In this episode I get to speak with Eric Ervin, the President and CEO of Reality Shares. Reality Shares is an innovative asset management firm, ETF issuer, and index provider that manages quantitative dividend ETFs that select individual securities using a proprietary system called DIVCON.
Eric is also very knowledgeable about blockchain technology and has led Reality Shares to the launch of an ETF that invests in the leading global companies creating and implementing blockchain solutions.
In this interview, we discuss the factors and strategies that drive Reality Shares’ dividend offerings, the motivation behind its new blockchain fund, and why Eric thinks that blockchain has the potential to be as disruptive as the Internet.
Full Transcript Below
Nick: Eric I just wanted to begin by giving you a hugely warm welcome for coming on and being interviewed on the Sure Investing podcast, we’re really happy to have you.
Eric: thank you and thanks for having me.
Nick: no it’s our pleasure. I thought we could begin by just hearing a little bit about who you are and the work you do at Reality Shares and I guess where you fall in the world of investing.
Eric: we started the firm – myself actually started the firm about five or six years ago. I was a financial advisor for many years about 15 to 20 years at some of the major Wall Street firms, Morgan Stanley being the most prolific out of that category. And my clients, they weren’t billionaires but they were certainly very successful in that five to five hundred million dollar net worth and with that they were a bit more conservative but they were a little bit mistrusting of the stock market and the general kind of equity markets and capital markets.
So they always wanted to have some defensive approach with that and that spoke to me as well. So when I launched Reality Shares it was with the idea of bringing good quality hedge fund-style strategies or other strategies that just made sense institutionally to the individual investor that my neighbor could invest in.
And that was really the first fund that we ever launched was focused on a market called the dividend swap market which is a really someone esoteric institutional market kind of an alternative to bond type investments. So a lot more conservative a lot more stable in terms of overall volatility but also a lot less potential for reward.
From that kind of thinking with that quantitative mindset of building institutional quality portfolios, we built out a model to predict which companies had the highest potential for dividend growth. And then built out a couple of funds based on that really you know focusing not just in the rearview mirror and looking at which companies did grow their dividends. But which companies could grow their dividends in the future. Which I think is probably the most important thing that people need to look for.
And so we built out funds across that category and then we also have a thematic approach as well so we built out you know the blockchain technology is really becoming prolific now and could be as big as the internet was to us in the 90s. And so in order to accomplish an investment vehicle for that, we built out an ETF and an index that will track the companies that are investing in blockchain technology and using that blockchain technology and that really kind of brings us to where we are today as a firm.
Nick: okay so it sounds like you just take a very quantitative approach to the dividend growth investing strategies that a lot of investors practice individually.
Eric: yeah if you know if I look back at my investing career from the first days you know anytime that I allowed my emotions to get involved in the process usually was it was a bad decision. And so the more I could take that out I kind of grew up in the computer science world and the more you can take process and build it into a system and then take that system and implement it and trust it and have confidence in the system the better off you are because then you know you’re less apt to monkey with the system.
And most you know most of the greatest money managers in history if you ask them do they have a system they would all agree yes I have a system. Maybe they don’t articulate it in writing but you can and if you just interview them right down to you know what’s your process what’s your universe of stocks that you look at what’s the factors and the quantitative system that you use to model out those stocks all the way down to you know finally when do you buy and when do you sell.
You can write up that rule set and then fire the money manager and build out an index that’s much cheaper and much more cost-effective in order to create that same outcome and potentially even a better outcome. Because again you’re taking the human out of the equation, so that’s really how we think of things is write down the rules create systems use those systems trust those systems and then offer it in a transparent format so anyone can use our same research to build their own portfolio just out of our best ideas.
Nick: so what are the factors that you incorporate into your systems that your Reality Shares ETFs?
Eric: so in the dividend space looking at dividend growers we boiled it down to, and we analyzed about 40 different factors. What we really wanted to do is solve for that question of what is a dividend grower? Is it just a company that grew its dividends in the past or is it a company that can grow its dividends in the future and has a higher aptitude to grow which is really what matters.
Just because you grew your dividends in the past like the dividend aristocrats or some of those other models we feel like that’s leaves you into a brick wall potentially if you’re in a crisis situation a lot of those stocks ended up cutting their dividends dramatically.
So 7 factors where we found to be most appropriate our dividend estimates, so analysts Wall Street estimates for dividend growth, the free cash flow to dividend ratio so how much is the company actually earning in real free cash versus how much is it paying out in the form of a dividend. And that would be a similar to like a dividend payout ratio of earnings but earnings are a lot more manipulable so it’s easier to fake earnings than it to fake free cash flow and that’s nice free cash flow matters a lot more.
The Altman Z-score which is kind of like a credit score for companies it’s like a personal FICO or score for people the Altman Z-score is that two companies and so that also factors into the equation. And then how much is the company actually doing in buybacks so if a company is buying back a lot of its stock and paying a dividend and they fall on hard times, they’re more apt to cut the buybacks than they are to cut the dividend.
They have kind of an extra bullet the chamber should they fall into two tougher times they can cut their buybacks and continue to increase their dividends. And then a couple other factors in there and then that winds out to what we call the Divcon score and then we have a couple of portfolio’s that only select those leading dividend growers. Or vice-versa that also short those dividend cutters those in the bottom tier of that index model.
Nick: that’s super interesting. There are a few things that really stand out to me there. The first is your use of share buybacks as a measure of dividend safety and interestingly enough the Sure Dividend investment strategy which is called the eight rules of dividend investing. We use the same criterion, and I’ve actually never heard of anyone else using it before, so that’s super cool.
The second thing that I found surprising was your use of the Altman’s Z score which is something that I’ve only seen in the writings of Tobias Carlisle. For our readers who may or may not be familiar with that score would you be interested in providing some insight into what goes into calculating it?
Eric: yeah and into Ed Altman, he was he’s a professor at NYU and is the father are known as the father of distressed investing.
Way back in the in the late 80s and early 90s he was instrumental or his research was instrumental and this idea that you can actually invest in distressed debt or junk bonds and earn a profit.
So investing in these companies that are you know right on the verge of bankruptcy but perhaps their debt is trading at a far lower value than them where it should otherwise be or vice versa. Knowing which bonds to avoid because the company is on the verge of bankruptcy.
And so he like us created a methodology in order to quantify just how distressed a company is and it uses a few things that we use actually. So free cash flow is one of the factors that goes into it the company’s debt level, so their debt service to their free cash flows how much are they paying in debt service versus how much free cash flow did they have what’s their total debt to equity ratio, and there’s a few other factors. And it’s it’s very transparent, so anyone can go to Google and search Altman z-score in order to understand exactly what goes into it.
But it comes up with an equation and then anything that’s less than I think it’s 1.3 on the Altman Z-score is considered a high likelihood of default. So if they are ready to default on their debt, they’re probably not going to be paying that dividend in the near future, and vice-versa a company that has a really high Altman Z-score is less likely to default and also more to be able to pay their dividends in the future.
Nick: you also mention that you have certain strategies where you’ll take long positions in companies that score well using the divcon model and short positions in companies that score poorly using the divcon model. Another investor who famously does that is Joel Greenblatt but at his Gotham asset management.
Would you say that he’s been influential in the way that you’ve built up Reality Shares over time?
Eric: yeah my just DNA as a as an advisor and kind of my overall investment philosophy it’s to seek out opportunities both long and short to put yourself in the best position to where you can kind of in my old days to where you could tell a client or an individual investor to hang in there and be confident that you’re doing the right thing.
Trusting in systems that’s one but also knowing that markets do correct and there’s times if you’re long only. Then you’re missing a great deal of opportunity. But you’re also you’re putting yourself in a position to where you know really kind of a third of the portfolio could get wiped up just because the market corrects and that has nothing to do with the quality of your portfolio.
Generally this that and forgive this you know this term but being long high-quality and short low-quality or long quality and short crap is a good overall strategy that lasts throughout time. Because as markets go down those lower quality companies are generally the first ones that portfolio managers will start to sell. And the higher quality names will be the last ones that portfolio managers or just the general market will want to sell.
You end up having a better what we call downside capture meaning you go down less with your high quality names then the market does and the low quality names tend to go down more than the market. and so if you allocate it appropriately which in our one fund which is the difficult to find is the ticker it takes a 75% long position in those difficulties and 25% short position and those low quality the divcon laggards.
We call them and so those are the companies most likely to show or cut their dividend so in a bear market those are the companies you want to be short and in the in the correction of 2008-9 that kind of back tested model would have been down only around 3% in that time period versus the market which was down almost 38%.
Nick: wow that is some fantastic downside capture as you call it. Now come I understand you have three or maybe four different ETFs that are based on the DIF consistent are the differences between the ETF’s based on their long short allocation or are there other differences as well?
Eric: that’s the key difference so these this divcon system is and actually we have we’ve applied that same difficulty to small mid-cap and later we’ll do it towards international companies.
But for these three there’s three ETFs that are based on the system for these three ETFs so we have the divcon leaders, LEAD is the ticker and all that does is it owns the leading divcon companies. these are the companies that have kind of overtime and over the history of the model have never had a cut in the in the dividend and they’ve also had about a 97, 98 percent likelihood of increasing their dividend in the next 12 months.
They I think of them as the highest potential for dividend growth not necessarily on a binary basis I like a yes/no but actually in growth rate which is probably the most important. so these companies on average grow their dividends about 16 percent over time versus the market of 7 to 8% over times. Almost double the sp500 dividend growth and then the other funds of the divcon defender which is a long short takes a long position in those different leaders of 75% and a short position in those difficult one stocks the divcon laggards we go 5 4 3 2 1 is how we rank companies difficult 5 is the healthiest all the way down to difficult 1 and there might only be 10 or 12 stocks that actually fall into that divcon 1 category and so at that point it would just be shorting those 10 or 12 stocks.
And then finally the guard portfolio GARD is dynamic so instead of being long short all the knowing that stocks generally rise what it tries to do is to it has a mechanism that says risks are very high. And so it’s time to be long short and it goes to a fifty-fifty long short position or risks or low of a bear market and so it’s a long only position and it’s again just long those leading companies.
So it’s all the same stocks and all three funds it’s just a GARD is dynamic it’ll be long only at times and long short and other times. And then DEFEND is long short at all times and then LEAD is long only all the time.
Nick: the third fund you mentioned the dividend GARD ETF I guess I have two questions about it the first is I presume that the answer to this is no but would that ETF GARD ever go 100 percent short?
Eric: and you’re right the answer is no. so what again kind of based on the system what we figure is we never want to take on too much risk so at that point in time if the GARD indicator signals a bear market is is coming. And it only looks at the market for really kind of prolonged bear markets that’s what it’s trying to avoid it’s not really trying to avoid the next five percent correction or the next ten percent correction. It’s really looking for like the 2001 market tech wreck or the 2008 you know market correction just trying to avoid those big mega bears.
So what it will do is it’ll drop your long only exposure to 50 percent and then it’ll add a short position of fifty percent. So your net position is neutral you know really kind of have 50 percent long 50 percent short. But your overall exposure is 50 percent cash and then 50 long 50 short so that’s the general gist of how it would do.
And then it rebalances in order to maintain that that balance until finally the market gets healthy again and starts to go along.
Nick: do you have any funds who use short positions to create leverage say 25 percent short and 125 percent long?
Eric: no but we did and you know when we were developing the divcon system so this is I think again part of our transparency and our belief that you know we just want to be there as a as really a research provider and if someone wants to use our ETFs that’s great if they just want to use our research it’s there for anyone to see and they can go on and find a lot of this research.
At Reality Shares Advisors. com or at Reality Shares.com but the thought was should we create like a one thirty structure where it’s a hundred and thirty percent long and thirty percent short constantly and actually the returns are quite good on that strategy.
So but we didn’t want any you have limited bandwidth just the markets ability to understand your products offerings so we wanted to just keep it to the three funds long only long short and then dynamic long short type product.
Nick: now it’s very clear just from this discussion that you have a focus on using quantitative screens and quantitative investment strategies to remove a lot of the emotional biases that impair long term investment returns.
Do you think there’s any scenarios where human investors will actually outperform a quantitative system?
Eric: yes but maybe not consistently and so there’s certain there’s certain examples where the human gets involved the human makes a good decision. You know maybe it was perfect maybe it was a perfect decision they got out of the market at the top or they got into the market at the bottom or something they’re about you know or they were better in selecting a company and a portfolio and outperforming.
But generally those humans will then make a bad decision at some point in the future which will negate those earlier great decisions or vice versa. And so if they have a system involved and they can implement that system and Trust that system. Then they’re essentially doing what we’re doing and they’re just taking themselves out of the equation.
So I do feel like you know humans can do a great service for themselves the more that they can write down their own investment philosophy into a rule set. And that’s essentially what we do.
We do have certain like for example in the blockchain sector so there you need you need humans because that technology is so new you need to be able to understand you can’t just do it with the number of patents companies have filed for example. You have to have some humans in the system deciding whether not the economic impact – this company is going to be as great based on their technology solution or not.
You know whether or not this company is just faking it and so you need software engineers you need other people who understand the technology and the business of blockchain to evaluate these companies.
But what we do is then use those humans in order to input a score so that on a zero to ten basis for example what will be the economic impact to IBM if their blockchain initiative is successful. And then so will score that and we’ll have multiple people scoring it in order to come up with an ultimate score for the botching economic impact of IBM as just to use that analogy.
So humans can still get involved but the human has to create a system that you can quantify and then replicate on an ongoing basis. And that’s the general I guess you know to where you’ve got a quantitative meets human involvement but they end up with a quantitative solution and an outcome that can be trusted.
Nick: that’s a great segue in the blockchain because you’re launching a blockchain focused ETF which implies that you think that this technology really has something to it.
For the average Joe listener to this podcast I was wondering if you’d be interested in providing a broad overview of what blockchain technology is and why you think it’s important enough to create an ETF to give exposure to self-directed investors?
Eric: yeah and so I I’ll do my best at kind of explaining at the surface what blockchain is and then a couple of use cases and then we can we can take it wherever you like.
But think of blockchain as a distributed database where everyone who has access to this this database most of the time these are fully distributed. But there are examples of some private blockchains where everyone has access to this database and therefore there’s no need for everyone to keep their own copy of different databases and reconcile those copies.
A good example of this might be in the stock market so right now if I have shares of IBM my broker is telling me or my brokerage firm is telling me or my custodian how many shares I own and I’m trusting that they that data right.
But then if I sell those shears to someone I have to tell my broker to sell the shares my broker then tells the exchange to buy the shares or you know sells them to someone else. Someone else is trusting their custodian or their broker in order to evaluate those shares and then of course the exchange has its own copy of who bought and sold shares and then in the case of the United States.
The DTCC which is the trust company which everyone subscribes to also keeps copies of this and every back office of every one of those organizations has to come together and reconcile their own databases in order to evaluate who now owns the shares and then when IBM goes to send out a vote requests for the share owners does the vote request go to my broker or does it go to the other broker and it costs a significant amount of money time and human resources in order to do this entire process.
If that was done in a blockchain as an example it would be one database of I own the shares if someone else wanted to buy the shares the shares would be instantaneously transferred there wouldn’t be any settlement the money would be automatically placed into my account. I wouldn’t even need to pay my broker as a custodian of my shares because they’d be held on the blockchain. If the company IBM say wanted to do a shareholder vote they would instantaneously know that I no longer on those shares someone else has them and that other person could vote in order to cast their vote to IBM and it could all be tracked without a whole host of intermediaries and costs associated with that so.
It was really developed you know many people have evaluated as Bitcoin and Bitcoin is watching Bitcoin is really the first killer app that the blockchain technology was developed underneath.
Just like email was kind of the first killer app of the internet but the internet went on to be so much bigger than email same thing is true with blockchain Bitcoin was the first killer app on blockchain technology and blockchain technology is so much bigger and the potential for blockchain technology is so much bigger than Bitcoin even.
Nick: it’s clear from that those comments that you think blockchain is going to be tremendously disruptive. How would you say that individual investors can position themselves in a way that they benefit from this trend?
Eric: yes, so if you if you take that analogy of the internet just like the internet became pervasive across every single segment of the economy and every single industry really from hard line manufacturers to railroads to shipping companies.
There’s so many different either revenue opportunities or cost reduction opportunities with the advent of the Internet the same thing is going to happen most likely with blockchain. Back office infrastructure can get reduced down to a simple technology click of a button and to use it in the case of the supply chain.
IBM has already worked with Walmart in order to create and not just Walmart but Walmart and Nestle and several other meat food companies in order to build out a solution for the supply chain so when mango is shipped from the farm to the trucking company and the trucking company to customs to the new just you know importer and so on all the way right down to the shelf of Walmart.
They can tell if there’s a food poisoning outbreak they know exactly where the mangoes came from they no longer have to take out billions of dollars where the items off the shelf now they can just take off those items that are infected. And so they estimate that it will be billions of dollars in cost savings just because of this supply chain initiative and they can do it in seconds now instead of what would have otherwise either been impossible or taking multiple weeks in order to evaluate where it came from.
So that’s kind of one example of that what other companies certainly in the financial system have been looking at it’s just cost savings you know from I would say if you take the entire GDP of the financial system. A good you know double-digit percentage of that is easily allocated towards cost and in terms of transactions.
So just moving wire transfers from one place to another to custody assets and you know kind of that overall friction of keeping that database and keeping that ledger and now with blockchain technology a lot of that can be alleviated with these shared databases. Where companies have access to you know the ledger on a shared basis and they no longer need all that back office infrastructure.
So one is cost savings and then the other one is is real revenue growth as IBM works with more and more companies IBM sees it as a huge revenue booster Intel is a good example and Microsoft are actually completely reinventing themselves we’re now blockchain is a service.
Just like software as a service with Salesforce all out of those companies blockchain as a service is now going to become a huge percentage of their revenue growth in the future because they can now offer this in the cloud and they’re the sole kind of really dominant player in this blockchain as a service arena.
Intel thinks their chip sales could go up almost 20% just from this one thing because of the way that the chip is designed it’s fully encrypted. So data comes in on an encrypted basis it gets decrypted calculated and then it goes back out on an encrypted basis.
If anyone you know evil an Amazon for example on their web services wanted to peek in and see what was happening in this blockchain they wouldn’t be able to do it because it’s more secure but it stays distributed so more and more people have access to that ledger.
There’s just a number of different ways in different companies that you can kind of get access to either cost savings or revenue increases and what we decided to do was just score every company just like our divcon system. Score every company based on their blockchain score you know what their impact in the blockchain arena is and then rebalance that portfolio every six months.
So you can constantly see the new portfolio of companies that have the highest blockchain score and in that arena.
Nick: and what factors go into the scores that you assigned to these blockchain opportunistic companies?
Eric: so we did it in a kind of two-factor so there’s seven different factors that go into it. But we did it in a like a dual path.
One is a little bit subjective and this is where we wanted to build out a blockchain advisory board that could help us answer some of the tougher questions on which companies are frauds and which companies are legitimately implementing the technology.
We look at the number of patents that the companies have filed we take every company in the globe and analyze these different things so are they publicly traded for one do they have a market cap greater than 200 million is there trading and liquidity you know greater than is the turnover and the stock liquid enough to support investment from individual investors then the 7 factors are how many patents have they filed are they a member of a blockchain Institute there’s a number of different organizations or initiatives where people can become members or companies can become members of these Institute’s and then what level of membership are they and then what about their role in the blockchain ecosystem. Are they a developer an implementer or an investor in the blockchain space are they kind of providing consulting services like Accenture or are they actually selling technology like Nvidia and Intel.
Those of you suppliers and then what is their blockchain economic impact so are they just playing around with the technology right now and so even if blockchain is wildly successful their stocks not really going to move very much. Or are they all in on blockchain technology and this is really the future source of all of their revenues or cost savings and so it’s meaningfully going to impact the stock if blockchain is successful.
So we measure these different things and then we have these blotching advisors such as Jeff Garza who was one of the original Bitcoin core developers he had worked on the software you know with the famous or infamous Satoshi Nakamoto.
The kind of the creation and development and he can actually look at the source code of a lot of these different blockchain related businesses and decide whether or not this company is genuinely actually implementing a solution or whether or not they just copied somebody else’s source code and they really have no interest in building out their own block chain solution they’re just doing it for pure hype.
And so we’ll evaluate these companies based on each one of those scores and then kick out the companies that don’t make it the companies that do and then only invest in the companies that have a blockchain score of 50 or higher.
Nick: that’s super interesting there’s lots of blockchain related financial markets behavior that is almost reminiscent of the stock market bubble of 2000 2002 the Internet bubble.
Do you have any advice for investors who want to gain beneficial exposure to blockchain but are feeling nervous or anxious about potentially investing in the next pets.com?
Eric: yeah and I think that that’s probably the biggest problem for a lot of this and unfortunately it puts a little bit of a black eye on the technology. The technology is very sound and really like being used in across almost every different sector of the economy. But there’s a lot of fraudsters and there’s a lot of companies that are just changing their name and not actually implementing solution like even say the pets.com.
You know creating a business that’s purely based on hype and fluff so what I would suggest they do is definitely take a look at our ETF BLCN and look at some of the holdings in there to evaluate which companies are legitimately implementing blockchain solutions.
And then look at some of the holdings that are not in there like for example riot blockchain technology that’s just a kind of a scam that was a company that just changed their name to riot blockchain they haven’t done anything related to blockchain they’ve done several secondary offerings they’ve sold a number of different items of stock and share offerings and the founders or the original kind of core investors have sold a number of their own shares.
So that’s another company that you know is doing something more on the height basis and not on the on the real justified blockchain initiative. Kodak is another one that remains to be seen whether or not they’re actually implementing a solution they just took over a previously announced ICO and then put it into their own name. And then created this kind of you know anyone who does their research is able to evaluate that and know that that’s not a legitimate player in the space.
What their use case is is actually quite interesting so this ability to track photography or digital assets on a blockchain. You know kind of on a blockchain that is very compelling but they’re not actually doing it they’re just talking about it.
They’re the real invention that Bitcoin solved is a way to make sure that if I own something digitally you don’t own it and that’s really what bitcoin was.
If you take every dollar bill here in the United States if you look at a dollar bill it has a serial number on it imagine if you could put every dollar bill into a digital form and we could ensure that if I gave you my dollar bill you knew I didn’t give it to anyone else that’s what the blockchain does so now take that same concept and apply its digital images or an article or this podcast for example you know this podcast is going to go out and it’s just going to be a series of zeros and ones and so if I pay for this podcast what if there’s a smart contract that’s embedded into those zeros and ones that knows that there can only be one owner of this podcast and I own it.
And I own it for my own use or I could sell it or potentially anyone can download the podcast but if it’s used for commercial purposes that automatically a payment is made back to the owner of the podcast or the creator of the podcast.
That’s really where you know you’re you start to see the opportunity in blockchain but it also prevents already you know presents another question mark oh how the heck is all this going to happen and it’s just going to take years of tech time in order for the technology to evolve into all of these different use cases.
But you know everything else in our lives is now digital it’s about time that our money and our assets become digital as well and that’s kind of the innovation that blockchain is able to solve for.
Nick: throughout this call you’ve given some really fascinating examples of the use case of blockchain technology and you haven’t not once really mentioned Bitcoin or gone into much detail about it anyway.
I’m curious what your thoughts are on Bitcoin because there’s plenty of people who see it as a store of value and you see comparisons between Bitcoin and gold and there’s other people like Warren Buffett has said that if he could buy five year puts on crypto currencies than he would.
So I’m curious as someone who knows a lot about blockchain what thoughts are on Bitcoin?
Eric: yeah and I spend a lot of time differentiating the difference between what blockchain as a technology is and what cryptocurrencies are and I think initially in my journey down the rabbit hole of learning about a lot of these things I think I started out as being a bit of a cryptocurrency skeptic.
But over time I’ve not only come to kind of be really passionate about the technology itself blockchain and all of its different uses. but also actually to be a bit of a believer in the in the cryptocurrencies themselves not necessarily knowing that where it’s going but knowing that we’re just getting started here and so I do feel like everyone should own a percentage of their net worth in cryptocurrencies as an almost like a call option on the future and I am by a certain portion I’m like talking 1, 2, 3 % it’s just for too volatile to own much more than that.
But because it has this asymmetric risk reward profile I mean if you price it right and let’s say you allocate 3 percent of your net worth to it the most you can lose is 3% markets do that in a month you know so stock markets and even potentially bond markets can do that and. yet you have this potential payoff that could be 5 10 15 times that original investment.
They don’t show any if any correlation to the other asset classes so you can truly treat it like a different asset class but if it’s sized appropriately I think it makes a lot of sense for investors. The problem is there’s just so many things to watch out for so there’s scams there’s hacks on different exchanges it’s important to know that there’s never been a hack on the Bitcoin blockchain.
So the blockchain itself is very secure incredibly secure and many users might ask well how’s that possible you know anything with cryptocurrency or anything with technology can be hacked. why is it that a blockchain is so secure and the key thing I think that the analogy that somebody gave to me was imagine because it’s so distributed so imagine your dollar bill is held in a thousand different houses and so in order for someone to steal your dollar bill they have to break into every single one of those houses and change the ledger or you know break in and steal a piece of that dollar bill from every single one of those houses to make sure that they own your dollar bill now.
It’s just not worth it to them it would cost more in electricity just to hack into all of those different computers and all those systems to steal something and that’s why the Bitcoin blockchain or many of these other cryptocurrency block chains are so secure. But by storing your cryptocurrency and a place like Coinbase coin based can be hacked because it’s a centralized exchange and custodian just like JPMorgan could be hacked.
That is the kind of the key differentiator is the blockchain itself has never been hacked so if you do own cryptocurrency you have a lot more issues around storing your own assets. But I do feel like it’s a potential asset class it’s a store of value it’s a very volatile asset class and it will be as it continues to go higher and higher and higher.
All of that volatility will keep hopefully a lot of the inappropriate monies from going into it and keep just you know kind of that speculative capital investing in it because that’s I think what it needs is it needs this bit of speculation effect in order to grow the network in order to grow the trust. And then as it gets more and more trusted it becomes less volatile over time. But that could take many years’ decades if in fact.
Nick: you mentioned you know 1% to 3% allocation to crypto those would be appropriate for many investors. Would you recommend the people just buy Bitcoin should they buy a basket of crypto currencies should they buy only several what are your thoughts on that?
Eric: yes this is actually one of the next businesses that Reality Shares is going to start to build out is a way for people to get access without all the complexity of public and private keys and a lot of the other things so they can invest in a portfolio of the top crypto currencies.
Treated it like an index portfolio of kind of the main cryptocurrency assets. But without that here’s a couple of things that you need to know so Bitcoin has is certainly the most dominant it is the most secure of all the block chains. The more it goes up in value the more miners which are really just computers on the on the network or players on the network that are keeping us secure. So the more they come in and keep it even more secure so it has this kind of self-fulfilling benefit to it.
However it has a lot of other issues which are downsides so it’s difficult to scale the Bitcoin can only do about seven transactions per second whereas visa can do about seven thousand transactions per second. So without original promise of being you know this internet money where people can buy and sell goods for nearly no cost it’s cheaper than a wire transfer. That’s no longer necessarily the case the average transaction fee now is it’s around thirty to forty dollars for one Bitcoin transaction.
However most of the software developers that are coming into the space are starting there and they’re working on Bitcoin because it is the most interesting and it’s the longest dated blockchain that we have. And so that’s where all the brightest minds are you know tcp/ip wasn’t scalable. You couldn’t do video you couldn’t do audio everyone said that it was a terrible protocol and there were much better internet protocols.
But that’s where all of you know the best and brightest minds came and that’s where they solved those problems to where now we have you know we’re able to make this call together over the Internet and so it’s very likely that people will scale and solve those problems of Bitcoin.
So I do think Bitcoin is going to be your core and then Etherium is a completely different asset Eetherium is actually kind of this global computer and Etherium is the currency or the commodity that allows people to use this global computer. You can have things like smart contracts where my you know in the future my autonomous car could be out Ubering people around and it would be getting paid while I’m sitting here at work that can only be done with blockchain related solutions.
You’re going to need something like an Etherium or some other corresponding blockchain for things like that where smart contracts can actually take place on a blockchain a smart contract another great example of a smart contract is let’s say flight insurance. So many people buy flight insurance and many people miss their flights but it’s such a pain to go back and to try to reclaim those dollars from the flight insurance that they never end up getting paid.
If the flight insurance was done with a smart contract it would know that you didn’t make your flight and it would automatically pay you and you wouldn’t have to do anything beyond that. You if you missed the fight you’re automatically paid or compensated for that flight insurance that can only be done with a blockchain related solution and a digital currency in that vein.
Bitcoin in Etherium for sure and then what I would suggest is maybe the top three or four other coins beyond that’s a Light coin is like the silver where Bitcoin is gold so you can track process transactions a little bit faster on the network and then just take a look at some of the other ones from there. And again we’re not you know trying to make investment recommendations right here but these are just my personal opinions.
Definitely don’t overdo it you know for your listeners in your audience like I say one to three percent allocation know that anything you’re putting there could very well go to zero. But it could also be kind of the next big thing and that’s where again I think if it’s sized appropriately and you know what you’re getting yourself into then it makes a lot of sense for people.
Nick: do you see any way in the future where blockchain technologies can meaningfully disrupt the investment advisory industry?
Eric: oh yeah just think hum so I think you know first there was the robo-advisor that they came on the scene and I think that there was an awful lot of hype and a lot of interest in that and certainly a lot of venture capital dollars and I think that that’s yet to be proven really as it you know there’s just several billion dollars in robo advisors it’s not even several hundreds of billions of dollars.
The financial advisory world is still you know that human interaction is still really important to the individual client. But the Etrades and the Schwab’s and you know a lot of those types of solutions have taken a significant amount of dollars from the old traditional financial advisors.
Advisors have had to innovate they’ve completely changed their business model from a stock broker style business model to a financial advisor who also manages money for a fee and maybe in the future it might be a financial advisor who advises on clients for a fee. But it doesn’t have anything to do with the assets under management it has more to do with the advice given based on those assets. And because everything can be transferred and custody on the blockchain eventually.
The advisor can’t necessarily say I’m your custodian you’ll pay me a fee or I’m your intermediary between you and the custodian you pay me a fee. The adviser is going to have to think about new ways to create a business model where they can offer the advice without that custody. Because with once you have custody the clients really handcuffed to you as a financial adviser. Once you lose that custody relationship the financial adviser and the client have to have a personal relationship with one another otherwise the clients never going to want to pay the fee and so that’s going to be kind of interesting.
But again this is probably five to ten years out you know over the next five to ten years that this takes place.
Nick: so you see this is a win for investors overall?
Eric: yeah just like the ETF industry was a huge I mean it’s still continuing to gain massive traction and massive adoption from mutual funds. The fees came down significantly the amount of total fees that are paid to the ETF industry is really around five billion or so.
That’s the overall revenues of a three trillion dollar asset management pool that would have been about fifteen billion if it was in mutual funds so huge benefit to the consumer and in a tough battle for money management firms. But that’s all good for the consumer so just like any time a new technology comes in. it just eats away at the margin of the incumbents like Amazon when they came at you know Amazon’s opportunity is someone else’s margin.
The same thing is going to happen when it comes to blockchain JP Morgan the reason that they’re so nervous about blockchain is because it could potentially put them out of business. Same thing with you know the post office and email right, so it’s just going to be a great thing for the consumer and a really challenging thing for anyone who acted as an intermediary all of financial advisers you know custodians banks really kind of across the board there’s so many different intermediary.
Even Uber and Airbnb who came in and completely disrupted to well-established industries in a heartbeat basically could now be completely disintermediated because of blockchain. There’s no more need for me to go through Uber to get a driver when that driver posts that he’s his a location he’s near me and I post on the blockchain that I need a driver instantly the two of us meet up we just cut out 30 percent of the cost of that intermediary which is Uber.
Same thing with Airbnb you know you put your apartment for let on air being on the Airbnb blockchain for example. I say I need it we interact with one another on the blockchain there’s no more need for an Airbnb to take that middleman fee.
Anywhere there’s a middleman or an intermediary they have to really be thinking about new ways to invent themselves using blockchain technology otherwise they’re going to get completely taken out.
Nick: now what are your thoughts just is going to circle back to Bitcoin a little bit but I’m curious as to what your thoughts are on the comparisons between Bitcoin and gold?
Eric: yeah and actually so this is a this is another question of you know gold was always known as a as a store of value for many years and because it’s known as that it’s become a store of value you know so there’s a little bit of that self-fulfilling prophecy of if people believe it then it starts to become it and so on. And I think we’ve been around for long enough or we’ve seen Bitcoins day long enough to where people are going to start to treat Bitcoin as a similar store of value.
If you’re you know here in in kind of the United States and Canada and kind of the the first world we don’t have a lot of the problems that people do that live under oppressive regimes and otherwise but if you needed to get all of your assets out of a country it’s not easy to convert them into gold. And then you know flee the country with all these bars of gold. you can do it in a heartbeat with Bitcoin if you store your assets in Bitcoin and you can leave the country you now just left with a hundred percent of your wealth intact in you know milliseconds really as long as it takes to do a transaction on the Bitcoin network you’re done and you can transfer anywhere around the world with those assets.
I think that you know for a store of value it becomes even more accommodative for people who live in difficult regimes that have a harder time storing their wealth in a kind of safe format from oppressive dictators and what it also builds out an entire financial system for the unbanked.
You know there’s so many people around the world Africa and other third world countries that don’t have access to banking they don’t have access to lending they don’t have access to even their real estate. You know in in South America if a dictator comes in and says you no longer own that real estate my friend does you have no recourse. But if it’s all posted to a blockchain then there’s an accurate record and no one can tamper with that record because it goes all the way back to the beginning of the blockchain.
That’s where you start to see kind of unbanked becoming now part of this financial ecosystem and they can in store assets and therefore they can get loans and they can be more productive in the world where they could otherwise have been just shut out for life so it’s really kind of like a big game changer for the way society is going to operate in the future that’s the I think the thing is and more and more people will adopt it instead of gold.
And that doesn’t mean that gold will lose its value in fact there are certain ways that like the London metal exchange I think is already issuing of gold based cryptocurrency. So you can trade like bits of gold on a digital format and you can transfer them digitally on a blockchain related solution.
They work with the CME in order to do that so you’re seeing blockchain done in a lot of different ways but they’re still going to be these decentralized systems like Bitcoin Etherium where there’s no like if you wanted to shut down Bitcoin you can’t do it there’s computers too many computers around the world no government can shut down Bitcoin.
Bitcoin can’t just decide to stop there’s no you know you on your own personal computer could have a node operating the entire Bitcoin blockchain and so you have your money right there. So that’s the real kind of benefit of a decentralized system such as Bitcoin.
Nick: my last question for you is this. Do you see any big opportunities for blockchain disruption that aren’t really being captured by any companies or individuals right now?
Eric: like any new technology think about this as a you know to use that analogy of Internet this is really early days of the internet and it’s pre Netscape so you know the internet was I remember you know in the early days it was just a black screen and I would hit tab to get to the next link there was no mouse there you know so there’s really cumbersome for the average person to use and see the value in internet.
I think that’s kind of where we are with blockchain and a lot of these cryptocurrencies so we’ll have years before they’re become these on-ramps to the system where anyone can get access to it and see it and use it and feel it in their lives and their daily operations. But one other outside of Finance is health care.
If you know right now we all store our personal medical records with our different health care providers and those health care providers get hacked into all the time and so you know that’s our personal health care records getting out there into the investment we’re you know into the public’s hands.
From there they can forge documents they can create all sorts of you know fake prescriptions we have a huge opiate crisis here in in the United States and around the globe. If because of this concept on the blockchain no two people can have the same digital record of something. So there’s only one prescription that gets issued there’s only one human that can take exposure to that.
If all of the pharmacies are on that same blockchain they know if somebody is going into two different pharmacies and trying to fill the same prescription twice. They you know so it prevents so much fraud along with you know kind of bad things getting out onto the streets because there’s only one digital record of it and so therefore you know you can’t have those duplicates.
I think that’s going to be a big one over time and the thought of putting your public profile out on a blockchain your health records your DNA you’re your you know all of these different things on a blockchain is frightening to some. But just to put some clarity to that you’re not putting your data out there what you’re doing is think of it like a Swiss bank account a Swiss numbered account. You’re just putting a number out there that’s your identity that number represents you. And so that digital record of you can’t be duplicated.
That’s what is on the blockchain so you can see anyone and their assets you can see anything but all you can see is in numbers you have no idea who that person is behind that number. And that’s why it’s a lot more secure, but it’s also transparent.
Nick: awesome well you’ve really given our lesson there’s a lot to think about.
So I wanted to thank you a bunch for your time today, but it was a real pleasure interviewing you Eric.
Eric: yeah no thank you for having me, and I really look forward to hearing future episodes of the show. I’m really excited for you guys I think you know I’ve been a longtime reader of the program and I know you guys put out great stuff and I can’t wait to hear some of these other interviews that you guys are gonna do.
Nick: thanks so much for listening to today’s episode everyone I invite you to check out our website at sureinvesting.co see our premium investment research at suredividend.com and also check us out on YouTube where we publish videos under the name Sure Dividend.
See you next time!