Crypto markets tend to massively inflate values due to ‘potential global scale’: Fund manager

Starkiller Capital General Partner and CIO Leigh Drogen joins Yahoo Finance Live to discuss how crypto markets are faring following the FTX collapse, hedge fund trends in the crypto space, and how to get a return as a crypto investor.

Video transcript

DAVE BRIGGS: FTT, the FTX token, popping after the new FTX CEO, John Jay Ray III, left open the possibility that the crypto exchange could return-- yes, return. In an interview with the "Wall Street Journal" Ray says, quote, "everything is on the table," end quote, in regards to the company, including a potential comeback if it provides a pathway to return money to investors and other creditors. He went on to say they are speaking with stakeholders who say they have identified what they see as a viable business. Who would have thought?

Crypto was less a topic of conversation in Davos than it was in years past. It was more of a punching bag in the wake of FTX's collapse. JPMorgan Chase CEO Jamie Dimon doubling down on his pet-rock analogy and adding a little flavor and calling it a "hyped-up fraud" this morning. Here's what Brian Sozzi and Julie Hyman heard about crypto.

MICHAEL GRONAGER: I think Bitcoin prices will come back, but it will come back in a way more organized way than expected. It will follow the interest rate. So when interest rate starts to fall, the Bitcoin price will come up. And everyone will ask, why did the Bitcoin price go up? Because of falling interest rates.

NOURIEL ROUBINI: FTX and SBF are not an exception. They are a rule. Literally 99% of crypto is a scam, criminal activity, total, really, bubble. Ponzi scheme is going bust.

DAVE BRIGGS: Leigh Drogen is the general partner and chief investment officer of crypto-focused hedge fund Starkiller Capital. Leigh, nice to see you. Your reaction to that last comment, a scam, a-- well, 99% of it is a scam. You heard it. What's your reaction?

LEIGH DROGEN: It's true. I don't know if it's 99%. Maybe it's 95%, you know, whatever it is. There's 30,000 legitimate coins out there that trade on exchanges, and, yeah, the vast, vast majority of them will never actually be real businesses or attain scale to the point where they provide any real utility.

But I think it's important to, at the same time, be able to hold two competing ideas in your mind at once. One, Roubini is correct in what he's saying there, and also the limited number of these chains and protocols that are very real businesses that will provide very real utility at very large global scale in the future, that's a very, very real and disruptive thing. It's just a matter of time before we see that kind of scale. But yes, a tremendous amount of fraud, tremendous amount of just ridiculousness.

SEANA SMITH: So, Leigh, given all that-- because at Starkiller Capital, for those who don't know, you're a crypto-focused hedge fund. So are invested in this business, or you're trading off of this business. You're not waiting for the progress here in terms of what we could see in crypto over the next 5, 10, 15 years.

You're out with a new paper, and this is really interesting because it examines the trend of crypto trading. And just to read a few lines from the paper for our viewers here, you liken crypto investing to, quote, "a hot ball of money that's constantly rolling in and out of crypto." You also say cryptocurrencies have very little intrinsic value, lacking fundamentals there. So where does that leave us just in terms of why you're trading crypto and that opportunity there?

LEIGH DROGEN: So if you look at the underlying potential utility for many of these coins and protocols and chains, the way that the market is treating them is basically they're startups, right? They just happen to be liquidly traded. And because of the potential global scale and how fast these things can scale given that they're permissionless, the market basically tends to massively inflate the value of these things over short periods of time associated with a given narrative. And then, you know, as it takes a lot longer than people think, it eventually-- that valuation eventually plummets.

When you have these kinds of dynamics associated with early-stage businesses, if you want to call them that, they tend to show a lot of what we call a momentum factor, and that momentum factor is arbitragebale, in a sense.

And so what we do at Starkiller is we take advantage of the specific time frames on which the history of this asset class shows that you can buy certain assets, hold them for certain periods of time, and then rotate into other assets, you know, and constantly go through that process. And it's been very profitable, and we've shown that, you know, it significantly outperforms Bitcoin, et cetera.

DAVE BRIGGS: So if someone's sitting at home watching you right now thinking, all right, I've never gotten into the crypto space, are you selling it on a long-term, practical usage or merely a short-term opportunity to make some cash?

LEIGH DROGEN: I think it's both, and you have to really know which one you're in for, right? So in my opinion, there are basically three ways to invest in the crypto market. One is you just buy some Bitcoin and/or Eth-- personally-- and this is not a firm opinion. This is my personal opinion. I think Ethereum likely has, you know, a larger and more long-lasting utility to this whole thing-- and you just have to basically forget about it because individual investors are really bad at dealing with the kind of volatility that these high-growth, high-volatility assets have. They tend to puke up their assets at the very wrong time, which would be kind of like right now instead of, you know, at the top. And so you kind of have to just forget about it for the next 10 years and close your eyes and deal with that.

The second way to do it is, you know, kind of like what we do, but that takes significantly more attention and risk management, but it's not rocket science, you know, frankly. We're not running massive machine-learning models. You know, there are many of them, but they're pretty basic statistical models, and they work.

And then you can day trade, right? And that takes obviously a lot of attention. There's a lot of money to be made there, but you have to be really, really good at it, and you have to have nerves of steel.

SEANA SMITH: Leigh, is this any different than what we're seeing in some of the meme stocks? I mean, we try to make sense of all the volatility and all the momentum that we certainly see in that asset class. Does that fall under the same thing?

LEIGH DROGEN: I think that there are similarities and similar things driving those two variables there. There's not a 100% overlap, but certainly concepts like excess liquidity, you know, in the economy, people having time to, in a sense, gamble on things-- we like to use the term that the casino of crypto is the boot program for the larger utility of it as we go. You can't have these big crypto networks become liquid and both sides of these marketplaces have enough people on them to have real utility unless you have people who want to be there without a lot of utility existing initially.

So the casino of it, the trading of it, the financialization of it is kind of the boot program. When we look at some of these other, you know, meme stocks, it's kind of similar in a sense. You know, they're betting on things that may not have a lot of intrinsic value today. They may not have a lot of intrinsic value tomorrow. And certainly there's interest rates and a lot of the things that drive-- you know, drive both of them.

DAVE BRIGGS: Very interesting conversation. Leigh Drogen, Starkiller Capital, thanks for coming on.