Matt and Felix (Outerlands): Analysts of the Month

What is your story? What was your journey into investing and into crypto?

Matt: After graduating from Notre Dame with a degree in Finance, I started my career at Ares Management within their Special Opportunities private equity fund, where I focused on evaluating a wide variety of public and private debt and non-control equity investment opportunities across a broad spectrum of non-distressed special situation, stressed, and distressed investments. While I am tremendously appreciative of my time at Ares for the role it played in fast-tracking the development of my investing acumen, eventually I realized that I wanted to do something closer to the cutting edge of innovation. While structuring rescue financings for cruise lines or meeting and office space providers that were battered by COVID was certainly interesting, these companies were not exactly on my short list of businesses with the potential to change the world, and I wanted to spend my time analyzing and investing in companies with more disruptive potential. I also felt called to do something more entrepreneurial with my career: I wanted a role where I was not just a small cog in a massive corporate machine, to a market that was more inefficient, and to an opportunity where I could be a thought leader with the potential to leave my mark on the way an asset class is viewed and valued. Crypto seemed like the best place for me to chase all those goals. The Web3 ethos and mission really resonated with me and the technology was clearly transformative. Blockchain was already showing traction with improving business processes across a wide range of applications, and the frameworks for valuing and investing in tokens were still in the very early stages of development. When I got the opportunity to join a liquid token fund that I thought was bringing an innovative and attractive approach to investing in the space, making that move was a no-brainer for me.

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Felix: Philosophically, an affinity for research is the common thread in my career path, and what got me into crypto after years in traditional finance roles. I grew up in a home where intellectual curiosity was prized and encouraged– that’s stuck with me and has always fueled a passion for learning about things outside my immediate purview as much as things in it. Maybe that’s why I entered college looking to major in physics and left as a finance major, or spent years building a career in fixed income to then pivot. Whether it’s science or investing, a deep desire to understand and uncover knowledge has been a driving force in my career. That ultimately led me to crypto as well, which, being such an evolving technology and marketplace, is an extremely fertile space to pursue that.

Once I had settled on a finance degree, I felt the gravitational pull to Wall Street and landed a role in capital markets at Morgan Stanley. After two years, I moved into the bank’s fixed income research department, which was a more natural fit for my curiosity as well as an eagerness to better understand investing at an institutional level. While in the research role I spent my days dissecting massive sets of fixed income data, always seeking to identify novel features, trends, and opportunities that could support new trade recommendations and help inform our clients’ investment strategies. This also involved research on implementing systematic strategies within corporate bonds, which at the time was a novel extension of such strategies (akin to what we are now doing at Outerlands Capital in the digital asset space). While rewarding, I knew I wanted a more ‘skin in the game’ type of role, and around the time I was looking to move to the buy-side, Colin (Founder and CIO of Outerlands Capital) approached me about an opportunity on the newly formed Strategic Investments team at Horizen Labs, which he had just left his job in academia to lead. We had been connected since my studies at the University of South Carolina, and seeing him “take the plunge” into crypto inspired me. We both followed the space for years, watching with growing fascination as the technology evolved. Getting in on the ground level with a trend as promising as blockchain and Web3 was, in my mind, a once-in-a-generation opportunity. So, here I am now, working alongside an amazing team at Outerlands Capital to bring the rigor of investment strategies and processes from the traditional space into the frontier of crypto markets.

What is Outerlands? Why did the two of you join Colin and team?

Outerlands is a liquid token manager built around the mission of applying the core tenets of factor-based investing onto digital assets. Systematic, factor-based investment strategies are validated by decades of success across traditional asset classes, pioneered by academics, and implemented by many prominent hedge funds and asset managers. Outerlands firmly believes that the foundations of factor-based investing are universal across markets and will hold as true in digital assets as they have in traditional asset classes.

Our approach manifests itself in a few distinct characteristics: The first is a data-driven approach to portfolio construction. Outerlands rigorously analyzes and backtests a number of fundamental factors and quantitative metrics, selectively integrating those with the strongest ability to predict token performance into the Firm’s quality factor model that underpins all investment decisions. This analysis spans both traditional factors with thorough academic and practical validation in equities as well as a number of new factors unique to digital assets that are enabled by the large libraries of data published by public blockchains. We are certainly not dismissing the strength of qualitative narratives, which have historically been strong drivers of token performance, but are of the opinion that water must eventually find its level, and basing decisions on fundamental data will lead to better long-run investment outcomes.

Outerlands’ other key differentiator is broadly diversified portfolios[MD1] .We believe this is a marked deviation from most other liquid token investment products available today, which tend to have a much smaller number of positions and are oftentimes weighted by market cap, leading to the vast majority of the exposure being concentrated in a small handful of the largest tokens. Outerlands’ low concentration does not mean low conviction or less actively managed, rather, it enables us to reduce idiosyncratic token risk and create a purer exposure to the quantitative, fundamental drivers of token returns. In addition to the risk management advantages of diversification, we feel that diversified portfolios are necessary to capture the full breadth of innovation occurring in crypto. Digital assets are still very nascent, with a huge number of emerging projects seeking to disrupt a wide range of end markets. We believe it prudent for investors to touch all those pockets of innovation, and doing so necessitates a large number of positions.

As for why we joined… Felix and I both decided to join Colin’s team at Outerlands for similar reasons. We both had a desire to make the move into crypto and develop frameworks for investing in a revolutionary new asset class. The whitespace for an investment approach like Outerlands’ was easily apparent to both of us. Perhaps most importantly, however, we were both former students of Colin’s during his career in academia at South Carolina and Notre Dame, and he was a person who we deeply respected and were excited to work for.

Felix: You spent time working in Debt Capital Markets and Fixed Income Research prior to joining Outerlands – how has that shaped your research and investment philosophy in crypto?

Fixed income has a lot of complexity (compared to say, stocks) which I always enjoyed. Cryptocurrencies compound that - incorporating aspects of equities, currencies, fixed income, and more into something that is at once a financial asset and, more importantly, a piece of technology. My career on the TradFi side taught me to lean into that complexity, as that was often where the most interesting work was to be found.

Working on the institutional side at a big bank also teaches you to think about things a) practically and b) holistically. By practically I mean focusing on what is usable and implementable. Research in the investing space is worthless if it can’t lead to a tradable strategy, or one that can’t be scaled to be relevant to the desired audience (institutions). While there are fun detours to take in the research process, having an eye on the practical outcome is ultimately why we’re here.

By holistically I mean seeing an asset class within the broader context of investors’ portfolios. As a corporate bond strategist, I could not simply ignore investment alternatives, as I knew our clients were always weighing the relative merits of allocations to a broad range of assets. The crypto space can at times seem quite standoffish from ‘traditional’ asset classes, unwilling to consider the lessons learned in other spaces or how crypto can co-exist alongside them. Realistically, crypto’s place in an investors’ portfolio is alongside a diversified mix of other asset classes. This is a basic concept in traditional finance, but has been a surprisingly useful carry-over to a space that hasn’t quite converged on the same conclusion.

Matt: You were previously at Ares before making the leap to Outerlands. How has your experience influenced the factor research and systematic strategies at Outerlands?

At first glance, distressed and deep value credit and equity investing might seem worlds away from early stage, growthy token investing. Beneath the surface, however, there are some key similarities. Both investment styles involve evaluating assets that have been cast aside by traditional market participants due to a perceived lack of value or extreme risk, but hold enormous potential for outsized returns for those able to separate the diamonds from the rough. At Ares, this characteristic of the asset class instilled within me a relentless focus on cash flow yields and other drivers of absolute value. As a result, when I joined Outerlands, my first order of business was evaluating why tokens should have any value at all. To my initial surprise, and I think the surprise of many others, there exist a number of tokens with earnings yields on par with or exceeding that of S&P 500, in an industry with a much more explosive growth profile, and those tokens are generally not the largest cap tokens that most people have heard of or that make up the bulk of most crypto managers’ portfolios. While not all tokens are structured like businesses that are capable of generating traditional earnings, instead relying on supply and demand imbalances to drive fundamental value, this finding was critical in shaping Outerlands’ mission of identifying the key metrics that serve as core drivers of token returns, leveraging those metrics to parse a wide universe of hundreds of tokens, and create broadly diversified portfolios that capture that highest quality tokens in the industry.

My experience investing in turnarounds and restructurings at Ares also taught me how to think creatively about what an asset could become in the future post a transformational change in its business model or cost structure– not just what it looks like today. This skillset translates to token investing where oftentimes the future drivers of token value are not implemented currently. For example, debates around a fee switch for Uniswap could lead to a dramatic change in the value accrual for the token, while new product lines can significantly improve the fundamental value of a token, as has recently occurred with Thorchain’s new lending protocol. In an asset class with such a rapid pace of innovation and change, it is important to be able to imagine and consider a wide range of future scenarios.

How important do you think fundamentals are to crypto markets today and how do you see that evolving? 

Matt: Outerlands disagrees with the sometimes popular mantra that fundamentals do not yet matter in crypto. We have spent the last two years rigorously analyzing and backtesting a wide range of factors, including traditional factors with long track records of success in equity markets like size, momentum, value, and beta, as well as new factors and metrics unique to crypto like usage and transaction growth, fee generation, unlocks and inflation, and developer activity, among others.

We have found that a number of these metrics have demonstrated a consistent ability to inform forward returns, with the highest scoring quantiles outperforming^[1] the lowest scoring quantiles across a variety of time intervals and market conditions. This outperformance can be further magnified by adjusting for sectors and factor correlations, or by combining factors into a broader scoring model. The myth that fundamentals do not yet matter in crypto is perpetuated by the high volatility of crypto markets oftentimes overshadowing the returns to a given factor. However, Outerlands remains firm in its conviction that factors and metrics grounded in rational economic underpinnings can be used to predict token returns, and expects the outperformance attributable to these factors to expand and become more evident over time, particularly as improvements in short liquidity improve the ability to isolate the alpha attributable to fundamental factors in crypto.

While we are already seeing buds today, we expect the importance of fundamentals to continue to grow over the coming years for several reasons. Improvements to fundamental data accessibility, spearheaded by firms like Artemis, will enable more capital to trade on fundamentals. Continued inflows of institutional attention, capital, and talent will lead to more sophisticated investment strategies that make token prices more efficient and reflective of fundamentals. Finally, aforementioned improvements to the breadth and depth of short liquidity will enable the market to more efficiently price low quality tokens.

Felix, you wrote a piece contextualizing digital assets in the context of other historical markets. Where is digital assets as an asset class in its history? Where do you think value will ultimately accrue among investors over long periods of time?

Felix: Digital assets are still a burgeoning asset class. The piece you reference (Digital Assets in the Context of Nascent Markets in History — Outerlands Capital) discusses how the market has made many of the same mistakes as other early markets throughout history. This is no reason to dismiss the technology or the asset class. In fact, as most markets have evolved, the growing pains are rarely inherent to the underlying asset or structure of the investment. It’s been the same human errors made over and over again, largely in the context of greed and fear. Perhaps it is a blessing that digital asset markets seem to be making the same mistakes just more quickly, and incorporating the lessons at a similar pace.

Digital assets is still a young asset class, but it’s evolving and maturing quickly. And, to be clear, being a young asset class shouldn’t preclude it from being considered as a serious investment. It just means the bar is higher for thoughtful analysis. Intelligent investments now could have transformative potential, akin to early investments at the start of the Internet era. Simultaneously, we shouldn’t expect digital asset markets to behave with the same level of maturity as stock markets. Both sides should be considered: the incredible opportunity digital assets present, and how to manage the inherent uncertainty surrounding an evolving space.

To me, value is going to unquestionably accrue in the long run to projects that solve real problems, at scale, that either hadn’t been solved before, or can be solved better by blockchain technology. That means revolutionary as well as evolutionary opportunities. And given the nature of blockchain technology and digital assets, the value unlocked by such solutions is going to accrue to token holders. For many projects, there may not even be a centralized entity whose equity can accrue value– this makes the blockchain space very different from even other technology plays.

You also specifically mention the long-term, which I want to reiterate the importance of. I think some players in the crypto space take that to mean… a year or two, or more likely even less than that. And surely there are good ‘trades’ that can play out in short time frames. But what I find truly inspiring is the potential for blockchain technology and digital assets to unlock and accrue value over multiple years and decades. The technology has the basic potential to revolutionize aspects of nearly every sector of the economy. That will take time to play out, but favors a patient, thoughtful investment approach that can weather downturns and hype cycles equanimously, with an eye to capturing that right tail of projects that become fundamentally ingrained in the global economy.

Can you share more about why you think institutional investors should position digital assets in their portfolios?

Felix: I’ll plug one of our recent research pieces here, where we discuss exactly this: Positioning Digital Assets in an Institutional Portfolio — Outerlands Capital. But at a high level, and building on what I mentioned before, blockchain technology has wide scale, revolutionary potential. At the same time, the determinants of success could have low correlation to traditional asset classes. An investment in digital assets is an investment in the secular change of money, value, ownership, and business structures over the coming decades. This mean performance will be driven by adoption and development, rather than just by prevailing macro themes or the performance of other asset classes. In turn, adoption could be driven by secular shifts in consumer preferences and expectations, driven by themes such as trust, accessibility and inclusion, privacy, and equality. This is all compounded by the fact that digital assets are a truly global market. On the technical side, the other interesting angle is the fact that digital assets can essentially provide venture capital type exposure to disruptive technology, with the liquidity and risk management benefits of a deep and active secondary market. Together, these characteristics make digital assets an attractive holding - giving investors exposure to important themes that can’t easily be captured in traditional asset classes.

Of course, investing in digital assets comes with a degree of risk that investors must be mindful of. Given the broad range of goals and risk tolerances that institutional investors may be solving for, there can’t be ‘one’ answer to what the right allocation looks like. And some of the staple tools that investors have relied on for decades (such as mean-variance portfolio optimization), simply aren't as helpful in an asset class with a short and volatile history.   In my opinion, it’s the forward looking expectations for the asset class that should really matter, and need to be informed by a fundamental appreciation of the profound technology bet that blockchains represent.

With all this in mind, I strongly believe that the right positioning in digital assets is above zero, given the magnitude of potential for the asset class and the technology it is built around. For some investors that could mean allocations in the high single digit or teen percentages. For others, it might mean 1%. But at this point, digital assets are large enough as an asset class that forgoing an allocation is an active decision to underweight a part of the market, which should be carefully considered in light of the opportunity.

How do you all think about real / non-investing applications in crypto? What applications are you two excited about?^[2]

Matt: We’ve both found these “real” applications of crypto to be the north star of the space: Projects seeking to provide solutions to difficult problems that are relevant to existing consumers or businesses. One way in which crypto can effectively do this is by aggregating and increasing the utilization of idle resources. We see a lot of DePIN (Decentralized Physical Infrastructure Networks) providing this sort of value. For example, Render (RNDR) allows people to contribute idle GPU rendering capacity to buyers looking to perform render jobs, helping to reduce costs in a rapidly growing and capacity constrained market for GPU capacity. Hivemapper (HONEY) harnesses the dashcam data from a global network of drivers to collect fresh map data around the world for navigation, automotive, logistics, insurance, and government purposes. Numeraire (NMR) is a data science protocol that allows data scientists with excess time and capacity to submit prediction models and receive rewards for successfully predicting stock market returns. Helium (HNT) aims to build decentralized, public wireless networks. These are projects with wildly different end use cases, all made possible by blockchain infrastructure and a token-based economy that efficiently incentivizes participation.

We expect new innovations in crypto to provide good, robust services that can stand on their own merit, where the  end user may not even know the product is built on blockchain technology. Crypto will simply be providing the more advantageous solution by being able to incentivize resource productivity to improve efficiency across a wide range of industries and use cases.‍

Felix: Outside of the types of applications Matt just mentioned, which I absolutely believe in as well, I think there is also wide open space within digital assets to really revolutionize the creative economy. One of the core innovations of digital assets is how they can revolutionize ownership of intangible assets, such as art. We’ve obviously already seen a lot of innovation with NFTs, but I think there are even broader applications, capitalizing on the programmable, smart-contract capabilities of blockchains, that could really redefine not just ownership but also the flow of value between creators and consumers. It was this concept of a better creative economy that actually got me into the crypto space originally, as art has always been a passion of mine. So, it’s a space I’m excited to see more evolution of, within crypto.

Why is diversification important when allocating digital assets and how do you see the importance of diversification changing overtime?

Felix: Diversification is hugely important in digital assets, just as it is in every other asset class. Again, we’ve written a lot about this theme (Research — Outerlands Capital). Contrary to popular opinion, returns across different digital assets are far from perfectly correlated– and why should they be? The digital asset space is fascinating and promising precisely because there are so many different angles at play. You have everything from cryptocurrency store-of-value plays, to blockchain infrastructure, to applications focused on DeFi, real world infrastructure, entertainment, and more. In turn, digital assets can have considerably different structures with regards to utility and value accrual. All this makes for a highly diverse ecosystem, with different parts levered to different return drivers. Investors can benefit from diversification across digital assets in the same way they can benefit from diversification within and across other asset classes.

I would say that so far diversification is underappreciated in the space, with a preference for highly concentrated, discretionary bets. This can of course be a profitable investment strategy, but is not appropriate in all situations. At the same time, I would argue that, given how young the market is, “picking” just a handful of winners (at the cost of not investing in other projects) comes with an extremely high bar for continued success. The evolution of the Internet over the last several decades has shown us that even the most well positioned incumbents have no guarantee of maintaining their positioning in the long run, and that the biggest applications of a revolutionary technology are unlikely to be fathomed in its early days. Returns in the digital asset space ultimately resemble a power law distribution, akin to venture capital. An actively managed, diversified strategy can aim to effectively bring down the chunky left hand side of the distribution (projects that lose money or go to zero) while bringing up the hit rate on the long right tail. I fully expect investors to learn to embrace the “free lunch” of diversification within digital assets just as much as inves

How have you been able to use Artemis in your fundamental research? 

Matt: Artemis has been instrumental in enabling and improving Outerlands’ fundamental research. Our research program is predicated on collecting key fundamental data points for a broad universe of hundreds of tokens. It is difficult to understate how challenging of a task this is—these tokens are native to dozens of different blockchains, each having their own methodology for exploring and accessing data; these tokens span a wide range of sectors and token types, with data collection for a Layer 1 blockchain being a dramatically different exercise than collecting data for an application built on top of that blockchain; and finally, there is no standard reporting methodology or way of defining certain metrics—even a question as simple as “What’s the current market cap of XYZ large cap token” or “What counts as an active user” can yield a variety of different answers. Artemis has been pivotal in helping us tackle these issues, thereby allowing us to acquire the breadth of fundamental data coverage that our investment strategy depends upon. They rapidly rollout coverage for new blockchains and applications, deliver data that is of exceptionally high quality that we know we can rely on, and help us frame and refine ways to calculate key metrics and KPIs.

How do I get in contact with Outerlands?

You can get in touch with the Outerlands team here. You can reach out to Matt on LinkedIn and Felix on LinkedIn

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_{[1] There is no guarantee that past performance is indicative of future returns.}

_{[2] The investments referenced are for informational purposes only. All investments involve risk including the complete loss of principal.}

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