Money Stuff: Take the Crypto Out of the Indexes

Programming note: Money Stuff is off the rest of the week. Happy Thanksgiving!

For a while, you could sell $1 of crypto on the US stock market for $2. You could take a tiny public company with a stock market listing but little or no operating business, merge it with a pot of, say, $100 million of Bitcoin or some other cryptocurrency, and sell shares of the pot at a $200 million valuation. This is called a “digital asset treasury company,” and it was a great trade and a lot of companies did it, though in recent months it has largely stopped working for the obvious reason (it is dumb). 

While it was working, though, one controversy was: Is the stock of a digital asset treasury company stock? Should it be in the stock indexes? Should stock mutual funds and index funds buy it? If you allocate 60% of your retirement savings to the stock market, should digital asset treasury companies be in that allocation? The arguments for treating crypto treasury stocks as stocks include:

• They are literally stocks.
• In some very loose sense, most digital asset treasury companies are not pure pools of crypto; they also say some stuff about how they will make the crypto more valuable by doing stuff with it, or educating investors, or whatever. (Plus often they have some residual non-crypto business.) They are companies like any other company, just in an unusual industry, so stock investors should invest in them.
• Stock investors — mutual funds, index funds, other institutions with equity investing mandates, retail investors who only buy stocks, etc. — often can’t get access to crypto by buying crypto directly, or by buying crypto futures, or by buying crypto exchange-traded funds, [1]  so these companies are a sort of arbitrage that allow stock investors to get exposure to crypto.
• For a while they mostly went up, and stock investors like to buy stocks that go up.

The arguments against include:

• They are essentially investment funds, and investment funds are not generally included in stock indexes or owned by institutional equity managers. (The S&P 500 Index, for instance, excludes closed-end funds, ETFs, business development companies, investment trusts, etc.) 
• Sure sure sure sure sure they’re not just investment funds, they’re doing their own special little business to make crypto more valuable, you keep telling yourself that. A crypto treasury company is mostly indirect exposure to its crypto holdings.
• Stock investors absolutely shouldn’t have a way to get exposure to crypto. If clients want exposure to crypto, they can put their money in a crypto fund. If clients put their money in a stock fund, they should get exposure to stocks. Giving equity mutual fund managers a way to sneak crypto into their portfolios is bad.
• Now crypto treasury company stocks have gone down, and stock investors do not like to own stocks that go down.

I also once made a sillier and more abstract argument for including these companies in stock indexes, which is that the point of a stock index fund is not to make investment decisions. Even if you think this is all very dumb — and I did, and do — the point of an index fund is to override your own sense of what is dumb and just give you the market portfolio. If the stock market has decided “hey let’s do a lot of crypto treasury companies,” then as an index investor you should own a lot of crypto treasury companies, even if you hate that. 

I think the default has mostly been “sure, these are stocks, so they are in the indexes until proven otherwise,” though none of them has yet made it into the S&P 500. (Strategy Inc., the biggest and first crypto treasury company, has been working on it.) But that is just a default, and I do think the arguments against including them are a little stronger, and last week my Money Stuff podcast co-host Katie Greifeld reported:

That’s what JPMorgan Chase & Co. analysts theorize may be one of the factors behind the downward spiral in shares of Michael Saylor’s Strategy Inc. A team lead by Nikolaos Panigirtzoglou pointed to a mid-October statement from MSCI, which noted that digital-asset treasury companies — of which Strategy is the posterchild, with its massive Bitcoin horde — may more closely resemble investment funds than traditional companies. As such, MSCI is proposing to exclude so-called DATs from the MSCI Global Investable Market Indexes.

Should Strategy be shown the door, it would face “considerable pressure to its valuation,” Panigirtzoglou and team wrote. The analysts estimated that with a market capitalization of $59 billion at the time of writing, roughly $9 billion of Strategy is held in index-tracking vehicles — $2.8 billion of which is following MSCI indices.

There is considerably more money invested in stock indexes than there is in crypto, and some portion of the historical demand to pay $2 for $1 worth of crypto wrapped in stock has come from investors whose mandate was “if it’s stock, buy it.” Now that demand might fall off.

We talked yesterday about possible contagion from crypto to the real economy. The basic mechanism of contagion, as I once described it, is:

People like a thing, so they buy it, so it goes up. More people like it, so they buy more of it, so it goes up more. It goes up steadily enough that people think “ehh I should borrow some money to buy even more of this thing,” so they do. Eventually a lot of very leveraged investors own a lot of the thing. Then something goes wrong with the thing, its price goes down, the leveraged investors get margin calls, and they have to sell the thing to pay back their loans. Their losses are big enough that they have to sell other things, things that were fine, to pay back their loans on the thing that went wrong. The big leveraged investors who owned a lot of the thing that went wrong also all own the same other things, also with leverage, so there is a generalized crash in the prices of the things that big leveraged investors own.

And the interesting question is: Is there contagion from crypto to, say, stocks or bonds or banking? If crypto prices crash — as they did in 2022, and as they have been doing recently — will that bring down other asset prices? Will it lead to failures of mainstream financial institutions?

Ten years ago it would have been silly to ask this question. Crypto was a hobbyist activity, too small to have much impact on anything else, and there were not a lot of large levered institutional crypto firms. Now, though, crypto is big and mainstream and levered, and there are various possible vectors of contagion:

1. Big stablecoin issuers own tons of US Treasury bills, and if there is a run on stablecoins then those issuers might dump Treasuries.
2. Banks are increasingly crypto-curious, and a bank that makes lots of crypto-backed loans could get burned if crypto falls.
3. A bank that takes lots of deposits from crypto firms could face a bank run, if the crypto firms suddenly need cash (due to losses or runs from their own customers); arguably this was the story of Silvergate Capital Corp. in 2023.
4. Mainstream hedge funds and proprietary trading firms have also been crypto-curious at times, which could lead to the normal kind of contagion, where a levered hedge fund has losses on its crypto and needs to sell stocks or bonds to meet margin calls.
5. Retail crypto investors might also be (1) levered and (2) heavily concentrated in certain other financial assets, and might have to sell those assets to meet crypto margin calls. We talked yesterday about Bill Ackman’s posts suggesting this might have been responsible for a decline in Fannie Mae and Freddie Mac’s stocks.

Etc. And one thing I suggested yesterday is that, to some extent, a goal of crypto advocates is (and should be! [2] ) to create more connections between crypto and mainstream finance, and more vectors of contagion. A world in which a fall in crypto prices could bring down the global financial system is a world in which (1) crypto is probably important and useful and (2) a lot of powerful people will try to prevent a fall in crypto prices.

I don’t think we’re there yet, but it’s a recurring worry every time crypto prices drop, and it gets more realistic each time. Crypto is bigger than it used to be, it’s more integrated into the real financial system, and it has far more political support in the US than it did even a year ago. That’s just sort of interesting. In a relatively short time, crypto has gone from a minor niche hobby to a mainstream asset class with deep and potentially risky ties to the financial system.

At Sherwood, Luke Kawa reports on a Bank of America research note worrying “that the proliferation of sports betting and prediction markets is creating new economic risks”:

“Easy access and gamified interfaces encourage frequent and impulsive wagers, which can lead to overextension of credit and rising loan defaults,” wrote a team of analysts led by Mihir Bhatia. “For investors this convergence of entertainment and speculative finance signals heightened behavioral risk that could pressure credit quality, increase delinquencies, and impact earnings for issuers and subprime lenders.”

Prediction markets are booming, with much of the growth in activity consisting of what are, in the plainest terms, wagers on sports.

The analysts flag that both academic research and recent surveys suggest these activities tend to result in an increased incidence of financial hardship, with young men and lower-income consumers particularly vulnerable.  Bread Financial, Upstart Holdings and One Main Financial are lenders that face “emerging credit risks,” per BofA, as these outfits are more exposed to those segments of the market.

I mean! The thesis here seems to be that companies that do a lot of subprime consumer lending are at increased risk because the boom in legal sports gambling and sports-gambling-through-prediction-markets tends to lower people’s wealth. That is sort of the opposite of the contagion story I told above. It’s not like “people put money into prediction markets, prediction markets go up, they get wealthy, they lever their bets, prediction market prices collapse, they lose money, they get margin calls and they have to sell other stuff.” For one thing, prediction markets don’t really have leveraged traders, though I suppose young men borrowing from Bread Financial and betting on sports are creating their own leverage. Also, prediction markets (and sportsbooks) don’t go up: You bet on a thing, and either the thing happens and you make money or it doesn’t and you lose money. There is no compounding growth, and since the customers are betting against each other or against the (normally profitable) sportsbook, in the aggregate they are not making money.

Still. Prediction markets and legal sports gambling are bigger than they used to be, more integrated into the real financial system, and have far more political support in the US than they did even a year ago. One can dream of a day when prediction markets are so big and integrated that, you know, the Patriots losing a football game, or Barron Trump dropping out of the presidential race, leads to a stock-market crash and a credit crunch. That’s how you’ll know they’ve hit the big time.

One important part of the social case for prediction markets is that they can help people and companies hedge against real-world risks. If you think that one outcome of the election will be bad for your business, buy prediction-market contracts on that outcome, etc. I am skeptical of this idea for various reasons, but the most important reason is that in the US in 2025 “prediction markets” often means “sports gambling through a regulatory loophole,” and I do not believe that a meaningful amount of sports gambling is driven by the hedging of real economic risks.

But people argue otherwise. “If you run a bar near a stadium, your business will be worse if the local team misses the playoffs, so you might bet against them to hedge your real economic risk.” Sure sure sure sure sure sure sure, is usually my response. Probably if you look hard enough you can find a bar owner somewhere who has had that thought! [3]  But if you’re standing in front of a mountain of player prop bets and same-game parlays saying “ooh hedging ooh” you are deceiving yourself.

But you know who is a public company and owns a ton of bars near stadiums, or rather at stadiums? Aramark, the food service business, which runs concessions for 26 US professional sports teams. A reader pointed me to this sentence in Aramark’s most recent earnings:

[Food and Support Services] United States revenue growth was led by [good things] — which more than offset a shift in the timing of new account openings and a majority of the Company's MLB teams within Sports & Entertainment ultimately falling out of playoff contention towards the end of the quarter.

Bad luck when all of your baseball teams fall out of playoff contention. To be clear there is no suggestion that Aramark is hedging that risk in prediction markets, but surely now some analyst in their finance department is thinking about it.

SolarWinds Corp. is a software company whose widely used network management platform was hacked by Russian state actors in 2020. This caused its stock to go down. As I often say around here, if a bad thing happens to a US public company, and its stock goes down, it will be sued for securities fraud. In the case of SolarWinds, the US Securities and Exchange Commission sued it for securities fraud in 2023. The specific alleged fraud was, approximately:

1. SolarWinds’ various public statements “claimed the Company not only had, but enforced, a strong password policy.”
2. In fact, “the password for the Company’s Akamai server was publicly available,” “a threat actor could use that public password to infect SolarWinds’ software updates,” and “the password that was publicly available was ‘solarwinds123.’”
3. Someone did use SolarWinds’ easy-to-guess passwords to upload malicious files and hack the system, and the stock went down.

Investors bought the stock thinking that SolarWinds had good passwords, but actually it had bad passwords, and they were deceived. “Bad Passwords Are Securities Fraud” was my headline at the time.

Well, a judge dismissed some of the case last year, and last week the SEC dropped it:

The agency said the decision to seek dismissal is “in the exercise of its discretion” and “does not necessarily reflect the Commission’s position on any other case.” A SolarWinds spokesperson said the company was “clearly delighted” with the dismissal.

These days, fewer and fewer things are securities fraud.

I am old enough to remember Napster as, uh, the service where my less law-abiding friends downloaded their music at the turn of the century, but apparently the name has been passed around since then and now it’s some sort of metaverse company that keeps announcing but not closing multi-billion-dollar investment rounds. At Forbes, Phoebe Liu reports:

 On November 20, at approximately 4 p.m. Eastern time, Napster held an online meeting for its shareholders; an estimated 700 of roughly 1,500 including employees, former employees and individual investors tuned in. That’s when its CEO John Acunto told everyone he believed that the never-identified big investor — who the company had insisted put in $3.36 billion at a $12 billion  valuation in January, which would have made it one of the year’s biggest fundraises—was not going to come through. …

The company had been stringing its employees and investors along for nearly a year with ever-changing promises of an impending cash infusion and chances to sell their shares in a tender offer that would change everything. In fact, it was the fourth time since 2022 they’ve been told they could soon cash out via a tender offer, and the fourth time the potential deal fell through. ...

While Napster is now alleging it is a victim, Forbes raised concerns about both the investor and the firm months ago. It all started in January when the company, then called Infinite Reality, reached out to Forbes announcing its $3 billion financing round. It emailed again on February 11, this time pitching Acunto, who then had a 12% stake in the Boca Raton Florida-based company, as a “prime candidate” for Forbes’ billionaires list. Facing an audience at a live event in Los Angeles in February, he exhorted: “Do you really think that we would talk about $3 billion dollar investments and be one of the largest companies in our space if we really weren’t doing what we’re doing?”

I mean? To get on the billionaires list? Maybe?

I suppose the way US politics worked in the good old days was that you ran for school board, then city council, then mayor, then you worked your way up to governor. But modern US Republican Party politics works mainly by trolling, and there’s no need to start by trolling the city council. You can start by trolling a hedge fund, then move on to trolling the Fed, and eventually troll your way to being governor? Yesterday James Fishback, who became famous for claiming he was the “head of macro” at Greenlight Capital and also telling his dad about Greenlight’s trades, announced that he’s running for Governor of Florida. Okay! Here is a profile of him in the Bulwark.

One helpful way to think about a lot of modern artificial intelligence models is that they provide:

1. A vast compilation and distillation of typical human behavior, particularly online behavior, plus
2. A dial that you can turn to make the behavior more or less extreme.

One well-known risk for very rich and successful people is that people will be too impressed by them. When you are a scrappy young nobody building a startup in your garage, people will tend to be dismissive of your bad ideas, so you will have strong incentives to come up with better ideas. When you are a famous billionaire who is paying the mortgages of everyone you interact with, nobody will be dismissive of your bad ideas, so you will have strong incentives to come up with worse ideas. 

Last week xAI turned the dial on its Grok chatbot all the way to the “praise Elon Musk at all times” side, which led to many funny Grok prompts that are not printable here. (Here are the Independent and the New York Post with some of Grok’s tamer replies, “claiming he’s in better shape than Lebron James, has mental skills on par with Isaac Newton’s — and is even the world’s greatest lover.” Here is Ryan Broderick with the less printable ones.)

I feel like the point here is that, as the richest person in the world who also runs like five companies and is a political kingmaker, Elon Musk absolutely could, in his personal and professional life, turn the “praise me all the time” dial up to 11 and everyone around him would pretty much comply. And then you would read some anonymously sourced articles in which people close to him said “yeah he’s surrounded by sycophants and it’s warping his perspective,” but then you’d read other articles in which other people close to him said “no he’s as sharp as ever and welcomes dissent,” and you wouldn’t be sure what to think. But with Grok you can watch him turn the dial!

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