Ben Strack

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 <li>Portfolio manager Steve Russell said he believes banks with crypto and blockchain-related plans are currently oversold</li>
 <li>Fund has decreased positions in miners “significantly” since the beginning of the year</li>
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Community banks and other financial services companies are not halting plans to delve deeper into the blockchain and crypto spaces despite ongoing volatility in the sector, according to co-portfolio manager of Emerald Mutual Funds’<a href="https://www.emeraldmutualfunds.com/emerald-finance-banking-innovation-fund" target="_blank" rel="noreferrer noopener"> Finance and Banking Innovation Fund</a> (HSSAX).



As funds with exposure to crypto-focused companies and others with plans in the space grapple with cryptoassets’ latest downturn, Steve Russell and his team have discovered finance firms looking to use distributed ledger tech for payments, support the Lightning Network or have a presence in the metaverse.&nbsp;&nbsp;



HSSAX launched in 1997 and had about $116 million in assets under management as of June 30. Russell noted that the fund targets banks that are lending to crypto or blockchain companies, or ones that are creating their own tokens.



It also focuses on banks using blockchain-based real time payments platform Tassat to offer customers instantaneous and secure payments. Customers Bank and Tassat <a href="https://www.customersbank.com/investor-relations/press-releases/press-release/6b0dbbb4-fa4c-4721-8b0c-3ace54fec043/" target="_blank" rel="noreferrer noopener">launched</a> the Customers Bank Instant Token (CBIT), on TassatPay last October, for example.



“Not all of them have necessarily turned their whole business plan towards utilizing distributed ledger technology or being involved in cryptocurrencies for payments, but are certainly aware of it and moving in that direction ahead of their peers,” Russell said of the companies in the portfolio.



The portfolio manager noted that the mutual fund’s objective makes it unique from many of the ETFs that focus primarily on the same crypto stocks, such as miners and exchanges. Though the fund holds such companies, Russell said, the firm has decreased its positions in miners “significantly” since the beginning of the year.



The Emerald Finance and Banking Innovation Fund’s <a href="https://www.emeraldmutualfunds.com/holdings/emerald-finance-banking-innovation-fund" target="_blank" rel="noreferrer noopener">top holdings</a>, as of May 31, were Customers Bancorp, Coastal Financial, Triumph Bancorp, Bancorp Inc. and Finwise Bancorp. 



It also had crypto-centric investments, including miners Marathon Digital Holdings and Riot Blockchain, Silvergate Capital, the Grayscale Bitcoin Trust (GBTC), Galaxy Digital, Coinbase, and Voyager Digital, which <a href="https://cms.blockworks.co/voyager-files-for-bankruptcy-days-after-freezing-withdrawals/" target="_blank" rel="noreferrer noopener">filed for Chapter 11 bankruptcy</a> last week after suspending trading and withdrawals on its network.



Though Russell declined to comment on specific companies, he noted that the continued fallout from the crash of TerraUSD (UST) and LUNA, as well as <a href="https://cms.blockworks.co/3ac-files-for-bankruptcy-as-co-founders-location-unknown/" target="_blank" rel="noreferrer noopener">Three Arrows Capital filing for bankruptcy</a>, will likely lead to the fund continuing to exit or adjust certain positions.



Though roughly 70% of the smaller community banks Russell and his team speak to do not have plans within, or even knowledge about, crypto or blockchain, many banks remain interested in exploring the space even as crypto market remains volatile. 



Russell expects more banks to get involved in blockchain for mortgage-related activities. Figure Lending and Apollo <a href="https://www.prnewswire.com/news-releases/figure-and-apollo-execute-mortgage-transactions-using-blockchain-technology-to-transfer-ownership-301504772.html" target="_blank" rel="noreferrer noopener">completed a transaction in March</a> involving the origination of digital mortgage loans and transfer of ownership via blockchain technology.



“They’re never going to be the leader in introducing technology,” he said of banks. “They want to follow somebody.”



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Read on for more excerpts from Blockworks’ interview with Russell:&nbsp;



Blockworks: How does the current turmoil in crypto markets impact how you think about managing banks with indirect exposure to the sector? The crypto-focused firms?



Russell: Those companies that were just getting started in the space…they’re moving forward with their plans. The market reacts to a lot of these names as if their earnings are based off of the price of bitcoin, which has nothing to do with their earnings and how they generate revenue.



We think a lot of these banks have been oversold…so we think there are some attractive entry points into some of these names.



Obviously, something like the exchanges that are out there, those have traded down for good reason. The quarter-over-quarter and even month-over-month trading volumes, you’ve seen them down 30%. That’s going to obviously affect their bottom line, so as those fundamentals weaken, it makes sense that people sell those names.



But it does get to a point where you have to decide when you’re looking at your valuation to start slowly going back into those names because some of the valuations are very attractive.&nbsp;



Obviously the Three Arrows situation, what we’ve seen with Terra Luna and how much bitcoin was used as collateral to leverage that trade up in the market obviously has created fall-out for several firms across the board and created some bankruptcies and firms that will close. I don’t think we’ve seen the full results of how bad that is.



Blockworks: What about crypto miners? How are you evaluating them right now?



Russell: You’re going to have a shakeout here we believe over the next year or 18 months, closer to the halving in 2024 where it’s a decision of miners with better balance sheets and positioned strategically well on whether they acquire.



It’s an interesting time for miners and we think it’ll be a smaller amount of players that really end up coming out on the back end of this. It’s all about do you have your energy cost locked in? Can you finance this growth? Everyone put out these great growth numbers. Half of them are never going to come close to that.



It reminds me a lot of investing during the dot-com days. While there were a lot of losers during the dot-com bubble, there were certainly winners, and it was our job then to find more winners than losers.”



We thought the profitability would be deteriorating here for a little bit, so we’ll reduce those positions as necessary. Already there are a couple miners that have gotten to pretty attractive valuations and we may start to increase [exposure to those] a little bit. But we want to get a little more clarity on where we’re going with some of the pricing and profitability in the sector.



Blockworks: What sort of conversations are you having with banks?



Russell: They talk about their future exposure to the metaverse and wanting to have a presence in the metaverse. They talk about payments and utilizing distributed ledger technology. They talk about being able to offer trading to their clients on the institutional side as well as the retail side.



They talk about how transactions will be settling utilizing blockchain and distributed ledger technology. They’re aware of the Lightning Network and they talk about how they can become a part of providing that infrastructure to help the Lightning Network succeed.



Those discussions and that research we do is really key. It’s not like you’re just going to be able to look at someone’s 10-K [disclosure form] or someone’s quarterly report and say hey, these guys are focused on the space.



Blockworks:&nbsp; What sort of regulation do you have your eye on?



Russell: We’re always trying to go where we think the puck is going. We think the best way to get adoption in this sector of blockchain and cryptocurrencies comes with regulation. We think a lot of that regulation is going to be geared towards banks and financial services companies that already have regulators in place.



We think the first things banks understand are stablecoins. So if you get clarity on stablecoins, I think that these early adopters will roll out various payment products, accounts receivable, accounts payable products for their customers and their commercial industrial borrowers.



They’re already trying to understand <a href="https://www.frbservices.org/financial-services/fednow/about.html" target="_blank" rel="noreferrer noopener">FedNow</a>, but FedNow is not the technology that gets them to where stablecoins can. They understand payments and the need for efficient transactions, and then we think they’ll start to understand smart contracts that can utilize stablecoins and be able to implement frictionless transactions that can happen 24/7, 365. &nbsp;



Blockworks: As a fund that owns GBTC, what do you make of the SEC denying Grayscale’s attempt to convert its bitcoin trust into an ETF?



Russell: We try to be long-term investors with three- to five-year investment horizons. When I look at GBTC, I think it eventually becomes an ETF and the discount to [net asset value] is attractive. It’s like owning a closed-end fund. They always trade at a discount, so that’s not unusual in the space.



It would just be nice if the SEC was consistent with how they are examining a spot ETF for bitcoin with how they examine or look at proposals of spot ETFs for other commodities. If you said this is a commodity, which they have, then why isn’t it treated like any other spot ETF proposal for any other commodity?



This interview has been edited for length and clarity.



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