Ether Capital Corporation (OTCPK:DTSRF) Q2 2022 Earnings Conference Call August 15, 2022 11:45 AM ET
Company Participants
Ashley Stanhope – Director, Communications
Brian Mosoff – Chief Executive Officer
Ian McPherson – President & Chief Financial Officer
Conference Call Participants
Ashley Stanhope
Okay. I think we can get started here. Hey, everyone. Thanks so much for joining us. My name is Ashley Stanhope. I’m the Director of Communications for Ether Capital. I’m joined by the company’s CEO, Brian Mosoff; and President and CFO, Ian McPherson.
We’re going to spend the next 30 minutes talking about Ether Capital’s Second Quarter Financial Results. And we’re also going to talk about Ethereum’s upcoming merge that we’ve — you’ve probably read in a lot of our blog posts or newsletters by now. So — and why we’re so excited for this critical upgrade.
Just a couple of things to mention before we get started. So, this presentation is for informational purposes only. So, we’re just going to talk about our business and we’re not here to provide any type of investment advice. We’re also going to keep it tight, so we’ll keep it to 30 minutes, and then we’ll leave some time at the end for a bit of a Q&A.
And if I don’t end up getting to all of your questions, please feel free to send me an e-mail to ashley@ecap.co, and I’ll get back to you as soon as possible. We’re also reporting this webinar and we’ll plan to publish it to our website and YouTube channel, so you can always play it back afterwards.
And with that, I will hand things over to Brian to kick things off for us.
Brian Mosoff
Thanks for that, Ashley, and hello everyone. Glad you’re able to join us today. As Ashley mentioned, I’m Brian Mosoff, the Chief Executive Officer of Ether Capital. I’m going to turn things over to Ian momentarily to discuss the recent financial results, but just very high level for anyone who’s new and is joining us and not familiar with Ether Capital, ee are a company focused on the Ethereum ecosystem and core infrastructure. We have some bullet points here just mentioning some highlights.
We hold over 44,000 ETH on our balance sheet and we’ve staked a large number of it. in the second point, over 20,000. The yield is currently over 4% on that. We’re going to get into what staking is and why that’s really exciting a little bit later.
And we generate revenue through those activities some consulting arrangements that we have, and we are in the process of transitioning from a holder of ETH to a holder ETH Plus having some operating business.
There are four key executives I’d like to point out today. We already know who I am; Ian McPherson, who is joining us today as our CFO; and Jill Friedman is our COO; and Shayan Eskandari, who is our CTO — our Chief Technology Officer. So, a strong management team who have joined us in the less than 12 months, and we are really excited about where we’re going.
So, with that, I’m going to turn things over to Ian to discuss the recent financial highlights. So, over to you, Ian.
Ian McPherson
Thank you, Brian and for those on the call, Brian is controlling the advancement of the slide and so periodical I’ll say slide and hopefully, that won’t be too annoying every time he changes.
But on Thursday morning last week, we issued the financial results for the second quarter and hopefully, everyone on this call has had an opportunity to review our press release, the financial statements, and the MD&A.
Today’s webinar will review the highlights of those documents and perhaps provide some additional insight into those numbers. So, everyone has a better understanding of the financial performance.
New slide. Well, a conventional quarterly earnings presentation, you would normally kick-off the webinar with a summary of our financial results, rather, I’m going to lead-off with our perspective, the key financial drivers of the business. Brian, can you go back to a slide, please? Thanks.
On this page is a list of at six items that investors and prospective investors should consider when assessing our company, and these include the price of Ether, our most important asset; the yield on staked Ether, which provides a company with revenue; consulting revenue, which is paid in fiat C dollar, prospects for future operating businesses at Ether Capital, which we address a bit later. The monetization of a non-core investment in Wyre, a private US company. And finally, taxes what is the liability given our corporate structure. For each of these, I’m going to spend a minute or so to provide an update on the factors, than aggregate them in a financial summary in about six to seven minutes.
Next slide. In this slide, we referred Ether as is apparent from this chart. The price has been a roller coaster for the past year. During Q2, we experienced the lowest price over the past year, and we ended the quarter at US$1,020. During June, in particular, there were many corporate participants within the crypto ecosystem that experienced extremely difficult conditions.
Many of you probably are familiar with the bankruptcies and failed business models of some high-profile crypto companies that were in DeFi. Brian will address these later on the webinar in more detail, but these cascading problems infected many participants. It led to force liquidations of digital assets and counterparty failure during June and early July, the loss of confidence in the drop in buying activity resulted in a material decline in all digital assets, including Ether. So, since the start of 2022, Ether declined 83% until June 30, most of it in Q2.
Now, interestingly, the price of Ether’s experienced a strong rebound since the June 30, date. In fact, it has gone up nearly 90% in six weeks and reached actually over US$2,000 this past weekend. There are not many assets in the world that have this level of volatility.
Next slide. The valuation of our company is very reliant on its balance sheet assets currently. Although, our external auditor has reviewed our financial information, these numbers are not audited. The decline in the during the quarter from $284 to $1,020 in one quarter had a very material negative impact from the valuation of our digital assets.
From this table on the slide, you can see the material decline in valuation by quarter since December 31, and you can link it to the price of Ether at the bottom of the table. Now, it is important to emphasize, though, that these are not realized capital losses, and there have been no transactions in our Ether or Staked Ether during the quarter.
Now given the Ether is closer to $1,900 this morning on August 15, the digital asset value would be close to $110 million today versus the $58.6 million value on June 30. Now for the accountants in the audience, there is a different valuation methodology for ether versus Staked Ether and Ether Rewards. This is due to the IFRS rules and that Staked Ether and Ether Rewards are currently deemed to be illiquid Level 3 assets. Ether is deemed liquid and it’s mark-to-market. So this is explained in more detail in our interim unaudited financial statements.
Next slide. One of the strategies that distinguishes Ether Capital is the ability to earn income or yield on our Ether there by staking it. This is not feasible currently with ETFs that hold Ether Bitcoin.
Now for those unfamiliar with staking, we post our Ether into a staking pool and validate new blockchains in Ethereum 2.0 network. We’re undertaking this activity, stakers earned fees, more detail about staking could be found in our financial statements in the MD&A. The company is taking approximately 40% — 47% of its Ether assets and earned a yield of approximately 4.65% in Q2, similar to the 4.76% for the first six months of the year. We are paid in Ether not U.S. dollars or fiat currency and we hold these Ether staked rewards on our balance sheet. Currently, there’s no market to sell these rewards for fiat currency, but it is expected that they will be liquid after the Merge. Brian will address that topic later.
The company intends to take more of its Ether given it is not an active trader of its Ether assets. And within time, such staking percentage may range between 80% and 90% subject to Board approval and prevailing market conditions. If this increase in staking from 47% occurs, it should positively impact the company’s revenue potential from its assets.
Next slide. Another source of revenue for Ether Capital is consulting revenue with Purpose Investments. Purpose is one of the largest crypto ETF providers in the world. When Purpose launched its family of digital asset ETFs, it relied on Ether Capital to assist that launch and the continuous marketing of those ETFs. We entered into a formal agreement about 18 months ago and a company shares in the management fees of those ETFs.
This slide summarizes the consulting revenue earned, which is highly linked to the assets under management of the purpose crypto ETFs. That period ending AUM is included in the table. The AUM is highly correlated to the price of Bitcoin and Ether, the two flagship funds managed by Purpose. An attractive feature of this revenue source is that it is paid in C dollars and allows the company to pay for some operating expenses.
Next slide. In 2018, the company considered a strategy of using its capital to invest in early-stage crypto companies. It was a CAD 2 million investment that was made in a private US company Wyre. Since that time, Wyre has increased materially in size and scope, and it agreed to a takeover bid by Bolt in early April of this year. Shareholders of Wyre have improved the transaction and are awaiting regulatory approvals in multiple US jurisdictions. Both Wyre and Bolt are private US companies, and there is no traded market for their shares.
At this stage, we do not have access to financial statements at Bolt. But based on various valuation methodologies, the company estimated the value of its Wyre investment of $4.175 million at June 30, a material reduction from the $6.2 million valuation on March 31. Now this write-down can be attributed to a material decline in publicly traded valuation metrics for technology stocks, all of them, and below budget operating metrics at Wyre. It’s our hope and expectation that the transaction may close in late Q3 of this year.
Next slide. To finish my remarks on financial drivers, I end with the most popular topic of taxes. We’ve not discussed this much previously, but this table summarizes our tax situation. Essentially, we have a tax asset that is discussed in the notes to the financial statements. And over the years, the company has generated income tax losses that totaled approximately $19 million. They are not on the balance sheet as an asset, but we keep track of them. This year there are two potential calls on the use of those tax loss carry-forwards that can be applied to shield the company from potential to access.
Firstly, we have a taxable income in 2020 year-to-date, largely due to the capital gains on selling some of our non-core digital assets such as Maker. This was offset by a capital loss we realized on the sale of a purpose Ether ETF we held in treasury during the quarter. In a nutshell, the estimated $3 million of taxable income in 2022 and resulting will result in current income tax expense, but it can be offset and shielded by using some tax loss carryforwards, we would essentially not pay any current income tax.
Secondly, the fair market value of our digital assets exceeds our tax cost base by about $1.9 million. This difference is unrealized and will fluctuate based on the price of the Ether. At this time, there is no intention of the company to sell any of its Ether assets and trigger a taxable capital gain. Regardless, we do estimate that, that potential tax liability for conservatism.
If the company had liquidated its digital assets on June 30 at fair market value, it would have triggered a tax liability for approximately $0.5 million. So to bring this all together, we have about $15 million of unused tax loss carryforwards and do not expect to be paying current taxes for the foreseeable future.
Next slide. On this page, we bring it all together. We’ve summarized the revenue and expenses. In 2022, we have arranged the expenses into two categories to assist readers. Operating expenses are one that management can control and can be applied to the revenue. The other category, nonoperating and intangible expenses reflect primarily changes in asset valuation such as impairments and realized gains and losses in selling assets. These expenses are extremely large and create a considerable amount of noise to the operating performance of management.
As such, the net income is very volatile, and the other comprehensive income category in the financial statements makes analysis challenging. And for this reason, we believe that readers would benefit from segregating the expenses between operating and nonoperating. The book value of equity has declined to $1.96 per share, largely due to the decline in Enterprise impacting asset value.
On a positive note, I can conclude by saying that the operating margin was positive $0.3 million year-to-date. This is calculated as our revenue less operating expenses. As a reminder, these numbers have been reviewed by our external auditor, but are not audited.
Next slide. This slide summarizes three implications for investors. Firstly, we are emphasizing that revenue, less operating expenses was positive year-to-date. Compared to an ETF that holds Ether, we do not have the expense drag of an MER. Secondly, there’s no plan to pay a dividend. We will use revenue to build our new operating businesses to be to discuss later.
Thirdly, we have a modest cash balance of $3.8 million. This will be used to fund our operations. Our estimated cash burn through December 31 this year is just another $1 million, but is highly subject to many assumptions. There is no assurance that the cash burn would not exceed this amount materially.
Next slide. On this slide, we summarize our assets. The audience should note that Ether staking rewards balance grows every day. In total, the company owns over 44,500 Ether as of June 30.
Next slide. Our share price has suffered with the decline in Ether price over the quarter. Since June 30, though, the price has increased materially from $1.33 close, and it reached $2.90 on Friday, August 12. The share price is an estimated 20% discount to the underlying equity value per share, assuming we could liquidate the Ether at the prevailing market price. Now this assumption is not totally realistic, given that many of our assets are illiquid, but it does provide a metric for valuation to investors. To emphasize, the share price is very volatile and the increase in price since June 30th is 118% in six weeks.
Next slide. From an investor perspective, we believe there are a few things to consider and we list them on this slide. One, 84% of our assets are Ether. Our valuation is highly correlated to the Ether price. Two, we are not just passive holders of Ether, we can earn a yield. Such yield varies daily and it’s been about 4% this year. After the merger, it is expected that the yield may increase due to the receipt of incremental transaction fees. Three, holding Ether Capital is a better value proposition than holding an Ether ETF, which we will summarize in the next slide. And four, Ether Capital believes that it can economically build some new operating businesses with its cash resources that will increase enterprise value. Such new operating businesses are being assessed internally and have yet to be disclosed to the public. They would take advantage of the current intellectual property and professional networks of the team.
Next slide. This is my final slide, and it provides an easy comparison between owning Ether Capital shares or units in an Ether ETF. In our opinion, it puts four compelling reasons why we believe that Ether Capital is in more appealing investment. Our company can generate revenue and provide a yield on these assets. Our shares have been trading at a discount to the theoretical book value per share. Investors would also have upside to future operating businesses and earnings with the underpinning of a strong un-levered capital base, something that ETFs cannot do.
With that, I’d like to turn it over to Brian.
Brian Mosoff
Thanks for all that color, Ian. I’m going to start by providing some color on the recent events that have taken place in the market and then relate that to what it means for Ether Capital shareholders.
So for some high-level market color, as Ian had mentioned, in the last quarter, we saw many of these centralized businesses become insolvent or mismanaged their balance sheet. There’s four that I’ve mentioned here that may have crossed people’s desks in headlines of news Voyage or Celsius, Block 5 and Three Arrows Capital.
And I think it’s important for people to contextualize that even though they were pretty meaningful failures in the industry. The protocols themselves didn’t have any issues. Ethereum didn’t stop working there might have been excessive selling pressure from some of these companies becoming insolvent. But the protocols themselves were fine and continue to operate as intended.
So for some people who would ask is now a good time to invest or what do you think about these centralized companies becoming insolvent. What does that mean for the space? My answer is that the picks and shovels may have failed, but the assets themselves will be okay and continue on building and developing. So I think that’s a really important message for people to take away from this.
I’d also like to highlight that layer 2 scaling solutions are continuing to roll out technical upgrades, so the ability to transact at a cheaper cost on Ethereum is continuing to ramp up. This is a narrative that has been dominant for the last number of years that Ethereum is too expensive or slow and so people are going to look to competitor networks to facilitate their activity. And I’ve been constantly pushing back saying that there are scaling solutions rolling out around the Ethereum ecosystem that are very meaningful, and we’ve remained focused on why we believe Ethereum will continue to dominate.
Regulation, of course, continues to evolve in this ongoing conversation. And as Ian had mentioned, we’ve seen a fairly significant rebound in price over the last 1.5 months. And we think that a lot of that may be driven by the upcoming Ethereum merge. So Ethereum merge, again, very high level.
Hopefully, people are already familiar with this. Ethereum is undergoing a transition from a proof of work block chain to proof of stake, this is the consensus mechanism. And so instead of people using computing hardware and electricity to validate transactions now they’re going to be able to stake their Ether, so lock up the native token into effectively a bond with the protocol
Ethereum 2.0 rolls out in a number of phases, Phase 0 went live about two years ago. And what is about to happen is this event referred to as the merger, which is expected to take place mid-September, and this is when all of the really exciting activity D5, metaverse, NFTs stable coins, all of that is currently taking place on Ethereum 1.0 and is going to transition over to the new network Ethereum 2.0.
So this is an event referred to as the merge. We believe it’s going to be one of the most important events this year in all of crypto. It’s been years in the making. This middle point is important because you’ll see on the next slide what percentage of the circulating supply is locked into Ethereum 2.0, meaning assets that have already moved from Ethereum 1 on to Ethereum 2. It’s currently at 11%.
And we think that this is going to be really important from a narrative standpoint also for large asset managers and investors who have been sitting on the sidelines who have struggled with the ESG narrative around proof of work mining. We hear a lot about concerns with Bitcoin mining and how energy consumptive it is. And now we’re going to transition to something that is 99%-plus at more energy efficient.
I pulled this out — this is from a website called stakingrewards.com. And I just wanted to put this up here for people to see that at the very top, you see in the staking ratio column towards the right, that as I said, about 11% of the total ETH supply is sitting on Ethereum 2.0. And when you look at alternative proof of stake blockchains, like Solana or Cordano or Polkadot, that’s number six on this list, you see that there is a significantly higher percentage of the total native tokens being stacked.
And so you might be wondering, why is that? Why is there only 11% of all of the Ether staked on Ethereum 2.0. And what insight might that give an investor of what’s about to happen when this merger takes place. So I thought this might be helpful for some people. And again, this came from a website called stakingrewards.com, and it’s constantly being updated so you can go to it at any point in time and see how these numbers are changing.
And so why is the merge an important catalyst? Why are we really excited about it? Well, a lot of people, we believe have not decided to stake their Ether to transition from ETH 1 on to 2 because there was this unknown time of when the merger would take place. As I said, Phase 0 Ethereum 2.0 launched December of 2020, and it was unknown when Phase 1 would go live. So when you would be able to actually get liquidity on your state Ether.
So we think a lot of investors have been sitting on the sidelines waiting for the merge to be announced and to come to fruition before they would like to stake. So in a post-merge world, once this event takes place and it’s successful and is properly technically executed, we expect a lot of people who have been sitting on the sidelines and those could be crypto-native people, they can be institutions to focus their attention on what is the opportunity around taking a long-only view to an asset like Ether and staking it to generate a yield and what this likely will mean is that there’s significantly less circulating supply of regular Ether.
So something that is very exciting in the community.
The third point is right now, there’s two things that contribute to the issuance of new Ether, one is the mining rewards. So mining being the proof-of-work miners currently are roughly extracting about 13,000 new ETH per day. And on the proof of stake blockchain, there’s roughly 1600 yields per day. When the merge takes place, those mining rewards are going to disappear. So, there isn’t going to be that additional 13,000 ETH per day there will just continue to be the 1,600 ETH per day on the prudent stake chain and so there’s roughly a 90% reduction of new issuance of ETH. So again, that may contribute substantially to the upward pressure on the price of ETH. Something that is really exciting and important to pay attention to.
We also think that a lot of people have been concerned over the last while about if the Ethereum community was able to successfully upgrade the network to actually launch proof of stake and just for some quick color, there are other proof-of-stake networks that are around, as I mentioned, Solana and Polkadot, Cardano, but there’s never been a network that started off as proof of work for consensus and then transition to proof of stake, not as what is really technically challenging here is to mid driving on the highway, a car switch its engine from gas to an electric battery and this takes place basically in about a 10 or 12 second period. And also, of course, Ethereum is the biggest blockchain by market cap. So, there’s a lot at stake here.
So, I think that the success of the merge taking place without any technical issue, we’ll put to bed some of the concerns investors have that Ethereum is able to execute on some of its ambitions and that it will be able to continue on its road ap towards a more scalable network that will have cheaper transaction fees, higher throughput and ultimately continue to be the centre of all the really exciting activity that’s taking place in this new asset class.
In terms of the yields, the yield is going to change. We don’t know what it will be, but things that will contribute to that number will be the amount of transaction fees that are taking place per block. So how much activity there is on the network, as well as how many people are staking and that you are splitting the rewards with. So again, we don’t know what these numbers will be. Currently, it’s just above 4%.
But right now, there’s none of the transaction fees going towards that yield because all of the activity is taking place on, if you’re in 1.0 and not Ethereum 2.0, when the merger takes place, those transaction fees will go to the validators. So, we don’t know what it’s going to be, but we are very excited and think it’s a very important inflection point for Ethereum in the community.
So, what does this mean for you capital to shareholders? Why should you be excited as we close off the summer and head into September? Well, hopefully the merge doesn’t get delayed and does take place in the middle of September and that there’s no technical issues and it is a successful transition. We think that this is really as I mention one of the biggest events in crypto of the year, probably the biggest in my view as East Bowl certainly is really exciting for me and everyone in the community.
Also, the current stake Ether rewards, so the yield that we’re generating on the East that we have staked is not liquid. And so at some point, just after the merge, it might be a month, it might be a two months, we will be able to get liquidity on those rewards. And so, it may change how we account for them on our balance sheet. It may mean that we can use a portion of those to invest into our operating businesses and technical team. So that’s an important thing to take note and we are still one of the only access points in the capital markets for these exposure and staking.
And we continue to lead what we believe is really sitting at the forefront of this ecosystem.
Ian had also mentioned the potential for us to stake additional ether. It’s something that I’m very excited for. Everyone on the team is very excited about, but it has to be when we believe it’s appropriate, when we see that the merge has taken place with no issues around the technical execution. So that would allow us to stake more of our ETH currently sitting on the sidelines and generate additional yield.
And then of course, we mentioned that we are currently developing software in-house. We are expanding our technical team. You saw Shayan’s face earlier, our Chief Technology Officer, and we are currently hiring additional developers to build really exciting tooling at that protocol level.
So with that, I’m going to open it up to Q&A because we only have a couple of minutes here, and I’m going to flip it back to Ashley to run through some of the questions that may have come in.
Question-and-Answer Session
A – Ashley Stanhope
Sure. So the first question is, do you think the merge will eventually lead to lower transaction fees and make ETH more useful for everyday transaction?
Brian Mosoff
So I don’t know that the merge specifically creates lower transaction fees. I think ultimately, where this is all going, is that Ethereum at its base layer is going to turn into this very secure, what people refer to as a data availability layer. And cheaper transaction fees for certain activities that may not be able to justify a $0.30 transaction cost or maybe a $2 or $5 transaction cost, is going to look for other places to perform that activity. So that could be a layer two. It could be another network and then use Ethereum’s base layer to kind of record the state that’s very secure of what that account has. So you could think of this like your checking account is on Ethereum at the base layer, but your day-to-day activity when you go about your life and you’re tapping your credit card for all these smaller transactions, maybe that’s not reported individually on those back to the checking account that takes place somewhere else. So I think we will get cheaper transactions. It’s just a question of where those transaction fees go and where it takes place, but the merge certainly moves the narrative forward.
Ashley Stanhope
Okay. Great. And then we have one more question, two parts. How do you see the potential fork of Ethereum proof-of-work playing out? Perhaps you can touch on some of the commentary from leading projects announcing a preference for Proof of Stake? And then the second question is speak to the development of the Web 3 project the company is looking to develop. How far are we from seeing this roll out?
Brian Mosoff
So there is this talk in the community that Proof of Stake is this great idea, but there’s another group that might think it’s important to continue proof-of-work mining, meaning the consensus mechanism that we currently have will continue on and that you’ll have what’s called a fork, a fork meaning that there will be two versions of Ethereum. I can say fairly confidently that no one really in the Ethereum community is in favor of Ethereum proof-of-work. This is something being pushed by Bitcoin community, by the mining businesses that are incentivized to make sure that their hardware continues to generate revenue for them.
So we may see a fork, but I think that most — or pretty much all of the important applications and activity will follow the Proof-of-Stake chain. We don’t know how it’s going to play out. It’s a rapidly evolving story, if this is just what’s called FUD fear, uncertainty and doubt or this actually will take place and maybe it’s a couple of weeks until we see a proof-of-work fork disappear. There’s really no way to know, but it’s certainly a really interesting narrative to be following.
In terms of some of the developments of the company and things that we see as opportunities for us to develop these businesses. We’ve said in the past, we’re not interested in specific applications in niche verticals. So we’re excited by DeFi and the metaverse and NFTs, but we think that there’s a lot of infrastructure to be built around the protocol level.
So just basic things like custody, and staking, and reporting things that are core to a thesis we have around, what is going to take place in the next five years? Will we see more financial institutions participate in this space? Where we see larger capital allocations from single individuals or entities? Absolutely.
And we sit around and think about, what is it going to look like, or what tools are going to be needed for that to be a reality? These are problems that as one of the few public companies focused on Ethereum and staking and having to take on these accounting obligations, because of our structure, we’ve had to tackle a lot of these pain points.
And we think that we can be very useful in helping solve those same issues for other entities. So we haven’t announced specific business lines yet or specific tools that our tech team is developing, but we hope to share that with the market soon. But again, we are going to focus on the protocol level core infrastructure, not specific verticals.
Ashley Stanhope
Okay. I think that’s all of the questions. I think we’re probably good to wrap-up. Thank you, everyone, for coming out today. And we’ll post this video on our website and our YouTube channel that you can replay, at a later time. Have a great day.
Brian Mosoff
Bye, everyone. Thank you for joining.
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