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

All right. We'll go ahead and get started this afternoon. Thank you very much for joining us for Galaxy Digital Holdings. Before I get started with Chris Ferraro, President and CEO of Galaxy, I have an important disclosure to read. Please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep.

So Chris, thank you very much for being here. Great to have Galaxy, again at our TMT conference. Maybe can you provide an overview for maybe those that aren't as familiar or don't remember exactly where Galaxy Digital sits at, an overview of your business and the evolution of various product lines?

Sure. So Chris Ferraro, Chief Investment Officer and Mike Novogratz might be a little…

Yes, might be upset, right?

Yes. So Galaxy Digital, we actually founded the company out of Mike Novogratz's family office way back late 2017, early '18. Business has evolved from a family office that owned and traded assets in the digital asset space and has really been focused on building operating business lines, focused on serving institutions and those institutions journeys, whether they'd be institutional investors or institutional service providers in sort of the transition into the digital asset world. What we're focused on today, we really have 3 business lines. We have a markets business, which looks a lot like a traditional sales and trading and investment banking business, except exclusively focused on blockchain, cryptocurrency, digital assets. So our markets business -- our sales and trading business has OTC spot derivatives. We have market making operations. We have a financing business where we finance client positions in cryptocurrencies and digital assets and our -- we have a boutique investment bank who provides M&A and capital raising advice for companies in the space as well as companies outside of the space looking to enter the space via acquisition. That's our markets business. Our asset management business, we have, again, a fairly traditional model there, in asset management arm. We have about $2 billion of AUM. We have really -- we have funds across active and passive investing, public and private investing. And so we have a venture capital sleeve today where we manage outside LP money, making investments, specifically in blockchain-based gaming and Web3 NFTs and then we have a passive business where we've partnered globally with other asset managers in different jurisdictions to be the sub-adviser and the back-end provider of services for the launching of Bitcoin, Ethereum and ETFs. And so we have that in Canada with CI. We have in Brazil with Itau. We're looking for the U.S. to open up where we have a partnership with Invesco. And so we're excited about that and we really -- our core competency is touching the digital assets, betting the vendors and being the service provider for bigger asset management platforms who are going to, we think, ultimately dominate that space. And then our third division is our digital infrastructure division, which is relatively new and has come together with 2 acquisitions we made at the end of the year last year as well as some of the organic activity that we've done over the last few years. And that's really where -- while our first 2 business lines are more traditional models that sort of sit on top of blockchain infrastructure and provide financial services, third division really steps all the way down to the infrastructure layer where we own, operate and provide services sort of at the blockchain native layer. And so that's where we operate Bitcoin mining nodes. We have -- we run validator nodes for proof-of-stake, and we recently have gotten into the custodial technology business with our acquisition of GK8.

Got it. So look, your interesting structure, and I think it speaks to Mike and the rest of the team's abilities across all those different areas and interest. But with that combination of being an operating business as well as your own investments, like how are you thinking about strategy during this period of really the last year, a little more than a year of weaker crypto asset prices and values. Like how do you manage through that?

Yes. It has been -- it's been -- it was a challenging 2022 for anybody in the space. Certainly someone like us who both are building for institutional clients who are inherently have been on an upward trajectory but fairly slow March as well as us as a firm because we do run the firm net long exposure. We own [ preferences ] in treasury, we have an investment portfolio. So 2023, for us, so we've made it to the other side, which is great. I think everyone at the company rightly so, where is a pretty strong badge of honor for having risk-managed 2022 relatively well, relative to almost everybody else in the industry. 2023 for us is about building. And so we think institutional adoption, again, both on the institutional investor side as well as institutions like Morgan Stanley and Goldman and you name it, from a broker-dealer bank, et cetera, perspective globally, are still continuing their aggressive march toward digitizing their businesses, and that might be digital issuances of securities, bonds, et cetera, or actually spending more time on sort of decentralized digital assets like Bitcoin, Ethereum et cetera. And so for us, we're focused on building. We think the right thing to do here is head down. We've created a product engineering org inside of the company that is a substantial amount of our head count, 25% to 30% of our head count in [indiscernible]. We run it like a tech org. We're focused on, for us, delivering a handful of products out to the institutional marketplace that's really product engineering focused as opposed to being sort of more traditionally bespoke one-off bilateral transactions with institutions. Yes. So it's about risk management, it's about keeping cost structure down, but head down in building for the future because we think the opportunity set is still there. And it's -- we think it's demonstrated by actual activity on the institutional side.

So you kind of alluded to it there in that answer, but maybe we should have started with the point around headlines over the past year and the pressures that, that's created both from a perception standpoint, the actual pressures in the markets themselves as well as from a regulatory perspective. I mean, I'd love to get your general state of the union on the crypto landscape. And where do we go from here and like what needs to happen for that to be realized or for the aspirations and opportunities to be realized?

Yes. I know it's going to sound like a well-trodden throwaway statement, but regulatory clarity would be my #1 answer to that specific question. We -- it depends jurisdictionally sort of when you asked the question, where do we stand today? I mean the U.S. has a huge opportunity to be a leader in this because there's a lot of talent that has come into the space that's invested their careers and lives in building. And -- but the U.S. has been a little bit backwards in terms of the way it's approached creating sandbox structures and creating the ability to build the technology, throw it out into the wild, use it and other global jurisdictions are moving fast to create that. So I think without that regulatory certainty in the U.S. board with an approach that's not enforcement first in the U.S., you would have much faster adoption on the institutional side, which is really what we think is the watershed moment for full adoption, full use case, real money coming into the space over time. So, yes, I mean, the space has undergone a lot of stress in 2022. A lot of companies are either dead and gone or are dead, everyone just sort of doesn't really know -- everyone knows it, but they're still alive and kicking, but really don't have a future. We're excited to have been -- we're excited now to be one of the handful that have made it through. There are a few other good companies and good sectors in the space that are still thriving and actually have a huge opportunity set. And what we see going forward is we see globally regulations rightfully so, sort of pushing the business towards regulated institutions that are well capitalized, they have diversified business models. And so while for us, we think, historically, our biggest competitive set has been really crypto-native firms like venture capital funded exchanges, broker-dealer -- nonbroker-dealer brokers, asset managers, that -- a lot of that didn't survive the last move. What we see going forward is we see groups at every bank, groups at every broker-dealer at every custodian, 25, 50, 100 person groups at big asset management shops who traditionally have traded every other asset on the planet, really investing in the next step. And so I think as regulation forms and it's going to be informed by those institutions, who have an opinion about how the regulations should be crafted so that they have their place in the future. I think that this has been an accelerant. That's going to come fast when that happens. Then everybody is going to feel a lot more comfortable about the lanes with which they can operate in the space.

So when you look back and you mentioned this couple of times that you guys are -- have made it through, if you will, '22. And feel like you're able to move forward from here. But at the same time, you described a lot of companies that actually died or maybe just zombie companies for the foreseeable future. What was different about what you guys -- what you were doing at Galaxy versus at least what you can identify in some of these other places that they haven't made it through?

Yes. So a couple of things, right? I think we're -- we've run our business, a, we're a public reporter in Canada. We have been almost since near the beginning. So from a transparency perspective, from a Big 4 audit perspective, like we've run our business exposed in that way, which has been a very expensive endeavor for us. But rightfully so, we thought it was the right way to build an institutional business, whereas a lot of other companies in crypto operated sort of not in that paradigm. So we're not as transparent.

So -- and I would even interject there. I think a lot of them like were of the view that like we don't want to be part of like what's regulated and we want to deliberately avoid like some of that transparency.

Yes. And I think part of that is right. I think it's a little less than nefarious -- it's not as nefarious as one would probably include, I think it was more from the perspective of while we're trying to build in this new asset class like are there -- can auditors figure this out at a cost that's reasonable and over time from that's reasonable for me to actually build my company as a start. We had the benefit of having permanent funding from the very beginning. And so we've had the luxury of being able to build smarter, albeit a little slower and more openly. I think the other big thing that happened in the industry was you had venture capital-funded enterprises that, as a result of that, had to show KPIs that showed growth. This is probably not too different from a lot of fintech companies outside of actually, who had expectations around showing top line revenue growth, customer growth, where the reality of their operations were really like leverage and asset liability mismatch-driven business models. And so at Galaxy, we think we've built a great institutional team. We've operated the business from a financing and counterparty perspective, we are laser-focused on counterparty risk, like that's ingrained in our DNA and our soul and when we operate the company in our financing activities, we only finance customers on an over-collateralized basis. We only finance institutional customers, no retail, which is where some other folks, I think, got themselves tripped up pretty bad. And so that's been the problem. It's been a stacking of centralized finance companies with largely unregulated, taking on too much leverage and having asset and liability mismatch, sort of one layer above the actual technology. Nothing [indiscernible] still going is still performing. It's got nothing to do what happened in 2022, unfortunately, for the space.

Right. So on that point, once again, you talked a little bit to it, but one of the questions or one of the things covering the broader fintech space that has been pretty evident, at least to me, I think, is that a large number of fintechs were really just beneficiaries of very low interest rates where and keep capital where they didn't have to really generate a lot of returns. And the arbitrage was really that the incumbents, either because of requirements from shareholders and/or regulators had to generate maximized returns. And so if you can go into an industry and say, okay, everybody else has to maximize profitability. I don't and I've got cheap access to capital, I can be disruptive, right? So when I look at the crypto space within that -- through that lens, like I'm left wondering is how much of the crypto world is basically the same thing. It's like an artifact of cheap capital versus what's real? And how are you separating that out?

Well, you are right to the real deep question. That's a good one. So I don't disagree with you at all broadly. I was -- we were -- our research team does a fantastic job every week, by the way, producing stuff on the crypto industry. We were looking at -- I mean, we always go back and look at the chart of M2 versus basically the chart of anything. They all look very similar, and there's a reason why they look very similar -- the -- when you zoom in on crypto, cryptocurrency assets, you got to kind of take a nuanced view across the board. They're not all built the same. So can we talk about Bitcoin, right? Like Bitcoin, we can probably spend the next 14 and 3 hours on with me about sort of the thesis behind Bitcoin and what it represents. Like did Bitcoin adoption and rise happen because of all interest rates? Absolutely. But like that's the very nature of the debate around whether fiat currency is stable or not relative to the purchasing power. And so whether it's Bitcoin or whether it's gold or other hard assets, like there's a real thesis there around what fiat currency is and how it's managed and low interest rates for a very long time, bases of value of that currency. So like the pullback in prices on Bitcoin specifically with the rise of interest rates, I actually think shouldn't surprise anybody. I think people confuse the notion of, well, it's not a great hedging, it's inflation. Like, well, actually, Bitcoin went up when the Fed was doing nothing about interest [indiscernible] when the holding interest rates low for a long time. And then Bitcoin came under pressure when the Fed started acting to fight inflation. That's actually what I think is supposed to happen. So like I think it's a separate bitcoin. The question on the rest of cryptocurrencies and Ethereum about whether it was a good allocation of capital with 0 interest rates, I think is a big question. We don't have the answer to, right? It portends -- it prefers a future where you can have composable financial transactions and then a whole lot more we can imagine on a completely decentralized computer that's not owned by the one stakeholder that allows for trustless composability of computer-based algorithms to sort of build a lot of different peer-to-peer transactions. And like I think as an early-stage investment in future tech, like that's a pretty interesting allocation of some capital. For sure, the amount of money that went in at certain valuations was very wrong. I think that's actually not like specific to crypto at all, it is actually…

Yes, I can find a lot of other examples right.

Right. So I think -- yes, and then outside of the centralized crypto and so Bitcoin, Ethereum, other layer 1s, layer 2s and things like that. When you talk about sort of blockchain technology and companies building core blockchain-based infrastructure, going forward, I think that like, I don't know, even in higher interest rate environment, there are a lot of companies, big companies spending real money right now at higher interest rates, investing in building out new infrastructure. So I think that the market is speaking on that. If you're talking about either sort of private permission chain building, if you're talking about blockchain-based surveillance companies, things like that, I think people are investing in them now at 5% 2 year, right? Like so I don't know, the market will speak on that. I think the embedded investment has persistent and will continue now.

I've been dominating a conversation here. If anybody has any questions, please raise your hand and I'll get you the microphone. Turning back to regulation and I think you're quoting your mantra is pretty clear about the desire for clarity and that kind of thing. At the same time, in general, banks aren't able to meaningfully play in the crypto world, given high capital requirements. Like how does that -- what's that creating for the opportunity for Galaxy specifically? Like how are you addressing that?

Yes. So our first 2 business lines, as I articulated, our traditional business models that existing banks and broker-dealers, existing big asset managers already have. And so those companies hesitance toward or lack of ability to touch cryptocurrency, for example, is our big competitive advantage in our moat that we've been building towards for the last 5 years. So for us, like we're building technology, we're very focused on launching for us, what we're calling GalaxyOne, which is our institutional technology first client portal to be able to access all the products and services we offer for cryptocurrencies, like our ability to do that exist today because name your big various money center bank today, they might facilitate futures clearing, for example, via CME in traditional sort of FCMs. But outside of that, aren't touching it. So that's a big opportunity for us. Same thing on the asset management side, our knowledge in the space of the right vendors to use, the way to create products that aren't going to break for investors, that's our competitive edge. I think the flip side of that is the struggle is we also market participants, including ourselves, rely on the traditional financial system to provide commercial banking fee on reps, things like that. And so that has been a challenge, and that will be a challenge going forward. Our hope is that commercial money center banks with the blessing of the powers would be behind them, recognize that this is actually a real big opportunity now for them to step in and really help shore up and control the market rather than cut it off and choke it off because I think that, that would be a huge mistake. And frankly, what's going to happen then is money is going to move either offshore or away from the U.S. and/or it's going to move into things like stable claims like USDC, like what's going on with Silvergate, we would -- I would not be surprised if people who relied on Silvergate's commercial banking relationship now instead turn and move their dollars into USDC, which, by the way, ultimately, is sitting at a very large financial institution that is one of the largest custodians of treasuries in the world and one of the biggest money managers in the world. So ultimately, it's getting there. It is a question of how is the customer relationship being developed? And how is it being curated.

So I want to spend the last few minutes here digging into the specifics of the different parts of the Galaxy business that you outlined and let's start with trading. It's definitely been constructive to see the continued growth in the number of trading counterparties. But can you give us a sense of your customer base and how it has evolved over the last 6 to 12 months?

Yes. So the last 6 to 12 months, I think, is -- well, it's certainly illustrative of a specific idiosyncratic cycle in crypto. Our customer base today is a mix of ultra-high net worth family office style counterparties, traditional crossover funds who trade long-short equities but also have a Crypto Sleeve, crypto-native hedge funds, so name your long-short crypto asset head fund, et cetera. And so that third bucket has certainly shrunk by virtue of either having gone our business or having lost the AUM in the downturn. The ultra-high net worth family office segment is actually pretty resilient. And one of the most interesting on the go forward from a likely readoption time frame and the traditional institutions hedge funds and then also long-onlies and ENF'S are -- haven't pulled back a whole lot, but to the extent that they were coming in fast have slowed down. And I think that, that's totally normal, like on the backside of what happened in 2022.

So then let's turn to the Asset Management business. Your venture business comprises, I don't know, roughly, I think, 56% is your last quarter, your total AUM roughly. Can you give us a sense of the pace of crypto formation over the last 6 to 12 months? And what really you envision that evolving to look like in the near to medium term? Yes. So for us, it's important to distinguish between -- so we have about $1 billion of AUM in -- across 3 venture funds today, series of Fund I, II and III, which we called Galaxy Interactive. Those funds are focused mostly on gaming and where blockchain and cryptocurrencies have met the gaming market. We have historically done the rest of our investing off of our balance sheet. And so you see an asset manager and you see a big portfolio that we actually own that investors in Galaxy synthetically just get a direct ownership in. The -- we've moved that team in that call activity into the asset manager, and we're working -- and so we will be -- on a go forward, our investing activity will happen out of the asset manager, not necessarily off of our balance sheet. So just as a level setting, it's 56% of the AUM now. It -- if we do our job right, the mix of our AUM and the asset manager is going to go heavily towards those activities that we are historically doing ourselves, which should be good for equity investors because then not only do you get the same exposure because we will see those funds with firm capital, but you also get the benefit of a management fee base and a promote base that theoretically stacks and grows more going forward. So to your question about what are we seeing on that front? What we see today is capital formation down dramatically. The primary markets are trying to figure themselves out. So valuation in the private market has still been disconnected significantly from the public markets. It is certainly wavering and coming down now. The issue is you're at a point in time where a private company that historically raised at pre-2021 prior levels, if they don't have to raise their nut. And so the only folks who are raising today almost self-select to be very skeptical about because they have to raise. And it's difficult for the rep around, head around a valuation change. So we're focused on actually -- we actually think the most interesting segment to be looking at as secondaries of the larger companies in our space that historically had been funded, who now are held by a broad group of investors who may have lost conviction in the space, may have been twisted upside down in terms of their commitments to liquids versus liquids. So there's a lot more sellers of securities than there are buyers of securities at the higher end of the market. So our asset manager, like that's one opportunity we're focused on now because we think it's the right way to deploy capital. It's a good risk-adjusted returns. I think what you'll see, though, is that cycle will play itself out and new primary capital formation. So the next Series A and Series B and Series C rounds are going to get repriced and for the good companies, and they're going to happen sort of after the last funding cycles have run their course and runways have gotten shorter. And so people will start raising again on the primary 2024 mid-year -- And then you mentioned back in the overview at the beginning of our conversation around even getting into your own proprietary mining, et cetera. You built your own site in Texas, which I believe went live relatively recently. Is that right? In Diboll, Texas, small one. Yes, correct. So how meaningful is that project in terms of your ability to scale your own self-mining capabilities? And I guess one of the questions is like, there's always the question around Bitcoin and environmental impact. What is the things that you can do through your own mining to help offset that?

Yes. Great. So that was a relatively small site that was our first organic build that I won't quite call it a test build, but it was a relatively small size. The bigger impact for us was our purchase of the Helios asset from Argo, which we closed in December. That's a up to nameplate capacity today of 220 megawatts, big footprint in West Texas, surrounded by wind turbines like and a very interesting long-term energy play for us, which is critical to the economics of Bitcoin mining. That's really been our big capital investment. That site has more than enough capacity for our currently owned ASIC capacity as well as for us to host additional customers to bring in their equipment where we as a data center provider, which is important for Galaxy, we think it's interesting for Galaxy because the more external customers we bring in and host, Bitcoin miners need excess electricity, which were effectively the electricity provider. And so all of a sudden, we're in the business of trading power in West Texas. 2, those miners create Bitcoin every day. And so at some point, they need to have liquidity, they'd like to hedge their exposure. And so we're really -- gives us a way to bring clients in that own the industry underneath it, which will fuel the markets business. So that was the real big strategic move for us in terms of owning infrastructure, the Helios acquisition. And look, on the ESG side, our firm is maybe the only or one of the only certainly the most focused on having a thought out well-planned ESG strategy as a public company. We think it's very important. We think investors think is very important. We've made commitments over the forward time horizon to hit a certain sustainable energy target, which we're still committed to. And so yes, I mean, that's the framework through which we're building that site. Got it. Well, Chris, we're out of time. Thank you very much for joining us today to talk about Galaxy Digital, an exciting things for sure. And I think the last year and kind of being able to come out on the other side and continue constructively is a big win for you guys. Congratulations.

Thank you very much.

Thanks.