4 x 4 Virtual Salon – Crypto in the post-FTX era

with Seamus Donoghue, Julian Sawyer, Mike Higgins, and Simon Taylor.

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This edition of the  4 x 4 Virtual Salon is focused on the future of crypto custody post-FTX.  Ben Robinson [aperture] hosted a lively panel discussion featuring 4 speakers: 


Main topics discussed:

1. Decentralization or Better Centralization?
2. Crypto failures and regulatory initiatives
3. Digital Assets: Coins, Regulated Securities or Non-regulated tokens?
4. The building opportunities that crypto winters bring

We ran 4 polls and we take questions from the audience. Watch the recording below:


4 X4 Virtual Salon – Crypto In The Post-FTX Era

Full transcript:


[00:00:11] Ben: Hi everybody, and welcome to our latest 4×4 virtual salon, where we’re going to be discussing crypto in the post-FTX era. For those of you who are new to the virtual salon format, or as a reminder, let me explain what we try to do in one hour, which is that we try to explore four different topics. We attempt to take four audience questions, we hold four polls, and we do that together with our four speakers who I’m going to introduce right now.

First of all, we have Seamus Donoghue, who is Chief Growth Officer at METACO. METACO provides core infrastructure for banks and other institutions to thrive in the digital asset economy. Seamus has over three decades of banking capital markets experience, and in his role at METACO he’s responsible for driving non-linear growth.

Next, we have Julian Sawyer, who is CEO of Zodia custody, an institutional cryptocurrency custodian backed by Standard Chartered and Northern Trust. Julian was previously CEO of Global Cryptocurrency Exchange BitStamp, and was also co-founder of  Sterling Bank.

Next, we have Mike Higgins. Mike is partner and Global Head of Business Development at Hidden Road. Hidden Road is a technology driven prime brokerage clearing and financing across traditional and digital assets. Mike has 20 years of experience in electronic trading, multi-asset class, and a bulk of that was in FX.

Last, but definitely not least, we have Simon Taylor, who is Head of Content and Strategy at Sardine, an API platform providing compliance and instant settlement to the crypto and DeFi wallet industry. Co-founder of 11Fs, an author of the excellent weekly Fintech Brain Food newsletter, Simon will be well known to many of you and is a very influential person in the world of FinTech.

We’re going to move us on now to the first of our four topics, which is around decentralization or better centralization. Seamus, I’m going to come to you first please. Seamus, where are institutions headed towards when it comes to deciding their custody strategy? Is it self-study, or is it using custodians?

[00:02:41] Seamus: It’s an interesting question and I think there’s a couple ways to answer. I think historically there’s been a lot of themes in the market. Obviously not your keys, not your coins, is a common theme in the market at individual level. I think for the past few years, even at the institutional level, we’ve seen everybody really focus on self custody.

Maybe they start with sub-custody as a easy go to market, but typically the plan has been eventually all want to do self custody. Now I think that that’s evolving now. The whole digital asset space is maturing. It’s no longer an experiment about, hey, we need to do cryptocurrency on-ramps, off-ramps. This is the end game. Our clients are asking for it, we want to do that. I think what we’ve seen the last couple years is, at an institutional level, there’s an acknowledgement that blockchain’s here to stay and that technology’s potentially transformational. Looking at things like DeFi, you can really think longer term how they can reinvent their intermediation they do.

I’ll quote Simon, DeFi protocols operate 24/7, 365 at zero marginal cost. I think that’s pretty profound when the banks look at their own technology stack, which is not that. I think the technology itself is becoming transformational as far as the banks are thinking.

What we’re seeing now is basically the market is becoming a bit more nuanced, particularly last year we had a lot of events whether there was 3AC, Celsius, FTX, and it’s clear that not everybody should be doing self custody, particularly the buy side. I think the buy side’s done it for a lack of choice. There hasn’t really been the large traditional custodians in this market. Those traditional custodians are now building I think LPs to all the asset managements side of the business, they will not tolerate their investment managers also doing self custody. We see what went wrong with Ameta, for example. You need segregation there.

What you’re going to see basically is you’re going to segregate the market about self custody and those that view custody as strategic to their business. Others, they’ll be more focused on the use case and custody as a way to get there.

What we’re seeing now is the, particularly we work primarily with like the large tier one banks, those that are traditional custodians are building foundational infrastructure on this. That is really them building direct custody infrastructure, self custody infrastructure. But even there the space is becoming increasingly regulated. It’s a nuanced answer from that perspective, because dealing with the Tradify space, they do both. Where they have a license, they’ll do self custodying; where they don’t have a license, they do sub custody. Even those that are strategic custodians will have some notion of working with both self custodys and sub custody to leverage licenses that they don’t have themselves.

But I think the broader markets that are really looking at let’s say a particular use case, will consume custody from these large custodians as they go to market. When a city goes to market, one provides some bankruptcy remote assurances around the custody. They have balance sheet, they’re regulated, they can provide the leverage that the clients are looking for, that asset managers are looking for. I think ultimately, we’ll see many of let’s say the buy side and those that don’t view custody as strategic, move to them as a sub custodian.

It’s a slightly nuanced answer. The strategic will do both self custodys and sub custody, but I think there’ll be a much more consumption of sub custody and more focused on the use case going forward. That’ll be their USP opposed to doing self custody themselves.

[00:05:56] Ben: Great. Thank you very much, Seamus.

I just want to say that we’ve opened the polls, if people want to vote. The first poll is about where people think this is headed. I think Seamus has given us already a pretty good insight into where he thinks the market’s headed when it comes to custody.

Julian, just a question for you then. Clearly listening to Shamus there is a big role for established custodians. What do you think their role is in terms of restoring trust and offering superior service relative to centralized exchanges, decentralized exchanges, or self custody wallets?

[00:06:28] Julian: I agree with what Seamus has said. I think there’s there is a role for third party custodians and there’s a role for self custody, and there’s a whole range of decisions you need to make to determine which is the right one. That really mirrors the ecosystem that is changing post FTX, where prior we had everybody doing integrated everything being in one bucket, and now we are seeing much more segregation. Mike’s here from Hidden Road, a prime brokerage, doesn’t want to do custody. We are a custodian, we don’t want to compete against that marketplace. That is super important.

In terms of trust, trust comes from a whole range of different attributes. Key management is one, but that’s actually quite a small part of the overall role of a custodian. Regulation, capital, governance, risk, compliance – all these things that actually add to a complete picture that enables you to have trust within your custodian. What is interesting now is that clients and people in the market are asking the right set of questions about what are the controls, what is the governance, who owns you, how are you working, what markets are you regulated in? I think that becomes super important.

Some very bright people have quoted how to build trust and how to destroy trust really quickly, it is not an overnight activity. But as Seamus said, I think you are going to get some of the traditional custodians coming into the market. As you said at intro, we are owned by Standard Chartered and Northern Trust. They felt it was better to do it outside of the bank, but owned by the bank. That becomes super interesting, I think, from a way to market and a speed to deliver within a dynamic industry. But I think in the future, you are going to see a number of bank-backed, or bank-owned custodians who are offering their services a across this marketplace.

[00:08:28] Ben: Fantastic. Simon, I’m coming to you next. What Julian’s been saying is about trust, it’s about regulation. Also, one of the themes he was saying there, which I think is really interesting is about specialization. Where do decentralized exchanges fit in this new world where we have increasing specialization? What’s the positives, the advocate I guess for decentralized exchanges?

[00:08:52] Simon: Decentralized exchanges are really decentralized market structure, and the decentralized middle and back office that provides an element of automation. One of the areas that’s possibly most interesting is the automated market makers. That’s what often people refer to as Dexus. UniSwap is a classic example. There are many, many others.

Now, these have got upsides and they’ve got downsides. The downside is, it’s not obvious how you make that compatible with existing compliance and regulation. But the upside is, there’s definite automation benefits. The middle and back office is straight through processing, no matter how many counterparties there are in a given transaction. That is an order of magnitude improvement on current, middle and back office processes. I think that’s why institutions like Northern Trust and Standard Charleston are looking at this area and saying, this is interesting, we should do it.

Having a specialist is going to be super worthwhile because that infrastructure is lightning fast, much, much cheaper, much, much more automated. But now I need to figure out how I make that comply. It would be really great if there was a specialist that could just go figure that out for me. That’s what custodians are starting to play the role of. I think if you look back and talk to a lot of brokers, historically there was a frustration with the inertia of custodians, but I think they got a bad rap honestly. They were dealing with the complexity of financial market structure that is like an onion. The thing makes you want to cry and it’s full of layers. Just horrific financial, it’s maze the existing financial market structure. To be able to automate that would be huge. But let’s not kid ourselves, this is at the cutting edge of both compliance and automation tech, and it’s still not really clear how you make all of it comply all of the time. It’s the cutting edge of cryptography as well.

There are emerging regulations in Europe, like MiCa. We’ll see similar things like that appear in the US. We’ll start to see as well projects from the Bank of International Settlements, like project Mariana, are very worth looking at if your audience hasn’t. This is the Bank Of International Settlements investigating how they could use automated market makers, aka decentralized exchanges, for cross-border transactions. Whilst there is a lot of talk about DeFi bad, there’s an understanding that the infrastructure, the technology that’s running out there and open source in the public domain, has value for financial markets. I think it would be silly to throw the baby out with the bath water on this one. Really, really go look at the infrastructure, but consider how you make it comply because that ultimately is your responsibility.

[00:11:51] Ben: Fantastic. Thank you, Simon. I really like the onion analogy there. Can I borrow that, if that’s alright? Mike, coming to you to get your viewpoint as a prime brokerage, do you think institutional investors will require hybrid custody solutions, i.e. sub custody and multiple custodians? If yes, how can that be offered both technically and operationally?

[00:12:14] Mike: I think my colleagues touched upon a bunch of it already, but I think the short answer, Ben, is yes in some cases. The question really boils down to the type of investors in the market. Unlevered investors have a greater need for custody, similar like in Tradify where the investors’ assets are not used for leverage. This implies that assets can sit in storage, meaning sit at the custodians. But for those types of clients, there’s a high dependency on solid, reliable custodians, which we’re certainly starting to see. As the guys mentioned already, you’re starting to see that emerge with some banks behind it as well.

However, the opposite is true for levered investors. Levered investors typically gain leverage by pledging and title transferring their assets. In this case, what’s more critical is the credit worthiness of the counterparty, and less so of the custodian. It really depends on how the market develops and breakdown of the investors. Till now, frankly, leverage investors have been far more active than unlevered investors. This has been demonstrated by some of the product that the clients are trading.

Just one quick comment on specialists, I think going forward we’re likely to see a series of service providers to help the market function. One of the first things we need to do is separate the function of trading from the function of asset holding and collateralization. By doing that, it’ll lead to best practices across both of those disciplines. That separation of church and state I think is where we end up. You’ll end up with custodians holding assets, exchanges running matching engines and providing matching services, market makers there to efficiently transfer risk, prime brokers or third-party leverage providers to make a capital and cost-efficient way for folks to access the market.

[00:13:57] Ben: Perfect. What all of you said nicely, tell us with the poll, I don’t know if our speakers can see the results here? But the clear consensus is around the institution regulated, crypto custody solutions will be the most popular choice going forward. Which I think very much agrees with what you guys have said so far.

Exactly at the quarter past mark, we’re moving onto our second topic. I just remind our audience that they can post questions and I will put those questions to our speakers here as soon as they come in. The next topic is around crypto failures and the regulatory response. Julian, coming to you first. Do institutional investors feel the pressure from the new regulatory announcements coming up, particularly in the US, around custody? What steps are they taking to comply, and can they realistically comply with everything that’s coming through from regulators?

[00:14:54] Julian: How long do you want me to talk on this topic? We can spend the next 45 going? Look, if you look at the various markets, the EU has got some great attraction with MiCa coming and some greater clarity in the regulatory roadmap. I think all of us would agree. We need to have that certainty, that roadmap for us to invest and for the market to develop. We’ve got in the UK HMT doing a consultation at the moment about a whole range of things, including custody, and I think that is really important. But some of the language and direction of travel is where we would expect that crypto custody is treated very similar to other asset classes, which it should be.

The US has got probably two or three different lenses going on at the moment. One is, who owns the regulatory activity of crypto? Some of that is political, some of that is regulators trying to work out who owns this, whether that is the CFTC, the SEC, the New York DFS, the Fed, all of the above, and probably one or two others which I’ve missed. Until we actually understand who is the regulator, it’s really difficult to understand whether the noises that they’re making and some of the actions that potentially, or particularly the SEC are taking, is actually the right direction of travel for custody.

Actually, what you end up doing is having this risk that what we’d call US clients are not operating on US property. They are out in Cayman or they’re in EU, UK, et cetera. I think that would be bad for the global industry because I think what we should be trying to get to is alignment, not equalization but alignment between the major markets: Singapore, US, EU, UK, and others.

What does that really mean?

I think it means that people are having more of a watch-and-see. talking to people in the market, some of the traditional custodians in the US markets are like, we don’t know. We can’t make the bet. We haven’t got enough information. We don’t know who to talk to, and we don’t know how to talk to them because we don’t know what the questions they’re asking. Which I think will then mean that that market is slower in evolving than perhaps what we’re going to be able to get in the UK and Europe.

I think people are looking at this deeply and trying to work out what to do. What is also becoming clearer is the integrated service providers who are doing custody and exchange, are going to have a real challenge in their business model, and how does that manifest itself in the future? Does a Coinbase, to pick an example, have to split up it’s trading activities from its custody? We can understand the turmoil that that is going to create for them and the market overall.

[00:17:52] Ben: Thank you. Seamus, coming to you next. What do you think are some of the key regulatory complexities for institutions that want to self custody?

[00:18:02] Seamus: Well, I would answer that to start with, echoing what Julian said, I think the biggest regulatory complexity is having a regulatory framework. I think with markets like the US where it’s very ambiguous what the requirements are, it’s a tougher go to market. Now the walls are going up, the hurdles are going up, depending on which regulator you’re engaging with. They all seem to be working, collaborating on making the go-to-market very complex, if not full stop at the moment. Whereas other markets like Germany where we have BaFin, it had been out front with a clear regulatory framework, taxonomy around the asset, the asset classes, and a licensing regime. We’ve announced two German banks have gone to market at the start of this year. I think markets like Switzerland, Singapore, similar story where they’ve really had a very clear process.

But regardless whether there’s a clear regulatory regime or not, I think narrative and how you engage with the regulators matters. I think the key point going to a regulator is, and I think this happens in many jurisdictions, crypto and digital assets is still treated a little bit like a science experiment. It’s gone through the new product approval process and we’ve approved internally, and that’s how it’s pitched to regulators in some instances. The banks have had some pushback there that that’s a nice start, but the key focus is really identifying what new risks does this asset class introduce to the bank, and how are they addressing that? Things like effectively you’re talking about an asset that’s potentially bearer. The keys are compromised, the assets going. How are you addressing that? What are there single points of failure in your control processes? Are there administrators that basically can compromise systems? Who can collude to create effectively catastrophic losses?

There’s some very basic questions that need to be answered. Then I think once you’ve identified those new risks, you need to also make sure that this new asset class is integrated into existing controls and governance programs. It really should not be managed as an exception basis, a separate asset class or process altogether. Things like vendor risk, if you’re working with a third-party vendor providing infrastructure. Has it gone through an internal governance review, which is consistently third party risk management? Often, it’s not, it’s in an innovation department. These are things that to accelerate the, let’s say the regulatory licensing or regulatory approval, you need to change the narrative that this is not something off to the side, but it’s integrated into all your co core processes, whether it’s key management that’s conforming with all your internal NIST requirements, which are effectively the international standards for managing keys and keys backup. It’s really important that there’s no ad hoc approach, that the programmatic controls are fully integrated.

The banks that have been successful where they go to market really have the approach where they identify the key risks and basically their existing asset classes are also fully integrated into all their existing risk processes as well.

[00:20:58] Ben: Thank you very much, Seamus. Simon, I don’t think you guys can see the results of the poll, but you see the questions. But here on the second one, we were asking people effectively what they think the regulatory framework should look like. , the consensus is that it should be light touch and it should be tailored from scratch to fit the needs of the decentralized nature of this market.

I’m going to ask you, this is a difficult question, how you think regulators are doing. Do you think they’re doing good job in terms of creating something that’s tailored to digital assets?

[00:21:33] Simon: Let me preface my answer with, the job of a regulator is actually really, really hard. Let’s be fair to them. They’re outnumbered by financial markets, they’re underpaid, they’re understaffed, they have horrible tools, and they’re given a very hard job and they’re hated by everybody no matter what they do. Let me start by saying that. Also, the regulator’s job is also set by government. They have a perimeter in which they can operate and they have tools that they’re allowed to use. Those tools and that perimeter is not always optimal to what they want to achieve, but it’s all they can do. We saw this, one of the mixes was added to the OFAC list, Tornado Cash, and suddenly we saw all of the unintended consequences of adding decentralized infrastructure to a list of wallets and an OFAC list that wasn’t really designed and wasn’t created. That perimeter and setup wasn’t set up, this infrastructure didn’t exist when that was set up.

There’s a lot of regulators trying to use tools for a context that doesn’t exist anymore. For that reason, I think there’s a lot of enforcing existing rules onto this new technology that are wildly suboptimal. In fact, if anything, they’re actually harmful to risk prevention. They’re harmful to efficient, fair, and transparent markets. They’re reinforcing some of the things we didn’t like about the old system.

We’re not getting light touch regulation. We’re getting the same old regulation, but they’ve no choice. How do you push back against that? I think you have to make the case for what’s new about this technology that is actually better, that’s an upgrade. I think this is the best technology that’s ever, frankly. Decentralized infrastructure is natively a golden source of records of transactions. Everybody has reconciled by default. There are no reconciliation errors, there are no issues of trying to find that piece of paper that happened somewhere in a filing cabinet, because it’s all digital. A lot of that investigative work that compliance departments have to do, and regulators and law enforcement have to do, is done for you. This is why law enforcement has been so incredibly effective at popping dart markets and identifying hacks in crypto. The reason you see so many headlines about those law enforcement actions is because it’s like fish in a barrel, and law enforcement gets to look good. It’s created a negative reputation because it’s really useful for law enforcement, which is so ironic, which creates a political problem. Because now it always looks bad, so we’ve got to kick it harder. When actually we need to reverse the narrative. Let’s lean into what the technology’s actually capable of.

I’m going to declare an interest, I founded an organization called Global Digital Finance. That is everybody from Standard Chartered to the DTCC, ELSEG, METACO, and many other organizations, but also Coinbase and DeFi projects like MiCa; coming together to say there is new opportunities to be better at managing risk. We produced codes of conduct for how you manage the new risks as well as the standing risks. Seamus made some great points. You should follow all of your processes to make sure that you have been thorough and diligent in how you have managed all of your vendors and how you’ve created your new products. But you have to recognize that this new technology presents both new risks and new opportunities to be more effective at compliance. Lean into that. That’s hard because the default is, well, I just need to get it live, the process is really hard, it’s the budget cycle, that person’s just changed it.

I know there’s a lot going on, but if you want an order of magnitude cost reduction, then I think the price is worth it.

[00:25:37] Ben: Fantastic. We’re getting a lot of questions here from the audience. I’m going to start with the first one here, which is from somebody called Alexander. Julian, I’m going to put this to you first of all. I don’t know if you can read it too, but it says, the traditional notion of custody in terms of holding an asset always struck me as odd when it comes to DLT. After all, custodians are not holding an asset where they also have a legally enforceable right to ownership. Instead, they hold a key to a public store, which determines ownership. How do you think this fundamental difference to traditional assets will be reflected in the market?

[00:26:08] Julian: There’s a lot of technicalities in that question, so I’m very happy to take offline if you want to go down any more detail. But some of this is about how you construct the custodian legal agreement. For instance, for us we don’t have Omnis accounts, we have segregated accounts. We have your assets in a trust, so we don’t actually own that. We also ensure that we have CAS rules in place. There are things that you can do with using existing legal structures under English law as an example, that enables you to ensure that you have got that right to that asset. In terms of bankruptcy, then you have that protection.

One of the things that we have seen in the industry in the last three or four months post FTX is the off exchange model, which we’ve got our product interchange and there’s other ones out there, which essentially means that you’re not pre-funding into an exchange in a venue, you’re keeping it with us. If one of the parties, either the trading party or the venue collapses, then we have complete understanding of the bankruptcy and liquidation processes.

I think this is about a maturity of using existing legal structures and best practice to deliver what we need in the end state.

[00:27:28] Ben: Thank you so much. Perfect. I’ll just take one other from the audience and then we’ll move on to the next section. Mike, I’m going to come to you for this one. What are some of the immediate measures that you’ve seen in financial institutions or custodians to prevent another FTX like event? Can I also put to another question which we have, which is, what do you think things like proof of reserves, audits, or proof of assets and liabilities would also make a big difference?

[00:27:51] Mike: I think some of the immediate measures that are coming in in place is that, again, going back to separating the function of trading from the function of asset holding and collateralization, and removing that vertical setup and horizontal, that’s going to require the industry to come together and have different parts of the ecosystem function. We are seeing some movements there where there’s tri-party solutions to hold assets off of the exchange and then reflected there from a credit perspective.

But just taking a step back then, when we first started in the digital space we were calling out two issues. One, there was credit risk in the system that wasn’t being valued or priced. The second again was that challenge around the vertical integration, the notion that the exchanges is running a marketplace while custodying the assets of the users. In certain instances, again, like running an internal market maker is mind boggling and certainly a conflict of interest.

We’re supporters really of educated regulation as well as counterparties educating themselves. They need to have a better understanding of the entities, the legal and operational structure of the entities they’re interacting with. The amount of times we hear people running around saying they’re a prime broker or they’re a custodian when legally and operationally they’re not set up that way, is frankly concerning. The faster that as an industry we can build that customer protection, again, I go back to the separation of church and state and financial transparency, the faster this repricing in the market will come in play.

Really just two quick lessons that we learned from last year. One, a large portion of the crypto market was based on unsecured lending, meaning no assets provided by the borrower. There’s a whole host of reasons that that existed. However, in TradeFi, unsecured lending to investor pool is almost unheard of. It’s very, very rare. Take to the treasury market, repo and reverse repo, it’s secured amongst the banks in the largest asset managers. Most of the unsecured lenders are either eliminated in this space, like the Block Five, the Voy Joseph, the Celsius, the Genesis of the world. But you could argue that the market’s already dealt with that problem and done it pretty harshly. But it’s unlikely that we’re going to see that unsecured lending again.

The second lesson is really around transparency. The lack of good accounting and financial disclosures among some of the biggest players was and is a major deficiency in the market. So requiring standardized and regular financial disclosures is an area where hopefully regulators will help. We need to do that as well.

[00:30:20] Ben: Fantastic. We’ve had a question from somebody called Cheryl, which I’m going to ask you to take in the last section. In the view of the time, I want to move us onto to section three, which is about how the demand for different types of digital assets is changing in light of FTX.

I’m going to come to you first, Simon. Has demand for cryptocurrencies or stablecoins gone down since the FTX downfall, and what can be done to boost adoption further?

[00:30:50] Simon: Yes. It’s gone down. The wonderful thing about crypto is you can go check all of the trading volumes out. It’s all public domain information. All of that exists. If you’re not big users of Dune Analytics and all of the many services out there, wonderful products like Nassari and other research platforms are just great ways to see that, yes, volume is down, activity is down, price is down. If that macro, is that credibility? It’s all of the above. It’s absolutely the case.

I think the more interesting question is what do we do to prevent this happening again? I think a lot of it is, frankly, if you remember the CEO of FTX had gotten into a position of being interviewed by Bloomberg and Reuters, and was really playing that game exceptionally well. Sometimes you can fake it till you make it, and you can fake credibility, and everybody loves a success story and everybody loves a winner. But underneath that, the picture appears a lot more complicated. This certainly appeared to be a phenomenal technology platform. Ask anybody who used it, and I think that’s what brought them the credibility. The tech was actually astonishing. We we should learn the positives from that. That might sound like a controversial thing to say, but why did traders love it? Why did it attract so much capital? It didn’t hurt that they had their own market maker, and it didn’t hurt that it looked like that market maker was doing some interesting things to hide its problems.

But if you even take that out, traders would still tell you it wasn’t just that. It was that it was really fast, it was really efficient. It wasn’t just how they manage collateral, it wasn’t just the unfair advantage. It was a good product. Let’s learn that lesson and separate that out, because I think that opportunity still exists to build incredible market infrastructure that works. I think we should. We should absolutely focus on that as the North star, because that is a rising tide for everybody if we keep that focus and take that lesson.

What can be done to prevent it? I think we’re already taking a lot of those steps. Frankly good diligent separation of concerns would be a really nice idea. I want to see us push the boundaries in terms of what on chain audits look like and what the technology can. Hiring an audit firm appears to be what everybody is crying out for, but FTX was audited and it wasn’t like the same auditors that Tether uses. There were decent auditors in there.

What we need is to recognize that part of the reason the problem was obfuscated is that they’d created a token, FTT, that looked like this wonderful little loyalty token that you got for using and trading the platform, but they were actually able to use that to obfuscate a relationship between Alameda and the FTX itself. How do you manage. Well, there’s probably going to be lots of things. On chain proofs are going to be really helpful, proof of solvency is going to be really helpful.

But you have a commercial issue there. If everybody has to declare their positions on chain in a public and open domain way, everybody’s going to know my trades. That’s no good. What happened to commercial privilege? What happened to confidentiality? What happened to privacy?

Balancing those two is going to be really important. I think that is Reg Tech’s supervisory tech, and it’s one of the things that I’m certainly spending a lot of time with from a GDF capacity under Sardine capacity, looking into how can we start to ensure that we’re using the best of on chain and off chain data in a way that is privacy and commercial confidentially preserving, that gives us adequate proofs that this is true at a state in time and can be ordered if there are any questions about it? I think if we know what questions we need to ask, which I think we do, then we can design that system. That’s one of the things that the digital custody working group at GDF is focusing on quite heavily. It’s one of the areas that I’m speaking to regulators out on a regular basis off, and I’d love to see standards emerge. I’d love to see us as an industry say, this is how we balance privacy, but this is how we meaningfully upgrade audit for the digital age.

What does audit 2.0 look like? Because I think that would mean that it will become near impossible for an FTX to occur, because regulators would have a dashboard, the compliance teams would have a dashboard. One of the biggest issues with FTX is most of the compliance people had no idea what was going on. By the looks of the evidence given by the new CEO who’s taken over the ftx, there was only two or three people that had the, this privileged information about the relationship between Alameda and Nord. The internal compliance controls probably looked absolutely fine to most people. We need this to not be possible, to prevent against internal fraud, to prevent against external fraud, but we need to do so in a way that preserves commercial confidentiality.

[00:36:14] Ben: Perfect. we’ve had a great question from Vene here, which I’m going to come back to at the end cuz he invites everybody, all the panelists, to share what they think is the most promising use case now and in the future.

But before we get there, I just want to ask a bit more about the different stakeholders in this market. Seamus, can I come to you next? METACO, as you’ve said, primarily works with large financial institutions, large banks. What are they doing? Are they still ‘touching’ crypto, or are they more interested in market infrastructure around securitization and tokenization? How are big banks acting in response to FTX?

[00:36:54] Seamus: I don’t think FTX has really impacted what they think so much. I think the last 10 years we’ve seen hyper pace of innovation in the crypto space. As I said earlier, I think the banks in the last couple years have recognized the technology’s not going away, it’s something they’re going to embrace.

From a crypto perspective, whether they get involved in a crypto or not, I think the reality for a large bank is it’s a tiny asset class still. Its peak was 3 trillion, you’re hovering either side of a trillion now. I think the way they’re looking at this is from that perspective, it’s not going to have a huge impact on their bottom line, whatever they do in a trillion-dollar asset class. But I think they are, as I was saying earlier, thinking of this as a much more transformational. I would say the last five years, last six years, even the last decade, the hot thing next year has always been tokenization will be taking off. Obviously it hasn’t happened yet. But I think now we have the largest institutions, I think their focus really on investing in that space. If they do crypto, that’s great. If they ever go to market there, they can start there. They can learn about all the risks issues, all the operational process, all the compliance process around this new asset class called Bitcoin, Ethereum, et cetera.

But I think they’re looking at a bigger opportunity. I think that opportunity, and we hear this more and more from some of our largest clients, that’s public, I have a podcast and I interviewed HSBC, they said at some point they view all assets will sit on chain. Now, if you think about that, you’re talking about a thousand trillion plus opportunity. Traditional capital markets are somewhere either side of 700 trillion, you’ve got fiat currency 40 to 50 trillion, 10 trillion in private assets, real estate’s somewhere around 300 trillion. If all assets, that’s how they’re starting to frame the opportunity.

They need technology with that end state. Now, the pace of tokenization of which asset starts first, that’s still to come. But I think we see the largest firms investing without eventuality. They’ve got a legacy technology stack that’s 20 to 40 years old, built on cobalt, running on mainframes, and anybody that knows how to support that is dead. It’s really about can they tweak that infrastructure? They don’t want to touch it because it works. What’s the next generation technology? That’s where they’re investing right now.

Indeed, I think dependent on the jurisdiction talking earlier, if there’s a regulatory regime, they may start with crypto. But given the size, that’s not where they view the longer term opportunity. They really view an opportunity to start tokenizing assets. You’ve got some of the largest firms now announcing they’re getting this space. I think it is the opportunity in the next 5 to 10 years. That’s really where we’re going.

[00:39:30] Ben: That’s cool. Julian, coming to you next. I want to maybe delve in on what institutional investors are doing and whether they’re still investing in a broad range of crypto coins or whether they are only their reputable ones, and whether there’s any geographical trends that you can point to.

[00:39:50] Julian: I just want to go back to what Seamus said, because I think it is spot on. There’s some people who want to go into crypto, and they are looking at this as a multi-year investment. A bump in the road like FTX, while terrible for everybody who was impacted, is a bump in the road and look back at it such, I imagine. But there’s a lot of institutions who are saying, what’s the tokenization? What do we do? How do we do it? What is it? What are the risks? What are the controls? What’s the technology we require? A lot of those answers are: well, if you do crypto, if you understand crypto, and that could be Bitcoin but it could be stablecoin, it doesn’t have to be the volatility of some of those assets; you’ll start to learn some of the complexities, some of the right questions to ask, and the risks and opportunities that Simon mentioned earlier.  

I think we’re seeing people saying, oh, tokenization, great. Then they go back to crypto to understand what are the systems and processes, as I’ve just said.

In terms of coins, it is super interesting that in a bull market, particularly on the retail side, you’ve got to be listing 2, 3, 4, 5, 600 coins and more. I think the last piece of data I saw was like, there’s 27,000 coins out there, which is just crazy. I think for us and for our institutional clients, it is about getting to the right range of assets.

We’ve just actually launched 38 coins coverage and supported at Zodia. We’re not going to go to 100. That’s a long way away. But we need to have enough in terms of what clients want to be able to help their assets. But without a doubt, our main focus and our client’s main focus is on Ethereum and Bitcoin, and may dabble or play with one or two others, or five or six others. But I think it is interesting that the clients that would come to us as a regulated, bank-backed, will be the ones who are more mature in their thinking and more mature about this asset class and the tokens. The ones that want to go to the 100th, 200th, 300th token is probably not a client that we would want to onboard or could onboard from a risk profile perspective.

We see a pure institution of crypto native world, and it’s very dominated by the two market leaders.

[00:42:12] Ben: Fantastic. Mike, a question for you then about the buy side how the buy side is engaging with crypto and digital assets.

[00:42:20] Mike: A couple of comments back earlier, I think Simon mentioned it, and I think one of the things we need to do as an industry is stop idolizing folks that have strong influencer presence. The community needs to come together and be more proactive in calling out those bad actors. That happens all the time in other industries, like in sports and Hollywood, where they frankly outcast the bad characters.

But to your question, Ben, around buy side and different trading strategies, we see a whole host of different strategies in the market that are active now. That ability to just run across platform has become hyper-competitive. This market similarly, like foreign exchange, is highly fragmented. You need to be able to access that whole ecosystem. I think like in Tradify, you need third party capital to enter the market. Credit providers or prime brokers like Hidden Road are experts in counterparty credit risk, managing liquidity, pricing, term liquidity, and setting appropriate limits. Leveraging PBs for capital efficiencies coupled with the largest trading firms that are now entering the space with real alpha, I certainly think we’re going to see more competition.

We are starting to see more of those startup type guys come in from the buy side. As the market matures and becomes more efficient, you’ll be able to run in a more efficient trading strategies.

[00:43:36] Ben: Fantastic. I wanted to come back to Vene’s question. Vene asks, it would be interesting to understand what digital asset use cases each panellist believes holds most promised now and in the future. I’m going to come to each of you in turn. Can you see the results in the poll now? I don’t know if you also want to work that in as well, because it seems like most people listening in think that the best use cases is tokenized regulated securities.

Who should o pick first? Seamus, you want to go first?

[00:44:06] Seamus: Sure. I think it’s tough to pick one because I think there’s a lot of different initiatives as we see our clients and folks in different areas. But if I focus on one that’s public in the market that I think is particularly exciting, is what JP Morgan’s doing with the JP Morgan coin.

You can think about the bank, and they’ve described it to me in this context as well, they’re connected to all the existing payment rails in most global markets. That’s effectively a layer one where you have real payments, real physical payments. What they’ve built on top of that is a layer two. That’s effectively the JP Morgan coin, which can be transferred instantly 24/7, 365, effectively with no friction.

You have this global clearing coin. Previously in another company we were pushing this idea of corporate coin. If you’re a large multinational, you could have a clearing coin that nets all your internal flows and you really just go ahead in the real market to pay coins. I think this is may transact actual real payments. This is what JP Morgan’s created. You can go to a large global cash intensive business, which has a lot of internal transfers across multinationals, and provide them a lot of treasury efficiencies with this type of coin.

That use case to me is one that I think has a lot of applications to a lot of corporate clients, and to me is a very exciting pathway. I think they’ve got clients demonstrate that there’s demand for it as well, or at least clients are learning why and they’re starting embrace it.

[00:45:35] Ben: Fantastic. Julian?

[00:45:37] Julian: I think there’s really two things. One is tokenization, and I think we’ve touched on that. Stable coins have a way of transforming a number of broken industries, whether that’s cross payment, remittances for consumers, supply chain finance, et cetera. I think that is going to be super important.

But I guess in my mind, wouldn’t it be great if we didn’t talk about this? We just talked about how we helped companies, people, individuals, consumers, governments, charities, in doing stuff. We don’t tend to have a lot of conferences about SWIFT and the inner workings of that. We don’t need to, we just need to know how we can move money. I think that becomes a really interesting point, where in, hopefully in a few years time, we’ll stop talking about what is the blockchain, what is the coins we’re using, and talking about use cases that are helping people, and evolve to those killer use cases.

Fr me, more of the near term I think is stable coins, we’re going to see more of that. I think when it becomes more regulated, I think that becomes super important. Then tokenization in the middle term.

[00:46:45] Ben: Mike, anything you’d like to add?

[00:46:45] Mike: I’ll take it from a different lens, but I do agree with Seamus and Julian around the many use cases that JP Morgan coin will allow markets to operate certainly more efficient. But I’ll do a different one from the DeFi side of it.

Our view is that DeFi on the institutional side will end up with these permission pools. There’s a use case that I’ll describe in a second. But currently there’s a few challenges in that space. Anonymity is something that’s attractive, but doesn’t really work for institutions because it trips across that AML and KYC stuff. The other part of the challenge is there’s a lack of intermediation there. It’s fully funded and there’s no intermediaries to prop up the leverage. But again, I think the future of DeFi and some use cases there is we need to build this institutional grade infrastructure.

Going forward, Ben, I think we’re going to see a bifurcation in the DeFi side of it. On the retail side, there’ll be these fully anonymous pools that are cost effective and efficient, but really in small scale. On the institutional side, this concept of permission pools, where we’ll have an independent auditor come in and stamp wallets to approve them, I think is definitely something.

The use case I’m thinking of is, take equities, the likes of BlackRock that are lending in equities to banks, and then they’re lending those out to hedge funds to short sell. If you use DeFi and smart contracts for that, you can disintermediate that trade. Again, if you did that in the permission pool, then we can get across or around that concept of the issues around AML and KYC. The beauty of this permission pool is really you leverage that blockchain technology and achieve efficiencies without tripping up that AML, KYC. It’s early on, but I think there’s certainly a use case now.

[00:48:29] Ben: Thank you very much. Simon?

[00:48:31] Simon: Yeah. I think everything here, Julian made a point a few minutes ago, which is like a lot of folks start wanting to do tokenization of what they do today and then realize they need to move to crypto to learn. A lot of CEOs say tokenization, good, crypto bad. But the reality is it’s all the same stuff. To a technologist, to somebody closer to the subject, it’s the same, go figure out the risks. I just wanted to make that point right upfront.

I think stablecoin are the most underrated conversation to have. Seamus spoke to it, Julian spoke to it. But really the ability to automate the PVP settlement of cash with a complex workflow at the top of it, is incredible. You can essentially program a contract. Like derivatives market, but you take an ISDA, and then everybody skips the first 90 pages to get to the end to see what’s actually happening in the contract. That little bit of logic is very, very programmable. But typically to figure out what’s happening with margin calls, you’ve got to find that bit of contract, enter it to a system, so that the system knows to update the spreadsheet so that we can move the payment and send the payments team so that they do a SWIFT message. What? That’s ridiculous. Some organizations have it a little bit more efficient than that, but most don’t. The reality is most of digital and financial services was turning that paper contract into a PDF and emailing it. Maybe it’s now a more secure email. But actually turning this stuff into funds, flows, and settlement that is atomic, even if it’s with collateralized, even if we’re managing those complex workflows, I think that’s going to be critical. But stable coins are going to be really key.

We need to win not just the institutional mindshare, because I think that’ll happen, we need to win the public mindshare. I think the way you win the public mind share is that by talking about the fact that stablecoins are already used. People miss this, but it’s already live. If you go to Nigeria, it’s much easier to move money cross border there via stablecoin than it is anywhere else. Chances are the wallet you use at the other end probably got better KYC, AML rules than most of the banks. It’s probably true. Probably got better fraud tricks as well, because they’re not doing it on paper.

The same is true with Latin. What they do is they do remote pay EA with the wifi issue. If you’re not familiar, this popped up during the workpfrom-home era where people could work in any other country. What you saw is lots of talent in Latin America started working for US companies. But of course the problem is moving money across borders is unbelievably expensive. You can as an Argentinian citizen go open a bank account in the US and get paid in US dollars, that’s absolutely fine. But Deal didn’t want to do that because it’s too much compliance risk. Everybody else didn’t want to do it because they’ve got to get on a plane and open a US bank account. FinTech companies couldn’t get it done. Guess what? Stablecoin just work.  It’s the same as taking your $10,000 in a briefcase that you’re allowed to take across a border. It’s cash. But you can do KYC, AML on it because it’s digital.

There are these use cases that are already live. About 5% of that platform that’s getting paid in Latin America, it’s already using stable coins. There are billions of dollars being used for real-world use cases in stable coins. It’s not just a trading thing. Once we understand that, we understand the need to level up the compliance in it. That’s why I think MiCa is really important. We need stable coins we can rely on. Project Guardian from the Monetary Authority of Singapore and JP Morgan and DBS is an really important project, because what they’re talking about is backing stable coins with deposits.

I don’t think consumer CBDC’s are going to be the thing. It’s not going to happen. CBDC’s are going to be amazing for wholesale markets and cross-border at some point eventually, in like 20 years, but stablecoin will get there first. Figure out how you make it compliant.

[00:52:52] Ben: Okay, so we’ve got five minutes left. I did want to touch on this last section, which is around opportunities. We’re calling this the building opportunities that crypto winters bring. We’re in a crypto winter, people have a little bit more space to build stuff, and I suppose to correct some of the things that haven’t been perfect in the past.

What I’m going to do is ask each one of you where you think there’s a major opportunity here. I’m going to come to you first, Julian, because you’ve been talking a lot about the ability. But when you unbundle custody from exchanges to create more liquidity, is that where you see one of the biggest opportunities?

 [00:53:28] Julian: Yeah, and I think that follows what Tradify does in separation of roles and responsibilities. I think then you look at where is the risk and how to minimize risk. Separating in its own way doesn’t change the risk, it just moves the counterpart. You’re having the risk assessment. I think things like off exchange settlement is going to become the norm. Standardization; in traditional markets you have a lot of MI and information and insight, which we don’t have within our market at the moment. I think that is super important.

For me, I think it’s, is going to be a regulatory challenge for organizations to work out how to separate, if they are doing an integrated business model. It’s not straightforward given the geographies and the local registrations and the requirements from a compliance perspective. It feels like that will be a big ask for these integrated businesses to actually separate.

[00:54:24] Ben: Fantastic. Mike, what about you? Where do you see a major opportunity here?

[00:54:28] Mike: I’m going to do it through the lens of a prime broker. I think the digital market is going through and maturing like Tradify did, just at a higher velocity. The reality is what took 20 and 30 years is happening in 5 years.

We’re making the same mistakes. There’s credit issues, liquidity issues, there’s counterparty credit risk issues. Technology can solve some of those things. Really, there’s no difference to what we went through. I think the demand for institutional side is still strong. Again, from the lens of a prime broker, there’s a demand for like a real PB to step in this space – truly unconflicted, provides real credit intermediation, helps mitigate counterparty risk, provides leverage and financing, and ultimately allows for a capital and cost-efficient way to scale across this fragmented market.

I think Ben, institutions are creatures of habit, probably for the right reasons. They require certain infrastructure to scale. I do think that firms are going to continue to build very interesting solutions. I think the custodian side, the prime brokerage side are very early stages, but necessary evils for this market scale.

[00:55:33] Ben: Fantastic. Seamus?

[00:55:35] Seamus: Well, I echo a lot of what’s already been said. I think it’s very sensible. From a technology perspective, I think the last 10 years have really been driven by innovation. Let’s just move fast, very much a VC mentality, move fast and break things. I think post FTX and as we enter the winter and the large institutions come in, agility is important, but security and compliance are number one, and how to scale this in a secure and compliant way. We’ve talked a lot about the different risks. Understanding those risks and addressing that, whether it’s counterpart risk of an exchange or unsecured lending, there needs to be solutions that probably can learn from what we do in the traditional wholesale space and apply that and leverage the new technology to create even more efficient processes.

I don’t think these things, innovation for its own sake is not going to happen.  We still need innovation because the space is moving very quickly. But I think the key point is understanding that there shouldn’t be any single points of failure in your processes. You shouldn’t have somebody like SPFF, Sandbank Fried, that has this god-like powers. You want to ensure all processes are fully distributed, the organization has proper risk frameworks, they can manage these assets in a secure way.

Echoing the scene, we’ve said many times, you have to understand the new risks and they have to be addressed. These are not afterthoughts. It’s not about let’s get into TradeFi fast. Let’s actually build for the long term, and let’s have proper processes and infrastructure that’s going to enable them to scale not just the crypto opportunity, but eventually this idea that everything will be tokenized, and what infrastructure you need for that.

[00:57:11] Ben: Fantastic. At last we are out time, unfortunately. I’m not going to attempt to summarize everything that we’ve discussed. But I think the certain key themes have emerged right around how this space is going to become more specialized. Mike used the term separation of church and state, how regulators have a difficult job, but there are massive opportunities for them to embrace here and they need to introduce some clear frameworks.

The other key takeaway was just around how this is amazing infrastructure, and a lot of investments going to go into it. The possibilities and ends benefits for consumers will be massive.

That was a great discussion. Thank you so much to the four of you, our speakers, for taking part. Thank you for all the questions. I guess you guys saw, we had a whole bunch of questions that we weren’t able to take during the course of the webinar. Maybe we’ll try offline to answer those and share those with the people that asked them. Thank you everybody for your participation.

If you’re interested in attending the next one, the next one’s going to be next month in April. We’re going to be looking into venture capital investing in what is now a slightly more challenging market.

Great. Thanks everybody again and hope to see you on the next 4×4. Thank you.

[00:58:26] Seamus: Thanks, Ben. Thanks, everybody.

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