The Motley Fool's Interview With Cryptocurrency Expert Nic Carter

As part of our Bitcoin (BTC -4.01%) Day coverage on March 18, our own chief growth officer, Anand Chokkavelu, sat down for a chat with cryptocurrency expert and venture capitalist Nic Carter on Fool Live. In this interview, Nic shares his thoughts on Bitcoin, other cryptocurrencies, the future of money and finance, the NFT investment trend, and much more. 

Anand Chokkavelu: Hi. I'm Anand Chokkavelu, and our next guest on Bitcoin Day here on Motley Fool Live is Nic Carter. His crypto waters run deep. He was Fidelity's first crypto-analyst. He co-founded Coin Metrics, whose mission is to empower people to make informed crypto financial decisions. It sounds a lot like The Motley Fool in the broader investing world. He's a venture capitalist at Castle Island, where they invest exclusively in blockchain companies. He's bringing a lot of knowledge to the table, and he's going to share it with us today. Thanks for spending some time with us today, Nic.

Nic Carter: My pleasure. Thanks, Anand.

Chokkavelu: Well, Nic, as our name suggests, we're a motley group of investors, but most of us are primarily investors in the stock market. I'd venture that most of our members and readers and viewers don't own any Bitcoin or other cryptocurrency. Can you make the elevator pitch for why someone should consider Bitcoin?

Carter: Well, I would say, first of all, it's a bet on a novel monetary system, and if that's interesting to you, if you are disaffected with the existing monetary system and you're looking for some alternative monetary rules that are nondiscretionary, that strip human decision-making from that system, then you might find Bitcoin attractive. If you are really interested in nonstate stores of value like gold, you might want to give Bitcoin a look. But it's certainly a pretty novel thing. It's outside of a lot of people's comfort zone. I'm not suggesting that it should be a part of everyone's portfolio or anything like that. But first and foremost, it's a bet on a new monetary system.

Then beyond that, it's an index on the growth of this crypto economy, which is now dramatically grown, and Bitcoin is a way to get exposure to that. So it's a growth bet, and then in many ways you could think of it as a hedge, although it doesn't always behave as one.

Chokkavelu: Right. Being less than 20 years old, it's hard to get the data on all of that correlation type of things.

Carter: Yeah, it's only been around really for 12 years. It's only meaningfully been financialized, I would say, since 2014, 2015. Frankly, we don't know what the correlation characteristics are of Bitcoin, what they're going to be in the long term. But to me it's sufficiently interesting that I decided to spend my career on it.

Chokkavelu: Right on. We talked a bit about investing in Bitcoin. For a regular investor who as we know has never invested in cryptocurrency, wants some exposure but doesn't want a lot of hassle, what would your advice be if they came to you and said, "Hey, what should I do? What's the easiest thing to supplement my stock portfolio?"

Carter: Well, there's obviously thousands of different cryptocurrencies available. I think it's very easy to get distracted and to try and bet on Bitcoin killers or new base players or new smart contract protocols or meme coins. There's a huge amount of noise in the industry and a lot of malinvestment and misspent activity. I think Bitcoin, it's not exactly the highest beta asset in the crypto space. You're going to find more volatile assets, if that's where you're looking for, if you're looking for volatility and excitement.

But to me, Bitcoin is really the most important phenomenon within the crypto space. It's a new monetary system. It has that credibility. A lot of these other crypto assets are shallow imitations of it. Certainly there are interesting things going on beyond Bitcoin, but I would just start with Bitcoin, trying to understand that system in the first place, and try and deeply grasp the things that make it unique, and why it's endured 12 years and why it's shrugged off so many competitors in that time.

A small amount of Bitcoin exposure would be what I would recommend, such that people can tolerate the volatility of the asset, which is incredibly high, so size it accordingly. Bitcoin has annualized volatility of 80%-100%. If you want to target a level of risk in your portfolio, you want to size your bet accordingly.

Chokkavelu: Related question I know I get asked a lot is, "OK, what's the easiest platform to use? What should I do? Do I get cold storage? Do I go with a provider?" Have you seen any solutions that, I mean, obviously, the market's evolving and things are better each year. Have you seen anything that's blown your mind as a simple turnkey solution for folks?

Carter: No, and frankly, we're dealing with the encoding of value in an informational format. And so we have for the first time digital bearer assets, which means that if you lose your private key, you've lost the value, right?

Chokkavelu: The nightmare.

Carter: It's a novel thing, right? We didn't have that before. And so the last decade, we've been struggling to try and build tools to make it possible for people to have custody of that information on their own without the threat of being fragile. That's really what we invest in. That's a big part of our investment strategy as a firm, is trying to invest in tools and businesses which help people transact and hold digital assets.

For the uninitiated and for folks that aren't holding a huge amount of cryptocurrency, honestly, custodial service providers, there's a few that are extremely credible and that I would personally trust. Now, if you are more paranoid and you want to take final delivery of your coins, that's when you start looking into different kinds of cold-storage setups. But that's only, I would say, if you have a really meaningful amount of coin, and you want to take true custody of the equivalent of storing bars of gold in your basement kind of thing. There's no simple solution to that problem. That's one of just the key intractable problems in the industry, is storing value as information. So it's always been a challenge, and I think it'll be a challenge for a long time.

Chokkavelu: To be clear for folks, when you say custodial accounts, you mean places like Coinbase or Robinhood or Gemini or the Cash App.

Carter: Yeah, there's significant differences between all of them. Robinhood, for instance, you can't withdraw your coins. From Coinbase, Cash App, and Gemini, you can. They differ along the axes of fees. But I would say all of those institutions are credible. As long as you have a two-factor authentication set up, they're a reasonable enough place to store a small amount of Bitcoin or another digital asset.

Chokkavelu: Right on. Now, cryptocurrencies, a lot of it is about the future. Let's step into the future a little. I'm sure we'll come back to this in a bit. What's something in the blockchain-slash-crypto universe most people can't envision today but they will take for granted five years from now?

Carter: Yeah, it's a great question. Beyond just a monetary transformation, moving to a new standard, I think probably one of the most interesting phenomena that's happening in the crypto space is the so-called DWeb, or decentralized Web services. The objective here is to take certain infrastructural components of the internet and strip them from these data silos that operate in Silicon Valley and exercise a lot of control over the internet and restore power into the hands of users by creating protocols, effectively, that manage the provision of DWeb resources, as opposed to having corporates control them.

Specifically, one category would be decentralized cloud storage, which is now reaching a threshold of maturity. That's quite impressive. You can actually use these protocols now. Filecoin (FIL -7.93%) was a really hotly discussed launch earlier this year. You also have Sia, Arweave. We're not recommending any of those in particular, but all these systems work, which is the important thing. In 2017, we had lots of initial coin offerings around the similar such ideas, but very little of this infrastructure actually functions. Today, you can actually use the systems to store data on a peer-to-peer model such that you have strong assurances that that data is still going to be there when you want to retrieve it. What that allows you to do is to route around the centralized internet gatekeepers that control and exercise censorship over our online selves. That's a wonkish infrastructure change where whether it's Amazon S3 or whether it's Filecoin that you're sending out your data to. But I think it has rippling effects on the whole topology of the internet.

I do believe that in five years or so, we're going to have a lot more power and control over our online footprint. Whether that means renormalizing the notion of running your own email server or really owning your online footprint, not farming out your blog to WordPress or a third party but actually being able to administer it yourself. Having these social media systems where you're the little proprietor in a physical sense and a legal sense of the data that you're serving up to some social media network, to me, that's the most interesting thing beyond just this monetary system that's being proposed, is basically a new topology for the internet entirely.

Chokkavelu: For the folks who maybe aren't engaging as much in the actual production on the internet and just living their lives, are there any things they'll be touched by, regardless of what they're worried about, blockchain or crypto assets, and just have to deal with five years from now?

Carter: Well, everyone is going to have to deal with inflation when it comes. That's completely inescapable. Whether or not you follow the actions with the Federal Reserve, you'll notice the prices at the pump increasing. You'll notice food prices increasing. Many of us tend to think that the specter of inflation is returning and that we're going to enter an inflationary environment similar to the '70s or even potentially similar to the 1940s, when you had significant inflation and low interest rates. If we have that, everybody will notice it, and Bitcoin may not be the ordained solution. Maybe you're going to go for some inflation and tax securities, or you're going to want to own gold, or you're going to want to own industrials or commodities. But certainly, people will feel that regardless of what their level of interest is in the Bitcoin space or global macro or anything like that. That's something you just innately feel.

At this point, you look at the fiscal position -- you look at debt-to-GDP ratio. You look at all these historical situations where the states are in similar fiscal positions. It seems that a soft default tends to be the only way out, so basically, an inflationary move to devalue the currency that your debts are denominated in. We as a society are tremendously indebted right now. I think we're going to have to work our way out of that regardless. I think it's a little overoptimistic to think that we can grow our way out of it the way we might have done in the '40s and '50s. I think we're set for a fairly inflationary decade. I think the Fed is telling us that, if we just listen to them. That will be something that will affect regular households regardless of how closely people follow the headlines.

Chokkavelu: I promise listeners and viewers we'll get to CryptoKitties in a second. But I've got a follow-up on this, where, when you look at monetary policy and monetary systems, do you see Bitcoin as not a replacement but similar to gold, or do you see it as something that could become the default currency of the world rather than the U.S. dollar? Or do you see them all kind of playing together? Or do you have a strong view on that?

Carter: Some people accuse us of saying, "Well, Bitcoin can't succeed unless all sovereign currencies fail," or something like that. That's definitely not my position, at least. I see Bitcoin as very similar to gold in a lot of its key respects. It is a nonstate hard money. When I think about what a global reserve currency is, that tends to be accompanied by a hegemonic power. I don't see a sovereign right now standing behind Bitcoin and declaring its intent to install it as a global reserve.

The dollar is the global reserve because the U.S. won World War II and created the Bretton Woods system and then backstopped the dollar with military force and diplomatic and economic force and all the institutions that they were able to create in its image. Bitcoin doesn't have that sovereign standing behind it. So I don't necessarily expect it to emerge as the sole global reserve currency. I do expect it to be a useful medium for the settlement of international trade as trust breaks down at the international level.

As we enter this much more multipolar world where trade is now, and commodities are priced in not just the dollar but the yuan and maybe the ruble -- as the dollar system frays, there's going to be scope for a number of co-existing currencies. And Bitcoin as a nonmanipulable currency, at least from the supply perspective, is a great option to be part of that mix. And so certainly, I think there's a role for it in the international system. I don't see it as being the sole currency that denominates commerce, though.

Chokkavelu: Now, I've foreshadowed CryptoKitties. Let's move to NFTs, nonfungible tokens. It's something like a lot of things over the last year in the finance space -- many of us had never heard of a week before, two weeks before; then it's in all the headlines. A nonfungible token is as opposed to a fungible token like Bitcoin, where everything, like is like -- a digital asset put on the blockchain and sold. You can think of it as artwork. We'll get to that example in a second. Trading cards like NBA Top Shot. Jack Dorsey has been auctioning off his first tweet on Twitter (TWTR). Probably the headline everyone's read now is people selling his digital artwork -- a jpeg, basically -- for $69 million through Christie's, a legitimate auction house, and that's a lot of money.

I guess the question for you is, as we hear about these NFTs, which certainly even a month ago we weren't hearing about, do you see them more like Beanie Babies, where it's more of a fad? Or do you see it like Bitcoin, which I assume you think will be around decades from now?

Carter: Yeah, it's a great question. Technically, I would say the notion of putting serial codes into a public blockchain context, and then making them freely transmissible on chain, that idea of basically putting a strong property-rights wrapper around some digital property, some digital content, which is unique or uniquely addressable, that has existed since about 2016 in the crypto space. You look at Colored Coins on top of Bitcoin; that was the idea behind that. The Counterparty Protocol, the Omni Protocol, and then NFTs themselves -- that's the more Ethereum (ETH -3.47%) incantation to refer to the concept. Before, I think people call them uniquely addressable assets. We saw them in 2017, and then of course, they've had a resurgence this year.

So it's not, strictly speaking, a novel concept. In fact, it's been around for five years, I would say there's definitely something there. I don't think the concept is going to fade away, because really, all it means is, let me take some data and encode it into a natively blockchain-based context such that I can financialize that data and render it innately tradable and transferable. That's pretty useful.

Of course, you do have liabilities. You have to have an issuer that says OK, the serial code matches this piece of content, or this song, or this video, or this artwork. So you actually do have that external dependency. So it's not natively digital like Bitcoin is, but it's sort of a hybrid.

But I think the idea is very strong, especially if you have a tight linkage between the underwriter of the content, the person that's creating it, and wrapping it, and putting it on chain, and the actual IP that's being put inside that wrapper. If we don't have that linkage, then you're going to have problems, because you're trying to take something which is dubiously owned, like, let's say I'm trying to put a meme in an NFT, Pepe the Frog or something. There's no real owner of that. Of course, you have the artist that created it, but it's this cultural phenomenon, so who can be said to own it? I can't really claim ownership over that thing, but then I'm putting it in a strong property-rights context. So I'm wrapping something that's dubiously owned in a blockchain context that creates very strong assertions as to ownership, and so you've got conflicts there.

I think it only really works in, for instance, a Top Shots context, where you have, the NBA has anointed a specific platform, and they are saying, yes, this is our intellectual property. You can't own it. We're not going to give you the rights to the IP so that you can go and resell them, but you can have the bragging rights to uniquely own this edition of this highlight, basically. So that's a very strong concept. The fact that it's on a public blockchain means that you can then trade it and financialize it, and there's an open API. That's the whole notion of blockchain. Anyone can read and write to the chain, which gives you really interesting interoperability potential.

So yeah, I think the core concept behind an NFT is very powerful and likely to stick around. Of course, there's a lot of confusion as to what it's really for, and a huge amount of misspent activity and speculative activity that's reminiscent of the Weimar Republic kind of thing, and we see that in every asset class, not least of which, we see it in NFTs, too.

Chokkavelu: So if NFTs are going to be around and growing over time, but it's hard to pick the winners, a question I have and I know a lot of people have is, Ethereum is the cryptocurrency and blockchain behind a lot of the NFTs. It's already the No. 2 cryptocurrency by market cap behind Bitcoin. Do you think Ethereum is a picks-and-shovels play for NFTs? In other words, not picking the winner, but it grows in usage as this grows? Is that a viable thing, or are there flaws in that theory? Too simple?

Carter: Well, honestly, in the crypto space, you just try not to overintellectualize things, because I've seen a lot of people that talked themselves out of positions and bitterly regretted that in years past. Ethereum does have the most traction when it comes to NFTs, and then decentralized finance and things like that. In prior years, I might have told you, no, there's no direct causal connection between the usage of Ethereum, the platform, and then Ether, the price of Ether, the native currency there.

But actually, that's changing a little bit. This year, the Ethereum leadership, or community, or whatever you want to call it, decided to put in a change to Ethereum such that when there's very high levels of fees, some of those fees get burned and basically reduce the outstanding supply of Ether, the currency of the network. So what that does is that creates a causal linkage between usage of the platform, and users pay tremendously high fees to use Ethereum. I made a few transactions yesterday and paid $80 in fees, which I thought was extortionate.

Anyway, [laughs] users will pay. The highest number of fees that have been paid in a day has been $150 million on Feb. 23 this year. Some of those fees will get routed into burning Ether, which tend to amount to a stock buyback. You can think of it like that. Now there is a bit more of a connection between the utility of the protocol and the actual underlying value of the asset, Ether, which, that connection did not exist in prior years. So that's why my answer has changed. Like I said, if you do want exposure to the usage of Ethereum and you think that's likely to increase, Ether is a way to play that.

Chokkavelu: Got it. Switch a little back to Bitcoin. Specifically, a lot has been written recently about the amount of energy used to mine Bitcoin. By design, it gets more resource-intensive as we go along. How do you think about the environmental impact of Bitcoin mining in the long run? Are there solutions that you think, or considerations people aren't factoring in, that mitigate the environmental impact?

Carter: Yeah, there's absolutely mitigating factors if you look into how Bitcoin miners actually interact with the earth's resources, for sure. Although before we even get into that, I will just say Bitcoin is a utility like many others, like aluminum smelting, or like any industrial process that produces a service that we consumers value. And like anything else that produces value, it's energy intensive.

So my general stance on this is that the solution is not to take a line-item editor's red pen and go through all the usages of energy in society, but it's to decarbonize the grid itself. To render the grid greener through a combination of nuclear, hydro, and other renewables, basically. We don't normally have this discussion where we look at usages of energy and we proscribe them and say, yeah, actually, you are not allowed to watch Netflix today because I, a third-party, perceive that to be wasteful. That's not typically how that debate goes, and so I find it curious that that's a stance that that debate is solely constructed in that way as it pertains to Bitcoin.

The other thing I will mention, the mitigating factor, is that Bitcoin buys energy on a geography-independent basis, which is not the case for the way that population centers consume energy. Typically, we need green energy to be generated near population centers. You can't just put a huge number of solar panels in the Sahara and then pipe that over to Europe, because the energy decays as it leaves the source. Bitcoin, on the other hand, doesn't care where the energy is generated. As long as there's internet, they'll buy it. Bitcoin will buy the energy from the earth. That makes it more suitable for otherwise curtailed or otherwise wasted sources of energy, in particular hydro. That's why we see a lot of Bitcoin mining in Southwestern China, in the Sichuan and Yunnan province, because that's where a huge amount of hydro was overbuilt. There is a lot of hydro, and so you have the option to either let the water out of the dam and let it be wasted or run the turbine and sell that excess energy to Bitcoin.

Equivalently, you have a similar situation in Texas, and Wyoming, and other parts of the U.S., where you have gas that would be vented or flared, which is a byproduct of oil mining and oil extraction, and that gas can be put to use, put into a generator. Some of those harmful gases can be captured, and then Bitcoin can be mined. That's net-neutral from an environmental perspective, or even net-positive.

Now, I'm not going to claim that no Bitcoin is mined with coal. Certainly, some is. But I think, ultimately, it's providing a service that's so useful to the planet and to civilization fundamentally that those externalities are worth it.

Chokkavelu: Got it. Do you think there are also ways that just the actual energy usage will go down over time at all, either through alternatives or just the way things evolve?

Carter: I don't believe any alternatives to proof of work, that rhetorical taxing will just move to some different consensus mechanism, doesn't make sense to me, because I've never encountered a consensus mechanism which provides the same assurances as proof of work. I wouldn't believe someone that tells you proof of stake will just fix it. It doesn't really fix anything. Proof of stake just basically installs a cartel and controls the chain, and that takes us back to any other cartel-based financial system, which was the whole thing we were trying to solve in the first place. If you want leaderless, decentralized consensus, you need to have the nodes that are in charge of the ledger, sacrificing something of value, and the purest expression of value is energy.

However, Bitcoin security spend, the subsidy that is provided to miners, which thus causes them to consume energy, that could reduce over time, 100%. We don't actually know what the trajectory of Bitcoin's energy expenditure will be. We do know that the Bitcoin subsidy, the actual issuance of Bitcoins, is declining every four years. Right now, at 6.25 Bitcoins released per block, 144 blocks a day, that gives us an annual inflation rate of 1.8%. That's going to become half three years from now, and then cut in half again four years subsequently, and so on and so forth, until Bitcoin's issuance has stopped.

That portion of the energy outlay and that issuance accounts for 85% of miner revenue right now. That's going to reduce to zero, and we're going to be left with the fee-based system, where the miners only make revenue from transaction fees. It's quite possible that that fee-based system would be less costly and thus provide miners less revenue, and hence less energy expenditure than the current system. I can't guarantee that, but the point is there's actually uncertainty as to the trajectory that Bitcoin energy outlay is going to take.

Chokkavelu: Got it. Well, we only have a couple of minutes left, so I'm going to do a couple of final questions. The first one is just, is there a fundamental misconception about Bitcoin, or cryptocurrency, or blockchain that you wish more people understood that we haven't talked about already?

Carter: They are so many. The No. 1 one, and I will try and be brief, would be the notion that Bitcoin transactions have an embodied energy cost, and so we always see this per-kilowatt hour cost of Bitcoin transaction. That's completely not how Bitcoin works. Bitcoin is operating regardless of whether you or I choose to transact. There's a very diffuse and weak connection between my transaction that drives up the marginal clearing price of block space and then the miner that chooses to consume an additional kilowatt-hour of energy.

The other thing is that Bitcoin transactions are final settlements. They're not really comparable to Visa transactions, or PayPal, or Venmo, which occur on a very high level of the payment stack. Bitcoin is the very base bottom layer where the fundamental final settlements are occurring, which is more equivalent to Fedwire, or a settlement and clearing system like CHIPS or Fedwire. You can't exactly compare the characteristics of Bitcoin to a retail-based payment system which does not have a settlement embedded into it. Bitcoin transactions are payments and settlements. Bitcoin can settle over $1 billion in a single transaction. We've seen this happen numerous times in the last quarter. If you see someone making a comparison between Bitcoin and Visa transactions, completely different systems, they have very little in common.

Chokkavelu: We've been fairly responsible throughout this interview. Now, let's end with a reckless, fun question. Price of Bitcoin five years from now. It's about $55,000 right now, has been recorded.

Carter: Yeah. I don't know if you can see it on my clock behind me.

Chokkavelu: No.

Carter: But it's got the price of Bitcoin. I think it's very plausible that Bitcoin exceeds the market capital of all the above-ground gold in the world within five, 10 years. I think it's very possible that a number of central banks will add Bitcoin to their foreign exchange reserves as a gold-like substitute or a gold-like asset. If those things happen and the institutional adoption that I'm seeing continues to happen, and we enter this inflationary environment with a yield curve control, I think the price of Bitcoin five years from now is far, far higher than where it is today.

Chokkavelu: Right. To give people an idea, gold is, I believe, about $10 trillion in market cap, which is about a 10x for Bitcoin from here.

Carter: Correct. Actually, there's less liquid Bitcoin around than people think. If you adjust Bitcoin for the freely floating supply, you get a market cap of about $800 billion. It's still under $1 trillion in terms of the actual liquid Bitcoin that's available for sale.

Chokkavelu: Got it. Possibly more than a 10x. With that, we will end. Nic, I want to thank you for joining us today. I think you've taught a lot of people a lot of interesting things around cryptocurrency and the blockchain and Bitcoin in particular. Happy Bitcoin day.

Carter: Thank you. My pleasure.