Questions and answers: Community banks continue with crypto plans despite decline, says portfolio manager

Community banks and other financial service companies are not stopping plans to delve deeper into blockchain and cryptocurrency despite ongoing volatility in the sector, according to the Emerald Mutual Funds’ Finance & Banking Innovation Fund (HSSAX) co-portfolio manager.

As funds with exposure to crypto-focused companies and others with plans in space are struggling with the recent downturn of cryptocurrencies, Steve Russell and his team have discovered financial firms looking to use distributed ledger technology for payments, support Lightning Network or have a meta-presence.

HSSAX was launched in 1997 and had around $ 116 million under management as of June 30. Russell noted that the fund targets banks that lend to crypto or blockchain companies, or those that make their own tokens.

It also focuses on banks that use the blockchain-based real-time payment platform Tassat to offer customers instant and secure payments. Customers Bank and Tassat launched Customers Bank Instant Token (CBIT), on TassatPay in October last year, for example.

“Not all of them have necessarily turned the entire business plan towards using distributed ledger technology or being involved in payment cryptocurrencies, but are certainly aware of that and moving in that direction ahead of their peers,” Russell said of the companies in the portfolio.

The portfolio manager noted that the equity fund’s objectives make it unique from many of the ETFs that primarily focus on the same cryptocurrencies, such as miners and stock exchanges. Although the fund has such companies, Russell said, the company has reduced its positions in miners “significantly” since the beginning of the year.

Emerald Finance & Banking Innovation Fund’s top holdings as of May 31 were Customers Bancorp, Coastal Financial, Triumph Bancorp, Bancorp Inc. and Finwise Bancorp.

It also had cryptocentric investments, including miners Marathon Digital Holdings and Riot Blockchain, Silvergate Capital, Grayscale Bitcoin Trust (GBTC), Galaxy Digital, Coinbase and Voyager Digital, which filed for Chapter 11 bankruptcy last week after suspending trading and withdrawals on their network. .

Although Russell declined to comment on specific companies, he noted that the continued outcome of the crash of TerraUSD (UST) and LUNA, as well as Three Arrows Capital’s bankruptcy petition, is likely to cause the fund to continue to go out or adjust certain positions.

Although about 70% of the smaller community banks Russell and his team talk to have no plans in, or even knowledge of, crypto or blockchain, many banks are still interested in exploring the area even if the crypto market remains volatile.

Russell expects more banks to engage in using the blockchain for mortgage-related activities. Figure Lending and Apollo completed a transaction in March that involved the establishment of digital mortgages and the transfer of ownership via blockchain technology.

“They are never going to be a leader in introducing technology,” he said of banks. “They want to follow someone.”

Read on for more excerpts from Blockworks’ interview with Russell:

Block works: How does the current turmoil in the crypto markets affect how you think about managing banks with indirect exposure to the sector? The crypto-focused companies?

Russell: The companies that were just going into space … they’re moving forward with their plans. The market reacts to many of these names as if their income is based on the price of bitcoin, which has nothing to do with their income and how they generate income.

We think many of these banks have been oversold … so we think there are some attractive entry points to some of these names.

Obviously, something like the stock exchanges that are out there, they have traded down for good reason. Trading volumes quarter-over-quarter and even month-over-month, you have seen them down 30%. It will obviously affect their bottom line, so when the fundamentals weaken, it makes sense for people to sell these names.

But there comes a point where you have to decide when you look at your valuation to slowly start going back to these names because some of the valuations are very attractive.

The three-arrow situation, what we have seen with Terra Luna and how much bitcoin was used as collateral to exploit this trade up in the market has obviously created a fall-out for several companies across the board and created some bankruptcies and companies that will Close . I do not think we have seen the full results of how bad it is.

Block works: What about crypto miners? How do you rate them right now?

Russell: You will have a shakeout here, we believe over the next year or 18 months, closer to halving in 2024 where there is a decision from miners with better balance and strategically well positioned on whether they buy up.

It’s an interesting time for miners, and we think there will be a smaller number of players who really end up getting out the back of this. Is it about having your energy costs locked in? Can you finance this growth? Everyone posted these great growth figures. Half of them never get close to it.

It reminds me a lot of investing during the dot-com days. Although there were many losers during the dot-com bubble, there were definitely winners, and it was our job then to find more winners than losers. “

We thought profitability would be worse here for a while, so we reduce these positions as needed. There are already a couple of miners who have made quite attractive valuations, and we can start to increase [exposure to those] a little bit. But we want to get a little more clarity in where we are going with some of the pricing and profitability in the sector.

Block works: What kind of conversations do you have with the banks?

Russell: They talk about their future exposure to the metaverse and want to have a presence in the metaverse. They talk about payments and the use of distributed ledger technology. They talk about being able to offer trade to their customers on the institutional side as well as on the retail side.

They talk about how transactions will be settled using blockchain and distributed ledger technology. They are aware of Lightning Network and they talk about how they can become part of providing that infrastructure to help Lightning Network succeed.

These discussions and the research we do are really the key. It’s not like you’re only going to be able to look at someone’s 10-K [disclosure form] or someone’s quarterly report and say hello, these guys are focused on space.

Block works: What kind of regulation do you see?

Russell: We always try to go where we think the puck goes. We believe the best way to get adoption in this sector of blockchain and cryptocurrency comes with regulation. We believe that much of that regulation will be aimed at banks and financial service companies that already have regulators in place.

We think the first thing banks understand is stack coins. So if you’re clear on stack coins, I think these early users will be rolling out various payment products, accounts receivable, accounts payable products for their customers and their commercial industrial borrowers.

They are already trying to understand FedNow, but FedNow is not the technology that gets them where stablecoins can. They understand payments and the need for efficient transactions, and then we think they will begin to understand smart contracts that can use stable coins and be able to implement frictionless transactions that can happen 24/7, 365.

Block works: As a GBTC-owned fund, what do you think the SEC denies Grayscale’s attempt to convert its bitcoin trust into an ETF?

Russell: We try to be long-term investors with a three to five year investment horizon. When I look at GBTC, I think it will eventually become an ETF and the discount to [net asset value] is attractive. It’s like owning a private equity fund. They always shop at a discount, so it is not uncommon in the room.

It would only be nice if the SEC was consistent with how they examine a spot ETF for bitcoin with how they examine or look at proposed spot ETFs for other commodities. If you said that this is an item, as they have, why is it not treated like any other spot ETF proposal for any other item?

Get today’s best cryptic news and insights delivered to your inbox every night. Subscribe to Blockworks’ free newsletter now.