Why did you decide to launch Cipher Technologies?
Before launching Cipher in the autumn of 2018, I had been managing a large venture capital fund called Altpoint Capital, through which we had significant exposure to digital assets and blockchain technology.
Textbooks would have it that blockchain, or distributed ledger technology, should be viewed as a vertical stack: from bottom-up, first, there’s the protocol, then the network – which introduces the likes of mining and incentives – and then there’s the application layer on top.
Some tokens combine all three of these layers, while some do not. We looked at literally hundreds of different blockchain technology applications, and for the most part, we liked them as grand, often fascinating visions, but they lacked clear business plans and strategies, so we invalidated most of the ‘use cases’ from an investment point of view.
However, there were a few exceptions, which invariably focused on money-like or commodity-like instruments with liquidity and the engagement of credible participants.
This piqued our interest to take a view on whether these assets, the tokens that we liked, could be a bonafide asset class worthy of engagement by sophisticated investment professionals.
The important distinction to make is whether these blockchain-based tokens show differentiation from other digital token creations, like American Express loyalty points or Minecraft points, for example.
Once this leap is made, a cornucopia of opportunities opens up. We validated and confirmed this view amongst ourselves, which gave us a foundation to assemble a new digital asset trading business that is different and separate from our venture capital business.
This is how Cipher Technologies came to be.
What do you view as the opportunities over the long term?
Opportunities are almost infinite in a new asset class. Presently, we are identifying unique ways to trade these assets, other companies are trying to create value at the foundational level, or building the infrastructure to facilitate the exchange of these assets, and that’s just naming a few.
Can you explain Cipher’s investment strategy in more depth?
Our approach lies in the investment and trading of derivatives on the underlying crypto assets. Derivatives on any reference asset class essentially do four things.
First, they create path-dependent outcomes; something that goes up and then down will yield a different outcome to something that goes down and then up to that same price point.
Second, the outcomes are tied to specific timeframes; if something moves from 100 to 120 today, versus something moving from 100 to 120 in two days’ time, it might reflect a very different outcome by the end of the month.
Third, the derivatives provide implicit and explicit leverage. And fourth, they enable participants to short the asset. These components commonly go by different Greek letter names.
We trade these ‘Greeks’ rather than the underlying assets, and each has its own dynamics that are uncorrelated to the underlying asset’s performance.
In this sense, what we do in crypto is not much different than what other quantitative volatility trading funds do with respect to traditional assets.
The difference is that the crypto sphere seems to have a lack of registered participants or market-takers of any size that fuse financial prowess, and the ability to trade Wall Street-like assets with a dollar value, with the analysis of the technology stack necessary to generate trading signals.
There are numerous shops that perform one of these tasks well, but we see an opportunity to combine both of these skills. This is what we are doing at Cipher.
How will the advent of definitive regulatory measures affect digital assets?
As soon as registered finance professionals begin working with something that has a dollar-denominated valuation, it invites all kinds of regulatory scrutiny regarding how these items should be exchanged and traded, who can engage with them and in what capacity. Furthermore, it invites rules about taxation, and regulations pertaining to market microstructure.
Almost all jurisdictions regulate finance professionals’ engagement with anything calling itself an asset class and the digital asset ecosystem is no exception.
There have been analytical and conceptual barriers around crypto for several years, which precluded the cutting and pasting of regulation applied to other assets. This is partly because the nature of these tokens is often a hybrid of technology and finance.
As a result, it has taken regulators in the US, Japan, the UK and other regions more time to reach consensus on the oversight of digital assets. We are optimistic about how US governmental agencies like the SEC and the CFTC are now looking at digital assets and recognise that they have potentially overlapping interests.
First, though, it’s worth considering how financial institutions have been appraising digital assets.
Banks, funds and asset allocators have been looking at these assets for the last 2-3 years, and those who generally support the foundations of blockchain have routinely faced pushback centred on three points: custody; market microstructure, and the state of regulation.
Institutions are mandated to do things ‘by the rulebook’, but a proverbial rulebook has not been available. We believe that this is now changing. Over the past year, since the hype around digital assets subsided, enormous progress has been made.
There is more work to be done, but there are now custodians doing a great job with regards to managing ‘hot’, ‘cold’ and ‘warm’ storage. Separately, it has become possible to use analytics at the blockchain level to gauge the flow, as well as the level of the overlays built on top of the blockchain.
It has now also become possible to analyse digital assets’ volume on various exchanges. These innovations allow us to decrypt – no pun intended – the bona fide price action from attempts at potential market manipulation.
Again, it is a full-time job to monitor these statistical signals, but the important thing is that this is now possible, whereas before these capabilities didn’t exist.
The overall ecosystem is craving transparency, asking for maturity, and seeking participants that it can trust. We created our fund with the intention of being a regulated entity that can generate this kind of trust and credibility.
We’ve introduced significant compliance processes that are required by virtue of our registrations with the SEC as an investment adviser and the CFTC as a commodity pool operator.
Registering with the CFTC stems from some tokens—specifically bitcoin—being designated in the US as a commodity. Whether this designation stays, or bitcoin becomes viewed as a security, a funds-like instrument, or a money-like instrument remains to be seen.
For now though, to trade digital asset derivatives in the US as a finance professional of any repute requires some form of CFTC registration.
You recently went on record saying ‘digital prime time was now’ – is this largely in part due to the establishment of a ‘rulebook’?
Absolutely. Anybody from the retail space who wanted to be in the asset class has already entered, for the right or wrong reasons. Institutions, however, have remained on the sidelines.
Now that these assets have been around for more than 10 years there is a realisation among banks, insurance companies, pension funds and other institutions that they may be here to stay – and that the functions imputed to these tokens may have a bona fide use case.
We see institutions now wanting to get exposure, but this needs to be coordinated in a legally sound way.
Because of this, we at Cipher are optimistic that regulators in the US, who we talk to regularly, are getting more comfortable with the nature of these assets and are now considering the right regulatory approaches to bring greater institutional credibility to the marketplace.
This is essential for institutional investors – pensions, endowments, foundations, etc. – to get comfortable in allocating capital.
What is your background prior to the creation of Cipher?
I was born in Russia and left as a teenager more than 30 years ago. My initial entry into the world of finance was in the mid-90s at Merrill Lynch in London where I was an equity derivatives structurer for many years.
This was a phenomenally successful group that straddled trading, syndicate work, placements and even elements of M&A and investment banking.
In the early 2000s, I continued doing much of that in a senior capacity at Dresdner Kleinwort. Subsequently, I joined as the head of the investment bank for a Russian lender called Rosbank, which was eventually sold to Société Générale in France.
From there I was presented with an opportunity to work at the investment holding company of Rosbank’s majority shareholder, Interros, owned by Vladimir Potanin for a short period of time. This was right around the time of the financial crisis.
During this time, several strategic business opportunities presented themselves in the U.S., one of which was in the private equity space.
I relocated and took over the private equity asset manager in which Interros was an anchor limited partner that also owned a small minority stake in the general partner’s management company.
This is how Altpoint Capital came to be circa 2009. Anecdotally, it was at this point that I changed my name from Guerman Aliev to Gerald Banks.
People had a hard time spelling my name correctly on the first try and it became burdensome, so the easiest solution was to change it. Altpoint has performed well and produced strong returns over the years. We are very appreciative of the trust our investors placed with us.
Importantly, though, Cipher is a different business to Altpoint. It has no affiliation with any one investor and the management company is 100% owned and controlled by our management team, all of whom are in the US.
Technically, at least for the time being, I remain at the helm of both firms but, in effect, 90% of my time is dedicated to Cipher, and my other senior partners are leading Altpoint’s business.
Do you still have a business relationship with Vladimir Potanin?
I do have a business relationship with Mr Potanin and value the competence of his investment team. Recently there seems to be a tendency to generate all manner of headline clickbait imputing nefarious intent to anything Russian.
Frankly, I find this type of journalism wholly disingenuous and a disservice to the public. We don’t do geo-politics at Cipher; we are in the business of generating returns for our investors.
What is the Cipher team’s background?
We have assembled a team of bright individuals all of whom bring distinct but highly relevant qualities, experiences and backgrounds to Cipher.
One of my senior traders is Vishal Shah, who is formerly a head of principal trading at Elwood – Alan Howard’s London-based fund dedicated to crypto assets.
For many years prior to that, Shah was an emerging markets FX trader at CIBC as well. I was also joined by Jake Stolarski, another senior trader at Cipher, who for many years was at the Chicago Trading Company as a pit options trader.
Other instrumental individuals include Jacob Comer, who led legal and compliance for Starr Investment Holdings – Hank Greenberg’s multi-billion-dollar private equity venture in Manhattan.
Clark Landis has also recently joined us as the head of risk and he enjoyed a long tenure at Lehmann Brothers as a senior risk manager in the options sphere.
We also have support staff, code developers, and business associates that, by any measure, make us an impeccably built institution. This lends itself well to courting institutional interest in what continues to be an emerging asset class.
What are your views on the future of the digital asset space?
Crypto markets have come a long way in a short period of time and the system is entering a stage of maturity now.
We believe regulators will soon begin issuing guidance that is robust enough for institutions to become participants. The infrastructure that was lacking at the time of the previous boom period is now substantially better.
While there’s more work to be done, and the proper regulatory guardrails still need to be put in place to provide investors with that next layer of comfort, we are seeing a strong case for the institutionalisation of crypto as a legitimate asset class.