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‘Stickiness to old products necessitates creating new asset management firms’: Arca’s Rayne Steinberg

  • Rayne Steinberg was a co-founder of WisdomTree, an innovative asset management firm in the ETF space.
  • His new firm, Arca, is a digital asset manager focused primarily on serving institutional investors.
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‘Stickiness to old products necessitates creating new asset management firms’: Arca’s Rayne Steinberg

It’s hard to differentiate between the hype around digital assets and what’s fundamentally changing in financial services. Our guest on the podcast today has a foot in both worlds. Rayne Steinberg is co-founder of Arca, a digital asset manager. He was also a co-founder of WisdomTree, a pioneer in the ETF industry.

Arca is an institutional grade financial services firm investing in digital assets, as well as building products utilizing blockchain — the firm launched The Arca U.S. Treasury Fund, a closed-end registered fund issuing shares as digital securities that are transferable using blockchain technology.

We talk about Steinberg’s journey from running an upstart ETF fund manager to the new world of digital assets and how the two experiences parallel and where they diverge. We talk about what institutional and retail investors need when it comes to crypto and where the opportunities are to serve them.

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The following excerpts were edited for clarity.

Focusing on the professional investor

When we created ARCA, we saw that digital assets were interesting as far as a technology innovation. It really wasn't driven by financial services. It was a technology innovation that came from an anonymous person or an anonymous entity, and that is very unusual for a financial service offering.

By the time that it had matured to the place where institutions could address it, or were starting to think about the value proposition, it really wasn't in a form that was familiar or useful to them. They need things that they know are legal and regulated. And that no matter what the return profile of the value proposition or offering from something like bitcoin, if it isn't legal, they feel they are going to run afoul of regulators or cause some problem with the other massive parts of their business. They're not going to address it.

We saw a whitespace for a firm that was specifically addressing those concerns. So, that means firming up the narrative and creating institutional grade products. There's already retail ways to invest in digital assets, and as we see those things become more commoditized and bigger, we'll definitely begin pushing them out to retail. We have retail offerings in our slate, including Arcoin, our ARCA US Treasury fund is also an '40 Investment Company Act product, so it's appropriate for retail. So it's not really just institutions.

Founding WisdomTree

WisdomTree is an innovative asset manager specializing in ETFs based on intellectual property that they created themselves. I founded it with my brother and a third founder in the early 2000s as an attempt to address an unmet need in financial services.

We identified that iShares, which at the time was owned by Barclays, was taking this ETF wrapper, which added intraday liquidity, tax advantages, and a bunch of very investor friendly options to investment vehicles, and they had locked up all the intellectual property that was out there. So MSCI, Dow Jones, things like that. And the asset management world was basically thinking, well, with all that intellectual property locked up, there really wasn't much to do with ETFs.

And our thesis was, there absolutely was. You could create indexes or index methodology or investment schemes that were interesting and differentiated and perhaps better than the underlying intellectual property of things like MSCI and Dow Jones, which, when you think about them, even though they're passive and lo fi, they weren't designed as investment products -- they were designed as media products to track the market.

And so that was the birth of WisdomTree. We created dividend weighting. We got the backing of Michael Steinhardt and Jeremy Siegel and our venture partner was RRE, which also led our venture round at ARCA.

The industry didn't get it

The only thing of the entire thesis that I would say was incorrect was we really thought the funding for WisdomTree would come from existing asset managers that saw what was going on with iShares -- that they were gathering assets, that this low fee, passive product was very dangerous to their high fee, fee based selling. And even if they didn't want a low fee product to come, they might look at WisdomTree as an interesting option call on it. That's where we were completely incorrect. 200 asset managers, with varying levels of sophistication and size, passed on funding WisdomTree.

That was eye opening, in the sense of how resistant to change financial services is and how hard it is to innovate when you have this heavy regulatory burden. Also, when you're dealing with fiduciaries of other people's money, there's a lot of employment risk for going with something new. So there's just very little reason to try something new and a lot of stickiness to old products that may not be the best ones. And it's times like that that necessitate the formation of a new asset management company. Because normally, you would push asset management products out of an existing asset management company. You don't have to recreate the brand, the distribution. It's only at these very transformational moments, things like ETFs, blockchain, digital assets, where there's just too much on the other side of the equation for existing players to address it. And it makes sense to start a new type of firm.

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The aha moment

I'm not exactly sure when I read the Bitcoin white paper. But when I did read it, it was an aha moment. It was like an incredibly elegant way to address things. And it changed me forever. It wasn't at scale yet and it wasn't appropriate for institutions. It was too new. But when it did come around back into my gaze, like really focusing on it in 2016 and 2017, there was an opportunity to do something similar to what we did at WisdomTree -- create a new type of asset management company that addressed this asset class.

Just the same way that Wisdom Tree had to tackle some problems around ETFs that were unique, this type of asset management company, ARCA, had similarly, unique challenges to address. Even more so than the ETF revolution, the digital asset revolution, decentralization, the destroying of trust premiums, things like that are even more dangerous or transformative to the traditional asset managers or financial service players.

Getting institutions comfortable

There are two things that are very important here. In an asset manager, we think you always have to create great products, great approaches, and appropriate pricing. First things, always be investor friendly. And that's something that the traditional world actually does do well. But those skills are very hard to port over here.

If you were starting, let's say, a hedge fund or an investment strategy for large cap equity, everything is very well known. The ideas about value are well established. There's a broad spectrum of service providers to choose from, things like prime brokerage. The banking system is well understood and intact. None of those things exist here.

So things like custody, operations, even fund accounting, are things that are developing along with our company. So there was a very large lift on getting the operational excellence and the things that you needed from a firm, that you wouldn't have had to start in another asset manager just to create the right type of products.

Then there's philosophically where something like this is in the spectrum of the evolution of financial service transformation. And I'll just give you an example. I founded an ETF company which specializes in low fee, passive products. Our flagship product on the investment side at ARCA is an actively managed hedge fund. And the reason for that is, is because right now, in this space, where we don't even understand value, and there are so many asymmetries of information, there's a tremendous opportunity for smart teams that research properly to add value with this type of product.

Passive products are hard in crypto

It's very hard to design a mechanical, passive index in this space when the next great innovation in digital assets could be created and launched while we're on this phone call, and actually start to scale and be meaningful in a couple of days. So it's very hard to create indexes and passive approaches: how do you weight them, what goes in and out? You have to kind of reframe the way you think of asset management. This is a little bit more like the beginning of trading stocks under the pear tree, before there was a New York Stock Exchange.

The narrative and education

I would say the other part of it, even more significant, is the narrative. Talking to people about it. This is not a space where there is a well understood nomenclature, where there are agreed upon ways of talking about everything. It's only 10 years old. And when we say 10 years old, that's looking back to bitcoin -- everything else is even newer than that. So that's difficult. So when you're going through an investment, when we're dealing with institutional investors that are usually fiduciaries of other people's money, they're going have to communicate to an investment committee what is going on here.

The other part of this that we take very seriously is working on education, bringing investors of all sophistications in at their own speed, trying to speak in a normal way. These are very heady times for our space. And there's all sorts of players that weren't interested just a few months ago that are now quite certain this is the greatest thing since sliced bread. We try to stay in the middle and still talk rationally about these things in both times of contraction and expansion.

Structuring a new type of asset manager

We have ARCA Funds, which holds our flagship investment product, The Digital Asset Fund. We have a suite of products that are also prepared to be launched as they get up to scale. And as the investors that come to us are more specific about how they want to address the space, they realize that there are actually other things to do. So we see us launching not just hedge funds under that umbrella, but also passive, low fee, as we deem them appropriate.

And then the other side of the business is what launched Arcoin or the Arca US Treasury Fund. We call that Arca Labs. Arca Labs is our innovation arm, where we are innovating financial products that leverage blockchain technology and something like Arcoin, or the US Treasury Fund, which is the first '40 Act fund that represents a tokenized version of short duration US Treasuries, which fills a lot of utility in this space.

That wrapper, which we like to call the BTF, or blockchain traded fund, is actually as flexible as the ETF. So the hard and fundamental work we're doing there of getting Arcoin on systems, getting early use cases that will translate to other asset management products based on that structure. Just like the first ETF was the SPDR. That did a lot of work on people understanding ETFs and their benefits. Similarly, we think Arcoin will own that ecosystem -- it's just more complex. There is no established exchange environment. This is all very new. So this would be akin to building ETFs when you didn't even have an exchange yet.

Big plans this year

2021 is going to be a very big year in this space. We're launching multiple products on the asset management side. And we are continuing to work on getting Arcoin funded and the heavy, fundamental work to do there. I would say that the thing to look out for is innovative, investor friendly products on the asset management side. In very short order, those will be coming out.

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