluating companies in the crypto ecosystem?

Yes. Listen, I think the founding team is really important. The community they can pull around them is really important, right? Crypto is a 2 punch gig. It's having something that provides real utility that can solve a problem. And then it's -- can you tell that story and bring people into the ecosystem, right? One of Galaxy's missions or superpowers is we're good storytellers. And so when we invest at a company, we can also have BitGo put them in the wallet and the custody. We can electronically trade them and provide liquidity as a market maker. We can stake -- we can run a validator node. We can write research about them. We can talk about them on CNBC and help bring people into their ecosystem. The ecosystems that won this year, right, the 2 biggest winners of the year were Solana and Terra Luna. Solana had Sam Bankman-Fried behind it. We participate in Solana, they had Jump Trading. They had Multicoin, some big crypto hedge funds. Luna had its group of people. We were big advocates of Luna, both run by bright guys, both building really cool products. It doesn't work unless there's good products. But then what gives them the value is getting people to understand and use that. And so there's a real role for the classic investment bank in helping get the story out. And I think we look for, again, founders that can do it, teams that can do it, but product -- projects that have a real story because they have utility.

Yes. No, I think we think the same way. We're trying our best to plot sort of the future market structure in these spaces and then think through what are the horizontal enablers? Like whether it's like BitGo, obviously, we invested back in 2018 in custody, if you're thinking about node infrastructure and node management and actually like helping businesses like what [ Devin ], data and analytics, Coin Metrics. So we're trying to think through like each layer of the stack that's creating this new asset class and world, how can we make sure we're positioned best to actually like help clients and ourselves actually build products. And I think the key thing is utility and the sustainable business model. And I think interestingly, over time, the regulatory environment is going to be quite interesting. So I think there could be instances where licensing actually provides a competitive advantage for certain players in this space.

Michael, did you want to close this out?

No, I can't -- see, it's like trying to follow the rolling stones. I think those guys are right on.

All right. Well, I think with that, we are out of time, but I wanted to say thank you again to our 3 panelists today for joining us. Really appreciate you guys taking the time, super interesting conversation and looking forward to having you guys back in the future.

Thanks for having us.

Great stuff.

Thanks.

Bye-bye.