Hi, I am Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing into blockchain companies and cryptocurrencies. I focus on early stage investments and want to share my thoughts and what’s going on in the industry in this weekly newsletter.
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4 years ago, Pantera invested in Abra and I am excited that they have continued executing on their thesis of financial inclusion.
Last Wednesday, Abra announced their latest product update –– a way for users to gain investment exposure to US stocks and ETFs using its bitcoin- and smart-contract-powered platform. Here’s a quick run-down of how it works and why it may soon outcompete other popular online trading platforms.
Abra is a popular cryptocurrency platform where users can hold bitcoin, litecoin, bitcoin cash, and ether as native cryptos but also invest in 25 other altcoins, 50 fiat currencies as well as the BIT10, an index token representing the top ten cryptocurrencies.
The non-native investments all take the format of “crypto-collateralized contracts” whereby an initial investment, in say Zcash or euros, is fully collateralized in bitcoin directly on the user’s mobile phone with no central custodian (Abra is based on a non-custodial wallet).
To buffer against price fluctuations, the consumer enters into a smart contract agreement with Abra. The contract automatically adjusts the amount of bitcoin the consumer is holding to be equal to the investment position. Abra then hedges away the consumer’s counterparty risk by various means in order to guarantee that the consumer is not exposed to the underlying price movement of bitcoin versus the asset being invested in.
Abra has already done this “hedging” with hundreds of millions of dollars worth of consumer investments in altcoins over the past year, and no user of Abra has ever lost a penny due to counterparty exposure — even when the price of bitcoin plummeted last year.
Abra announced features in the app whereby users will be able to also gain investment exposure to the top 100 NASDAQ products and reap much of its benefits –– without actually holding any shares in companies. As described above, Abra pegs the notional value of a user’s crypto collateral against the price of a stock, meaning that users can invest in any stock. This is all done without the user having to understand any of the underlying complexity of the crypto-collateralized contracts. From the user’s perspective, they are simply investing in Apple, IBM, XRP, Zcash, pesos, or euros.
Since users don’t invest directly in any securities, Abra is exempt from a lot of the regulations that hamper activity on platforms like Robinhood and TD Ameritrade. All Abra user holdings are in bitcoin, which is considered a “commodity,” not a “security.” The smart contracts that Abra is creating function as a form of swap contract that is physically settled on the Bitcoin blockchain and is therefore exempt from commodity swap regulation by the Commodity Futures Trading Commission (CFTC), which has a specific carve-out for swaps that physically settle.
Abra’s new offering is intended to expand stock-investing to people in 155 countries globally, capturing a much larger market and democratize one of the most-popular investment mechanisms.
What is Abra?
Abra is a cryptocurrency platform where users can become their own bank by holding synthetic fiat currencies or other synthetic real-world assets all based on bitcoin, or what Abra calls crypto-collateralized contracts. Consumers are always in control of the keys to the bitcoin they hold with Abra. In most cases, consumers don’t even know that they’re using bitcoin. They just see their synthetic balances in fiat currencies, altcoins, and soon stocks or ETFs.
Unlike most other online investing platforms, Abra does not store user assets via a centralized custodian like a bank –– users always have full ownership of their capital, no matter what the format of the investment exposure. Abra does this by immediately converting all fiat cash to bitcoin and storing the keys directly on the users’ smartphones (another way to think about it is that the funds are stored on a user’s phone and accounted for on the Bitcoin blockchain). This ensures that users have full access to all their assets at all times. This also limits the potential attack surface for Abra, and since there is no centralized account, the company cannot be hacked and users’ funds stolen.
In order for the crypto-collateralized contract model to work, and to account for volatility in the price of bitcoin or any cryptocurrency, Abra hedges its risk as soon as users invest in the platform. That means that the company can honor all user trades at any given time. So if users invest in fiat (eg. euros) equal to 1 BTC, but the price of BTC falls, Abra makes sure that users still have access to exactly the amount of fiat they invested, by sending more BTC to the user’s account to make up for the difference. Abra hedges its own positions and trades them algorithmically to buffer these price fluctuations and make sure that users always have full access to the value of their investments.
Figure: Abra’s hedging process. For simplicity, assume initially 1 BTC = 200 USD.
Since Abra runs on bitcoin, it automates all of its processes like asset holding, hedging, and user transactions with smart contracts. It supports 30 cryptocurrencies, 50 fiat currencies, and is led by crypto/finance leaders like Bill Barhydt/CEO (formerly a VP at Goldman Sachs and Technical Director at Netscape) and Daryl Puryear/CTO (formerly Director of Software at Mint.com and VPE at Motif.)
How does their new product work?
Essentially, Abra has taken its existing platform and extended it to support assets available on the NASDAQ, starting with the top 100 stocks and ETF’s.
Once users invest capital into the platform, they can choose to “invest” in one of Abra’s 100 stock/ETF offerings, which represents stock investment exposure in corporations like Facebook, Apple, Amazon, and Alphabet/Google. As soon as a user adds money to the Abra app, the capital is immediately transformed to bitcoin. Then, using Abra’s crypto-collateralized contract, Abra keeps the notional value of that bitcoin investment tied to the current value of the stock. This is done with what’s called a multisig bitcoin address, where Abra and the user sign a contract to peg the amount of cryptocurrency to the value of the asset. Abra users then hold an asset that track the exact price and volatility of the given stock.
While users don’t actually hold any shares in the company they still receive dividend payments because of the means by which Abra hedges itself on the contracts — super cool. The platform can also support short selling which Abra hopes to offer in the future.
Why does this make electronic stock investing any different?
The mechanism by which Abra enters into these smart contracts means that Abra can offer this investing service legally in 155 countries. That is a first for investing in US stocks, commodities, cryptocurrencies and fiat currencies via a single service.
The SEC and CFTC have clarified that the definitions of the terms “swap” and “security-based swap” do not include forward contracts. These definitions exclude “any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled.” These organizations later provided guidance on how this physical settlement exemption applies to Bitcoin. Abra operates under this exemption.
This means that Abra’s investing tools are much less regulated than other trading mechanisms. Since other online stock trading platforms like Robinhood, TDAmeritrade, or Charles Schwab actually invest user assets in real stocks and act as a full broker and custodian, they do have to follow rules set by the CFTC, SEC, and other securities commissions. But Abra’s model means they can expand the market of pseudo-stock-investing globally, beyond these specific geographic boundaries.
What are the greater implications?
Abra’s company ethos is democratizing finance. Their entire value is built off of being a platform where a first-time investor from the developing world can make the same returns as the hot-shot finance guys from New York. Abra’s new offering helps accomplish that by introducing pseudo-stock-trading to hundreds of new markets, making it a feasible investment mechanism for people in 155 countries globally.
Abra’s new tool might also affect the price of bitcoin. On Abra, all users become “hodlers,” crypto-speak for someone who holds onto bitcoin without regularly trading it for other currencies and assets. Past financial studies have found that hodling is one of the key driving factors behind bitcoin’s price fluctuations. Since Abra’s platform automatically converts user capital to bitcoin, all users become hodlers and thus could, at large scale, drive changes in the price of bitcoin. Depending on how many people hop onto Abra’s new platform, we might see a short- or long-term spike in the price of bitcoin as more people use bitcoin as the underlying means for their every day stock and ETF investing.
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