ETF Expert Corner

BKCM’s Brian Kelly Talks Blockchain, Bitcoin ETFs

July 31st, 2018 by ETF Store Staff

Brian Kelly, Head of BKCM, highlights the investment case for the REX BKCM ETF (BKC), which owns companies involved in cryptocurrencies and blockchain.  Brian also discusses the prospects for a bitcoin ETF.



Transcript

You can listen to our interview with Brian Kelly by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: We are now very pleased to be joined by Brian Kelly, Head of BKCM. They run a cryptocurrency hedge fund. Brian is also a regular contributor on CNBC, he's authored a book on bitcoin titled "The Bitcoin Big Bang", and he has over 25 years of experience in equity trading and portfolio management. Brian is a portfolio manager for the recently launched REX BKCM ETF, ticker symbol BKC. This is one of the new blockchain ETFs and it's what we'll be focusing on here today. Brian is joining us via phone from New York. Brian, a pleasure having you on the program today.

Brian Kelly: Yeah. Great to be on. Thank you so much for having me.

Nate Geraci: Brian, first, maybe give us a little background here. How did you first become interested in cryptocurrencies and blockchain technology and when was that?

Brian Kelly: Yeah, sure. My background is as a global macro investor. My specialty is in currencies, fixed income, commodities, but really currencies is what I focused on. In 2012, I stumbled across bitcoin. I think I read about it. It might have been in the Financial Times or something like that. I read an article and pretty much summarily dismissed it, thinking that this is a scam. It's not going to work. How could this be a real currency? It's this digital currency of some kind. I can't touch it. It doesn't have an army. You can't pay taxes with it. All the things of why this couldn't work, I had in my head. In 2013, as the price started to go up, I started to pay a little more attention to it. Then I did a deep dive for about a year and really went into what the technology is, trying to understand why this is important. Then I had my “a-ha” moment. The “a-ha” moment was when I realized that ultimately, cryptocurrencies and blockchain technology are simply just software that allows us to remove the middleman from a lot of financial services. Once I realized that, I understood, "You know what? This is going to change everything about my business. This is going to change everything about the way I do business. It's an emerging technology that I want to be involved in." I wrote a book in 2014 called "The Bitcoin Big Bang". Since then, I have been an investor in the space on both the equity side and the cryptocurrency side.

Nate Geraci: Alright, before we get to the ETF, let's quickly touch on a few of the basics surrounding blockchain technology. How do you describe blockchain to the layperson?

Brian Kelly: Real simply, blockchain itself is a database. All it is is a way to store data securely. What we're using it for is to store the value of a currency securely, but that's really all it is. The way that it works is simply every 10 minutes, all the transactions that happen between you and I are gathered up into a block. That block is then broadcast out to all the miners, which are the computers that run the software, and then they verify and process the transaction, just like a typical bank might do. That's called a block. That block is then linked to the previous block that happened 10 minutes ago and you have a blockchain. Where the cryptocurrency comes in is the cryptocurrency is the economic incentive to run the software that is the entire system. Pretty simply, it's a database with an economic incentive attached to it.

Nate Geraci: My sense is many investors are familiar with blockchain primarily because of cryptocurrencies or cryptoassets, things like bitcoin, but of course, there are many other potential use cases for blockchain technology. Can you maybe walk us through an example or two of those other use cases?

Brian Kelly: Sure. Any place that you have a trusted third party or a middleman involved is probably a place where you could use blockchain and cryptocurrency. Besides the currency part, something like title insurance or just titles in general, real estate titles. The process now is somebody has to go back and do the title search and look for every person that ever owned the particular property and then verify they owned it. Then once you want to sell your house, that title then gets transferred to you. Using blockchain technology, the ownership of the property is recorded in the blockchain always. All you have to do simply is say, "Yeah, you know what? My house has been recorded in the blockchain. The title, you can see the ownership all the way back from the day the house was built up to today. We can verify it. Great. Sold my house. Let's move on." You don't have to have all the lawyers, all the title insurance people, everything involved in a real estate transaction.

Nate Geraci: Our guest is Brian Kelly, Head of BKCM. Brian, let's talk about the ETF, the REX BKCM ETF. Again, ticker symbol BKC. This is actively managed by you. Tell us about your investment process, what the ETF holds, and what the overall investment goal is here.

Brian Kelly: Sure. Let's start with the overall investment goal. What we're trying to give people is exposure to blockchain and cryptocurrency ecosystem. What I think about this portfolio is the picks and shovels play on the space. We have a new technology, very similar to how the internet was a new technology in the early 90s. This is a new technology for this generation, in my view. What we're trying to do is we have a portfolio of global equities that are generating revenue and are devoting material resources to blockchain and cryptocurrency. What we'll do is we are weighted about 45% towards Asia. We are weighted to the small and midcap sector. Primarily, that's because that's where most of these companies are residing right now. Asia adoption is very big. Small to midcap are where we're getting the purest plays on the space. That's kind of the big picture of what we think about the portfolio. Drilling down a bit, we have four pillars that we invest in, four themes. Number one is Wall Street disrupters. That's anybody using blockchain to change the way that we trade securities. Number two are the mining and exchanges. Anybody who's providing that on-ramp so people can use this, the cryptocurrency exchanges, the cryptocurrency miners, or even the banks that are servicing those cryptocurrencies, exchanges, and miners. Then we have enterprise blockchain, that's our third pillar. That's anybody who's using blockchain technology to streamline a business process. IBM is a good example for that one. Then the last one is decentralized internet builders, or Web 3. These are anybody who's using this blockchain technology to change the way that we use the web. The example there is what we found with Google and Facebook. They have an awful lot of our data and they're able to make billions and billions of dollars a year off of our data. Web 3 is going to be a decentralized internet where you the user control your data and you the user get paid for your data. We're looking for companies that are building that or devoting material resources towards that.

Nate Geraci: Brian, I mentioned this is an actively managed ETF. Why do you think active management is important in this space? Because there are some other ETFs that have taken an index-based approach.

Brian Kelly: Yeah. That's a great question. It's interesting. There's a concept called “bitcoin time” that we joke about in the industry, but it just means that everything is sped up because we're on the cutting edge of technology, every week there's some new information. Every day there's new information. What was popular last week and last month may not necessarily be popular or even viable this week. For me, this entire sector and industry is ripe for active management. If you look back at the history of tech, it changed a lot. Myspace existed well before Facebook. What I want to be able to do is to adapt and adjust to the changing, the rapidly changing, landscape, and that's where active management comes into play.

Jason Lank: Brian, this is Jason Lank. A portion of the blockchain ecosystem that fascinates me are the miners. I read a lot about the blockchain, but who are these miners? Not much is written about them. Are these giant corporations just operating with data centers or are these individuals, a couple of teenagers stringing together a few Xboxes? Give some high level color on who the miners are and if I want to be a miner, how do I become a miner.

Brian: Yeah, sure. It did start with essentially teenagers and gamers and computer enthusiasts that were stringing a couple computers together and mining. In terms of bitcoin mining, it has become an enterprise, a big corporation type of thing where you have these massive data centers located throughout the world. China's big. Canada's big. Washington State in the US is big because the electricity costs are very low. Effectively, all they're doing is putting computers together that are running the software, the bitcoin software. All they do is they act very similar to how a bank acts. They just do it with a computer and they just do it automated. They verify that, "Yep. You know what? Brian Kelly owned this bitcoin, and I'm going to send it to Mary Smith." They verify that I owned it, it's not counterfeit, and they process the transaction. That's what the miners do. Right now, you see there's probably three or four major global corporations that are miners on bitcoin. If you want to mine at home, there's ways to do it. There are other coins that you might be able to do. There are a couple websites, and the names escape me now, that'll tell you which coins are profitable online with your home computer. Certainly, the home gamer can get into it.

Nate Geraci: Brian, going back to the blockchain ETFs, I'm sure you've seen some of the criticisms surrounding them, that they're basically just semiconductor or financial services plays. How do you respond to that?

Brian Kelly: First of all, this is financial technology. It's fintech, so there's going to be an element of that. I also think when I look at our portfolio, I'm very conscious that we are not simply just replicating XLF and XLK, which are the financial and technology ETFs. What my team does, we have boots on the ground throughout the world. In fact, my head of research just got back from Korea yesterday. He was there for two weeks. We're really digging through all these companies, trying to find the companies that are really at the heart of this ecosystem. Then what we'll do as an active manager is we're going to overweight the pure plays. We're going to overweight the companies that are getting most of their revenue, or a significant portion of their revenue, from this. If you say, "Well, I'm just going to do the financial and technology ETFs", what you're really getting there is exposure to something very different than blockchain. Most of that revenue is coming from, whether they be gaming chips or AI chips, they're in the financial sector, they're coming from traditional financial systems. You look at what we have in the portfolio, the financials that we have in there are banks that specifically are servicing cryptocurrency exchanges and funds. They're growing their asset base significantly, which will have an impact on their revenue more than something that maybe a Bank of America or a Citigroup. You're not even going to move the needle there. That's what we're really focused on.

Nate Geraci: On that note of companies' exposure to blockchain, earlier you touched on some of the other uses for blockchain outside of cryptos, but how much do you think the real upside of companies involved in blockchain is ultimately dependent upon cryptocurrencies like bitcoin really catching on mainstream? How tied at the hip are these?

Brian Kelly: You can think of the price of cryptocurrencies as somewhat of a barometer of acceptance. There is some connection that if bitcoin and other cryptocurrencies are used a lot, then the value of the currencies should grow to support that ecosystem. As a quick look, you can say, "Hey, yeah. You know what? This is one way to look at acceptance." On the other side of it, there's cost savings that can happen. I'll give you an example. IBM has been working with Walmart in China to use blockchain technology to track pork from the farms all the way to the Walmart stores. What they found is they were able to significantly reduce spoilage. They're also able to track any foodborne diseases quickly - quicker than they could. Walmart is saving a lot of money by using it. It may not necessarily show up on the price of bitcoin, it may not show up on the revenue line in Walmart, but it'll certainly show up on the savings that they're getting.

Nate Geraci: Brian, we have just a couple of minutes left here. Before we let you go, I have to ask you about the potential for a bitcoin ETF. Last week, we saw the SEC shoot down another bitcoin ETF filing. There's, of course, been a lot of back and forth between ETF providers and the SEC. It seems like there are still some fairly significant hurdles to overcome. What are your thoughts on a bitcoin ETF? Do you think the SEC is right to play it cautious here?

Brian Kelly: I'll tell you, I think the SEC's been very thoughtful about their regulation of this industry. I would applaud them, number one, on that. I think the blockchain/cryptocurrency community still has a couple hurdles that we have to get through. The SEC has said, number one, that it would like to see a US-based regulated exchange for cryptocurrencies. We don't quite have that yet. We're moving in that direction. Number two, and this would be part of that exchange likely, or some solution, is a custody solution. Right now, a lot of these assets are self-custody. I think probably by the end of this year, we'll probably have a custody solution that the SEC will be comfortable with. My view is ETF, bitcoin ETF, in 2018, I think that it's a low probability, but I certainly think 2019 is a very high probability.

Nate Geraci: Brian, with that, we'll have to leave it there. Really appreciate your time today. Thank you very much for joining us.

Brian Kelly: Thank you. Really appreciate you having me.

Nate Geraci: That was Brian Kelly, Head of BKCM. Again, the ETF is the REX BKCM ETF. You can learn more about this ETF by visiting rexshares.com. That's rexshares.com.