Fill in the blank

While brainstorming ideas for this week’s newsletter, the inevitable materialised: should we write something about the Coronavirus and its warpath of havoc all around the world? It’d be a great way to say something smart about human behaviour and how irrational or rational different people can be, surely that would be something worth writing about?

Fortunately there are far more educated people than us in this regard so that isn’t going to be the case. What we would say is that our thoughts are with everyone impacted by the virus, directly or indirectly, and while we have no idea how this will pan out, panicking isn’t going to do anyone any good. Wash your hands, eat healthy, sleep well and this, too, hopefully shall pass.

We decided ultimately to turn to the reason why we’re struggling to find something to write about this week: because we’ve been largely stuck in the weeds of pushing the final bits of paperwork through to get all our businesses launched, from the wording of introducer agreements for 3BC, our capital introduction/deals platform, to the final details of valuation policies and regulatory status for the fund’s final draft private placement memorandum.

This could be it - the week we get to the end. The end of the beginning.

Which then takes us to the question that we’ve been trying to answer for the past few months, the one which - somewhat annoyingly for ourselves - we’ve managed to put off. In typical examination style, fill in the blank:

Three Body Capital is a/aims to ____________________________________________. To that end, we currently have 3 business lines: 1. A performance fee-only hedge fund, investing in what we call “emerging opportunities”; 2. A distribution platform connecting top quality investors in the developing world to private investment opportunities; and 3. A trading platform that provides individual professional traders access to institutional grade trading infrastructure.

One phrase to complete that sentence. So close, yet so far. Suggestions welcome.

Old world, new world, brave de-fi world?

Those who know us also know our views on the finance industry: change and evolution are mandatory for survival. Far from being cyclical, the decline in earnings in traditionally lucrative parts of the finance industry like research sales and high touch trading is likely to never reverse. Those days are gone, replaced by electronic trading, direct market access and an increasingly passive view towards single-stock picking. The banks, of course, continue to do decently, but not every boat in the ocean is being lifted in this rocky tide.

Furthermore, some trends, once put in motion, don’t reverse even if the initial impetus is removed: take, for example, the unbundling of research costs from trading commissions that came as a result of Mifid2. Even if Mifid2 were repealed, the glory days of high-touch salestrading are categorically gone - investors’ expectations, now anchored firmly on the idea that research is worth US$10-20k/year to read, and that execution-only trading commissions are worth a single digit basis point, are unlikely to accept re-bundling.

The common belief is that “Fintech” is the next frontier - almost everyone is on the case with Fintech investments of all sorts, and for sure, there are gains to be had.

The success (so far, although that’s starting to change, too) of fintech platforms and “challenger banks” like Robinhood, Monzo, Revolut and N26 has been inspiring, although like every other start-up, they too are starting to hit problems with monetisation and scale, inadvertently finding their freedom reverting to the convention of the very system they sought to disrupt. The risk is that it’s just more of the same but with a shinier interface.

Perhaps the biggest disruptor to the evolving status quo is decentralised finance, better known as “De-Fi”. De-Fi isn’t the same as fintech - it could well be a subset of fintech, but a clear line needs to be drawn.

Ultimately, where fintech falls into the bucket of “doing what we currently do better” (e.g. cheaper payments, faster transfers, trading for free, applying for mortgages with one-click etc), De-Fi falls into the bucket of “doing everything differently”.

And at the heart of most De-Fi applications is a name which, for most “seasoned” investors, conjures up feelings of disdain and ridicule: Ethereum. Along with it comes the fundamental token on the network, Ether.

A discourse on the disruptive potential of De-Fi is deserving of its own post, but if for one moment you think that this is a “fringe” concept, the preserve of geeky crypto-nerds who are just playing “a game”, think again: around $1bn of value, mostly in Ether, has been pledged (or “locked”) as collateral, backing De-Fi applications such as Maker, Synthetix, Compound, Kyber and Uniswap. If those names sound foreign to you, it’s time that you got to know them - these applications, built and developed over the past few years, crypto mania/depression notwithstanding, form the bedrock and the underlying circuitry for the De-Fi economy, powering permissionless lending, leverage, collateralisation and conversion.

And the best part of it is they’re doing it without any institutions: no banks, no central counterparties, no custodians, no administrators, no lawyers. Just code.

Emerging Opportunities

Contrary to “Emerging Markets”, a definition which we very much loathe, we’ve introduced the notion of “emerging opportunities” - investment opportunities which represent a permanent structural change (rather than mean-reverting opportunities), delivering a long-term underpinning of returns growth.

Such themes include the rising prevalence of AI applications, the rise of gaming as a new form of immersive entertainment (not just for the antisocial kids) and the decentralisation of finance. Some of these are themes we observe from a distance, and invest accordingly as we seek to make an investment return: companies like CD Projekt, MercadoLibre and iFlytek remain enterprises that we deeply admire, notwithstanding the inevitable ups and downs in an increasingly correlated market.

But De-Fi as a theme cuts to the core of our very business: its implications are more than just a parameter in an excel spreadsheet model, but a material manifestation of how we’ve decided to go about putting our business together.

They say if you can’t beat ‘em, join ‘em - many have tried, but “joining” the de-fi crowd (in its current state) carries massive risks and complexity: from the incompatibility of digital asset custody and pricing with existing systems, to the reluctance of traditional service providers to underwrite and support such novel, untested counterparties, to the outright fact that as an industry, everything is so new that no one has any track record long enough to be reliable to the traditional, conservative investor.

So we decided on a different way: Bridge ‘em.

Baby steps, big leaps

“Finance” as an industry often conjures up images of slick glass and steel buildings, packed with the most risk-loving individuals who swing their proverbial money bats in either direction, raking in the big bucks. Another piece of bad news - that image is at least 10 years out of date, even as it makes for good storytelling and moviemaking. Banks are now some of the most conservative, risk-averse institutions on the planet, worried that a sneeze in the wrong direction could trigger a regulatory sanction.

At least, in general. The way we see it, only those who have the foresight to advance into the unknown, perhaps at the near-term cost of what is a profitable, incumbent business, will survive - and even then, that may not be enough in the De-Fi world.

The opportunity for us lies in being the bridge between the old world that we’re all familiar with and the new world - De-Fi is just one angle, perhaps the biggest one, but also dealing with the challenges of rising passive dominance and the inevitable institutionalisation of digital asset investing. Even more so is the disintermediation (and decentralisation) of the traditional construct of “finance” that we’re all familiar with, from dealmaking to trade execution - whatever we’ve been doing for the past few decades, that all needs to change. In the beginning, we’ll look similar to the familiar. Over time, we expect that to change. Baby steps, but only forwards.

We’ve had the privilege of partnering up with some of the best and most innovative in the industry, with one aim: embrace the change that is happening in the industry, and lead that change by looking forward to where the opportunities are and will be, rather than scrambling to reconstruct them as they were.

If we’re in the right place, building strong fundamentals, then at the right time, we’ll be ready to grab the big opportunities as they come - whatever they may be.

A lesson in optionality

Whenever we find ourselves drowning in neverending to-do lists that come as the result of launching three business lines at the same time (like we have in the past two weeks), it helps to remind ourselves of one thing: one trick ponies never work out.

Just as we seek out “emerging opportunities” which provide us intrinsic optionality - steady core earnings with the chance to hit a few sixes (or home runs, depending on your preferred sport analogy) once in a while - we’ve built for ourselves a business that hopefully gives us the chance to take shots at the biggest opportunity of our careers from different angles: distribution, execution, capital allocation and whatever else life may toss our way.

It all starts with one very basic idea: build a business that we’d love to invest in.

We still haven’t worked out what to fill into the blank, but whatever we end up describing ourselves as, it’s something we’re deeply proud of.

Who we areEdward PlayfairFebruary 14, 2020