Across the wide, global landscape of crypto markets, financial institutions often face challenges in connecting to venues, managing liquidity and coordinating order flows. To tackle this challenge they often to turn to order management systems providers like Talos.
But as the industry gets more sophisticated and complex, the scope of services offered has to keep up as well. As it develops to keep up with demand, Talos and its Co-founder/CEO Anton Katz have collected unique insights on needs and preferences of financial institutions who are expanding their operations.
In this episode of RULEMATCH Spot On, host Ian Simpson discussed the state of liquidity in crypto, the developing institutional crypto space as well as Talos’s expanding feature set with a view towards new business opportunities and the coming world of tokenization.
Episode show notes:
(1:16) Intro
(2:16) A Talos perspective on crypto liquidity fragmentation
(4:26) Anton’s view on the future of fragmentation
(4:55) The incentive to split off liquidity
(6:09) Where Talos stands at the entrance to a fragmented market
(6:56) The most common question from Talos clients
(7:46) How smaller (and bigger) players are trying to take advantage
(9:19) Fragmentation of the stablecoin space
(10:58) The urge to use stablecoins for settlement and other use cases
(13:38) The main trend among stablecoins
(14:03) “Old-fashioned” stablecoins for the risk-averse
(14:38) Top considerations for choosing a venue
(16:45) Order types as a key point
(17:09) KYC or KYV for venues
(18:18) The consideration of post-trade options for choosing a venue
(19:16) Risk as a sizing function
(19:54) Why people forget about counterparty risk
(20:51) Comparing market models in crypto
(23:04) Possibilities for M&A among trading venues
(24:22) How Talos’s focus is changing over time
(25:34) Connectivity moving towards “plug and play”
(27:15) How latency is changing the game
(28:31) Differences in alpha
(29:15) Why TCA is becoming so important
(29:51) Evaluating market needs over time
(31:13) Why liquidity providers also need TCA
(31:52) Progression in TCA tooling and wash trading detection
(35:10) Fragmentation among settlement models
(36:56) How prime brokers are helping out
(37:28) “One-click settlement”
(39:43) Demand for various settlement models
(40:59) Tools to handle the flood after ETF approvals
(41:20) Talos’s tools with traditional asset classes
(43:13) Diving into PBs
(44:49) Rivalry between PBs and exchanges
(47:12) An opportunity for banks as prime brokers
(49:10) Will regulation change the venue landscape?
(52:40) The shadow of MiCAR
(55:19) Working with clients on compliance regulation
(55:45) Remembering the advantages of regulation
(56:20) Peering into the future with tokenization
(58:29) Fireblocks and Talos with broad network “distribution”
(1:00:24) Looking into the crystal ball with stablecoins and lending/borrowing
Disclaimer: The information contained in this podcast about RULEMATCH AG (“RULEMATCH”) and any guest company is for general informational purposes only and should not be considered exhaustive. They do not imply any elements of a contractual relationship nor any offering.
Neither Talos Global, Inc. nor any of its affiliates is an investment advisor or broker/dealer. This does not constitute an offer to buy or sell, or a promotion or recommendation of, any digital asset, security, derivative, commodity, financial instrument or product or trading strategy. This is not intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.
With more and more financial institutions offering crypto and digital asset services, the need for sophisticated tech to handle crypto is more important than ever. But it goes (far) beyond simple custody…
Fireblocks SVP of Corporate Development Adam Levine spoke to Ian Simpson about the expanding role of tech providers in coordinating crypto market infrastructure – connecting liquidity and enabling banks and financial institutions to do bigger and better things in the growing digital assets market.
Episode show notes:
(1:02) Intro to Adam and Fireblocks
(2:15) Is Fireblocks still “just a tech provider”?
(4:01) How tech and Fireblocks is developing as the market remains fragmented
(6:12) The “layer on top” that institutions demand from crypto market infrastructure
(9:00) A difference of attitude and approach between US and European banks
(10:36) Why American banks are the least advanced
(10:53) The good thing about Europe
(12:45) Outsourcing vs “build-your-own” for crypto custody among banks
(14:50) Why there is a greater opportunity for banks in Europe to compete
(15:10) SDX Web3 custody as a prime example of Fireblocks tech in Switzerland
(15:35) What happens when companies “play at being a bank” with custody?
(16:55) Why vertical integrated offerings will disappear
Disclaimer: The information contained in this podcast about RULEMATCH AG (“RULEMATCH”) and any guest company is for general informational purposes only and should not be considered exhaustive. They do not imply any elements of a contractual relationship nor any offering.
The relationship between banks and crypto has been complicated over the years. It has also evolved significantly since the first days of the industry. Along the way, Switzerland has been a leader in crypto banking – unrivalled around the world.
One reason for that is crypto native banks like Sygnum Bank, which received its banking license in 2019. As Head of Trading, Dominc Lohberger has been involved in building the banks offering – and in particular the trading systems and processes that are needed to fulfill the stringent requirements of regulators.
In this episode of RULEMATCH Spot On, Dominic and host Ian Simpson walk through the backstory of Sygnum’s operations, the challenges of the fragmented crypto market and discuss what new approaches are being developed – both at Sygnum and in the wider industry.
Episode show notes:
1:12 Intro
1:59 Where institutions are looking for opportunities in crypto markets
3:55 Navigating the liquidity maze in crypto
5:44 Why market makers are key
7:21 Where Sygnum sits in the crypto/traditional finance world
8:25 How the product shelf grows
10:25 Balancing retail and institutional considerations
12:24 The boring things that banks and institutions really care about
13:40 The non-existent transaction cost reporting in crypto
15:20 Putting the puzzle pieces together for a financial institution in crypto
17:40 The really tricky thing about capital requirements for banks in crypto
20:02 Is there any standardization coming?
24:10 Who is driving off-exchange custody setups?
25:30 Is finding a quick fix for institutional requirements a good thing?
26:05 How the overall market structure will morph and change
27:05 How post-trade settlement went missing – until now
28:14 The complex scene of settlement across venues
30:25 Building settlement batches in Sygnum Connect
31: 30 Tying in traditional security settlement to crypto flows
32:20 Leaning towards prime brokerage?
33:33 The unavoidable topic of regulation
36:08 Business and operational balance across regions
36:58 Will liquidity in the EU be cut off?
38:30 Dealing with stablecoin trading under MiCAR
40:24 The special considerations for stablecoin popularity
Disclaimer: The information contained in this podcast about RULEMATCH AG (“RULEMATCH”) and any guest company is for general informational purposes only and should not be considered exhaustive. They do not imply any elements of a contractual relationship nor any offering.
SDX and RULEMATCH deliver a complete, end-to-end, institutional-grade solution for banks and financial institutions. This Swiss-made partnership signals the coming to age of the crypto market, centered around efficiency, security, and compliance.
Institutions will be able to trade on RULEMATCH’s platform with post-trade clearing and settlement, eliminating the need to pre-finance their trading activities. Using the integrated solution of SDX and RULEMATCH, they can hold crypto assets in SDX’s secure custody and easily manage clearing collateral on a dedicated SDX account. The integration removes the need to hold collateral with the trading venue, providing a seamless and secure solution.
Investors will also be able to increase their crypto collateral positions within seconds, avoiding the lengthy delays often associated with traditional on-chain transactions. The integrated solution with SDX’s custody services and RULEMATCH’s trading and settlement platform will be available from Q4 2024.
Commenting on the significance of the partnership, David Newns, Head of SIX Digital Exchange, said: “Until now, the digital asset space has been held back by concerns around speed, compliance and fragmentation. Our partnership with RULEMATCH tackles these issues head-on by providing transparency, capital efficiency and, crucially, a clear separation of trading and custody roles. This means institutional investors retain full control over their collateral via SDX’s custody and can segregate assets by crypto address, ensuring clarity on asset location at all times. As part of SIX, a trusted provider of global financial infrastructure, SDX continues to uphold the highest standards of security and compliance for institutional investors.”
David Riegelnig, CEO of RULEMATCH, added: “We have always believed that separating the roles of trading and custody is key to serving financial institutions in the digital assets industry. As a pure market operator, RULEMATCH is thrilled to partner with SDX and integrate its custody services with our trading and settlement platform. And we know from our participants that many of them would love to use a secure, independent custodian like SDX to manage the full lifecycle of their crypto asset holdings, while also leveraging the competitive advantages of trading and settling on RULEMATCH. Thanks to our partnership, they can do exactly that.”
SDX Group AG (SDX) and its subsidiaries operate financial market infrastructures (FMIs) for the issuance, trading, settlement, and custody of digital assets, licensed by FINMA, Switzerland’s financial market regulator. SDX operates a stock exchange through SDX Trading AG and SIX Digital Exchange AG, Switzerland’s first and only Central Securities Depository (CSD) on DLT. SDX Web3 AG is also part of the Group and offers institutional-grade crypto asset custody and staking solutions. As part of SIX Group, SDX is subject to the Group’s high quality and security standards covered under Swiss law. SDX is headquartered in Zurich, Switzerland.
RULEMATCH is the premiere crypto and digital asset trading venue for financial institutions. It operates as a market operator for spot trading of the most liquid cryptocurrencies vs fiat. RULEMATCH is never a counterparty in trading. Fiat funds are held in fiduciary accounts with a state-guaranteed, AA+-rated Swiss bank and cryptocurrencies are handled on fully segregated wallets. With integrated multilateral clearing and post-trade settlement, as well as institutional-grade trading technology, RULEMATCH helps provide ultra-low latency, capital efficient trading and robust market integrity. Its offices and operations are located in Zurich – the heart of Europe. Its participant network is open to banks and securities firms only and limited to select countries. RULEMATCH is not available to US-based financial institutions.
The topic of MiCAR – the European Union’s Markets in Crypto Assets Regulation – is top of mind for crypto asset service providers (CASPs) not just in Europe, but also around the world. The implications of MiCAR for the current crypto market and its potential to shape institutional involvement in the space are wide-ranging and far-reaching.
In this episode of RULEMATCH Spot On, host Ian Simpson spoke to Dr. Joachim Schwerin, Principal Economist at the European Commission and a contributor to the drafting and writing of MiCAR. Together they discuss MiCAR’s background, implications for stablecoins, liquidity, bank and broker operations and much more.
Episode show notes:
00:55 Intro and Dr. Schwerin’s background in drafting MiCAR
2:52 How big a deal is MiCAR (really)?
4:32 The second part of MiCAR’s development
6:52 The danger in global convergence of rules
7:48 The true scope and scale of MiCAR
9:30 How MiCAR reverses the “burden of proof” onto regulators
10:45 The need for a liberalization of financial markets with MiCAR
11:28 How will MiCAR change the crypto market in 5 years?
13:45 How the crypto community should consider regulation
14:19 Traditional financial regulation for crypto is “dead”
15:40 MiCAR: horizontal or vertical?
16:10 The real things to look for in 5 years
17:10 Bottom-up innovation needs new forms of regulation
17:45 MiCAR as a desire to target specific market players
19:02 Creating a “radical place that is driven by experimentation”
19:12 Why educating “the right” way is important
20:06 The influence of MiCAR on regulation in other places
22:40 Why competition goes beyond just company vs company
23:49 MiCAR in the context of industrial policy
24:40 MiCAR and GDPR as EU exports
25:56 GDPR as the first crypto regulation
28:20 Specific implications of MiCAR for: best execution
32:07 The ongoing discussions around best execution
33:43 Specific implications of MiCAR: liquidity
34:50 The political reality around stablecoins
35:20 Competitiveness, the dollar’s decline and Europe’s imperative
36:26 “Deal with it”
37:30 Analyzing the “protectionist” view of MiCAR
39:26 How global crypto players will adapt to MiCAR
41:05 Stablecoins as a passing phenomenon
41:59 “MiCA prohibits nothing…”
42:34 Specific implications of MiCAR: tokens deemed securities
46:44 The potential for tokenized assets in Europe
50:10 A curious case of private crypto tech
51:21 Jealous of Switzerland
54:01 Thoughts on Switzerland’s DLT law and MICAR 2.0
56:38 NFTs and MiCAR
58:40 NFTs in the financial domain
1:01:10 The “unexplainably” strict rules around reverse solicitation
1:04:50 The pace of 2nd-level standards publication from ESMA
1:05:44 Is the tail wagging the dog?
1:07:25 The unhealthy focus on a few standards
1:08:59 The number of CASPs in the pipeline for MiCAR
1:10:33 How long will it take for MiCAR to “populate” across European countries?
In that regard, me, MiCAR is a success because we have something workable.
But now, of course, comes the moment where a lot of provisions have to be studied in detail.
What does it really mean?
A number of provisions have been finalized in a very short timeframe at the end of political discussions. That is always a compromise.
So, of course, certain parts of MiCAR are not perhaps 100 % politically in line with other parts of MiCAR because different people from different parties and different interests looked at this.
And this is now material that we can work with.
Ian Simpson:
Hello and welcome to another episode of RUMATCH Spot On, the only podcast focused exclusively on the institutional crypto and digital assets industry.
I’m your host, Ian Simpson.
And if you want to know what banks, security firms, hedge funds, asset managers and others are doing in crypto and how they’re doing it, this is the place for you.
My guest today is Dr. Joachim Schwerin. He’s a Principal Economist with the European Commission and he’s been closely involved in helping to draft and shape the MiCAR – Markets in Crypto Assets Regulation from the European Union.
Dr. Schwerin, welcome to RULEMATCH Spot On.
Joachim:
Thank you so much, Ian, for having me here today and for hosting this discussion and welcome to everyone out there for what I hope is a fascinating journey to MiCARland.
I’m Joachim Schweren. I work in the unit that is responsible for the digital transformation of industry at the European Commission.
My remit is policy development for all types of blockchain, crypto and token applications for the real economy.
I’ve also been involved in all the financial aspects of the blockchain work of the European Commission, be that the MiCAR regulation, the DLT pilot, the digital euro work, etc.
And we have a long track record within the European Commission of having a positive attitude towards blockchain technologies already for the last 10 years.
We think that it is a game-changing technology to the benefit of companies of all sizes and citizens to be empowered for more self-organization regarding their value propositions in their daily work.
And I’m very happy to discuss now specific aspects of this year today with you, Ian to see what we can learn from the work on the MiCAR regulation, but also perhaps related things.
Ian:
Very interesting. Let’s dive in.
So just starting off kind of high level, when we think about MiCAR, it would be interesting to know your perspective.
How big of a deal is this legislation?
Many people are talking about how important it is. I wonder sometimes if people overestimate the importance of MiCAR or if they underestimate the importance of MiCAR.
What do you think?
Joachim:
It’s a very complex question because first of all, it depends on your expectations and then also on the context.
I would say if you look at the whole crypto universe of what we have out there in terms of tokens and business models, MiCAR covers a tiny part of that universe for a number of reasons that we might go into because originally MiCAR, as we see it now in 2024, is the result of a process that started about six years ago.
In 2017 we had the ICO hype. It was then the idea of some forward-oriented people in the Commission to further explore the opportunities of that.
We know with the ICOs that at the end of the day it didn’t work out as expected. It was over relatively quickly.
But people without having a political mandate, which is the normal case in Brussels that you have a work program and then you are supposed to draft a regulation.
That was not the case, but people were sitting together, a few colleagues, and looking at how can we actually support these new types of business models.
Now we are in 2024.
So the world, especially the crypto world, where innovation is so fast, as we know, that it evolves massively quickly, is so much further than MiCAR itself has much developed.
It has additional parts, which is mainly the stablecoin part that came two years later when politicians were getting concerned about the Libra project and then asked us to make a stablecoin regulation.
And then we combined the stablecoin part with the very liberal utility token part, as I would refer to it, and came quite quickly with the proposal of the MiCAR regulation.
After that, it entered a political process as always in Brussels.
We call that a trialogue where the European Parliament with its committees and different parties is in detail looking at it, but also the 27 member states.
You know that we are developing rules that apply to 30 countries, so 27 EU member states plus three associated countries.
And that means that it is a very detailed and long political process where all sorts of changes are being proposed before an outcome is there.
That was then finalized and then comes what is now in discussion, the Level 2 standards.
So once you have a text, the text is, I would say, asking a lot of more detailed questions on interpretation, on filling certain provisions with life.
And then comes the discussion on the technical administrative standards. This is where we are now and that is again another phase.
So in that sense, MiCAR is a hybrid product to put it like that.
If you look at the substance of what legal certainty does it really give me for my business model in crypto and how innovative is it, you could say that the focus is relatively limited.
If you however approach it from a broader perspective of taking the perspective of bringing 30 countries at the end of the day together, very different decision makers from all political colors to have a much more intensive dialogue than you would have in one country where you basically have a government that decides at the end of the day, you get a product which is more or less the best of our knowledge at the current moment after all these times.
So I’m not saying it’s a perfect product.
No one is saying that.
But I think it is a very honest product that shows what is possible in a political context at this moment.
And that is, in my opinion, also a reminder for people that are always calling for global convergence of rules.
I mean, imagine now that on top of all these countries, we got the US, we got China, we got all the innovating countries everywhere in the world on one table and would have to decide on a set of commonly applied rules.
That would be very challenging if not nearly impossible. So I think in that regard for me, MiCAR is a success because we have something workable.
But now of course comes the moment where a lot of provisions have to be studied in detail.
What does it really mean?
A number of provisions have been finalized in a very short timeframe at the end of political discussions.
That is always a compromise.
So of course, certain parts of MiCAR are not perhaps 100% politically in line with other parts of MiCAR because different people from different parties and different interests looked at this.
And this is no material that we can work with.
Ian:
So in one sense, you could say that the actual scope of the law is perhaps limited, less important or less big than some people might think.
And yet from a market perspective, the European Union as a group, as you say, of many countries and economic activity, it’s really quite big.
Joachim:
It is quite big.
I think that is something, and I don’t like that word…some people refer to it as the Brussels Effect because…people tell us, and that might be or not, that we are good on regulation.
I mean, the narrative, and I don’t agree to that, is that innovation is mostly coming from elsewhere.
But then we are regulating that.
I would say, first of all, I’m not the typical regulator, certainly.
I look at opportunities, and I must say the whole MiCAR team looked at opportunities of how we can actually support these business models.
Also, we have massive amount of startups in Europe, so that’s not really a lack of ideas as such.
But I think the key novelty is indeed to bringing that together and feed that into a political process, which is now much bigger in terms of effect than was originally foreseen.
Originally, I mentioned briefly the utility tokens. The whole idea was to take the existing prospectus regulation, where you have for financial instruments, prospectuses that Dublin is requiring.
They are also driven by all sorts of concerns, always negative attitude first:
“What could be a risk, what could be a risk, et cetera.”
And then you go on hundreds of pages of all your risks.
And we said, we reversed that.
So as we fully believe in the potential of blockchain, we have said from day one that we see blockchain as a game-changing technology to the benefit of society.
So we want to foster it. And that’s where we said, okay, look, let’s see the opportunities.
Let’s get rid of this prospectus. Let’s make a white paper that should only be a couple of pages on your business model, basically a pitch.
And we went even further and that is still in MiCAR on utility tokens that you do not need to wait for approval from your national regulator.
You send your white paper to a national regulator. The burden of proof is reversed on that regulator to prove to you based on existing legal principles that you do something wrong.
Otherwise you can go forward.
You don’t even need to wait for the response for your national regulator, but you can already issue the token and you have a passport for 30 countries. That is revolutionary.
That is the first thing in the financial domain that we have something like that.
That was the core idea.
And that is relatively narrow on things that are not primarily financial. Then because of the political will to include the stable coins and the ensuing discussion that now everyone in crypto feels they should somehow fall under MiCAR, which I fully contest because that has never been the original idea.
People are getting disappointed because they feel that it’s not very clear on my business case, it’s not very clear on my business case either.
But it was never forget that the basic idea of MiCAR is a liberalization of traditional financial markets, which in my opinion are more and more getting obsolete in the digital domain.
And I think that idea is developing some traction. So it’s not only the size of European capital markets or whatever, but it’s this basic idea that we consider blockchain and the applications that are in between the financial world and the real economy, which is my domain, that these are fundamentally positive and need to be supported.
And that is a traction that I feel very strongly now in also lot of countries outside the EU.
Ian:
So this regulation is coming into force. It’s potentially going to have revolutionary effects and potentially changing things very much.
If we sat down and had this conversation in five years or so, how do you expect or how do you think that this regulation will have changed things?
And I’m thinking in particular for certain market participants, whether it’s for a crypto startup, whether it’s for a broker, for an exchange, for banks who want to deal and work with this technology and with crypto assets.
What is your expectation of how things will change?
Joachim:
The main thing in my opinion is that in five years we will have better educated decision makers.
We will have more mature markets. We will be five years again ahead in this discussion, which is a very positive element. In a way, a regulation as I see it, especially this one as it is a novel one and not just the so many three iterations – is a learning curve.
And I think that is the thing that we are doing.
Now we have a text. Now everyone is looking at the details and is coming with very detailed questions to us.
What do you mean with this? How does this part of the regulation deal and relate with another part of another regulation? How can we bring that together?
And these are questions that cannot immediately be answered because even if you are an experienced policymaker,
And most people that have actually worked on this document also in the parliament and the national countries are not experienced crypto policy makers.
You will never be in a position to think through all business cases as such.
So we have a lot of questions now which are being discussed. There’s a number of initiatives like a round table with the ecosystem that I attended in Zug earlier today.
It goes also to a number of other countries where people from the market are coming together not only discussing questions, but also proposing solutions.
That I find very strong because I think that the ball is indeed in the field of the crypto community.
They should not really see a regulation as cut in stone forever, but they should actually see it as something that they can hopefully can influence, improve and give other reality check of what is going on out there in these models.
And this effect will lead in five years to a much better understanding of crypto models.
It will give us a more realistic view on what should actually be regulated and what should not be regulated. I think, as said, the Commission took, in my opinion, rightly a very light and liberal approach.
But the more it gets up into the higher political discussions, but especially in the regulatory domain from the European regulators, the more top-down regulated it again becomes.
And I think that is the wrong approach. So we are having a major discussion ahead of us as regards to the current architecture of the supervisory authorities, but also of the political process still suitable to crypto.
And in my personal opinion, it is not.
And that is also what I tried to explain when I, for example, educate upcoming financial regulators or basically everyone out there in different formats. Traditional financial regulation in the field of crypto, in my opinion, is basically that.
And the reason for that is the advances of the technology.
Now we’re only talking blockchain. Now think of the combination of blockchain and AI, for example, of the business models that this brings about.
Think of supercomputing and quantum, of what that means in terms of encryption and standards.
There are so many questions where technology is not only as an individual technology moving so fast forward, but also in the re-combinations that you will simply never again be in a situation where you have a regulation.
And then as on banking or on capital markets, you sit in your chair, five years later, you revise it, you say that, Article 23 paragraph, whatever, can be a little bit fine tuned, et cetera.
That is not the crypto reality. The crypto reality is disruptive.
And that is why we need a different process in order to deal with that. And it refers back to what we discussed on MiCAR.
There are people who think that MiCAR is a regulation that is horizontal in a way that you have MIFID for financial instruments that you have the e-money directive, and now you have MiCAR as a sort of horizontal thing next to it.
MiCAR is below MIFID.
The original idea is basically to say that we want to have a more lenient approach for things that exactly are not financial instrument. And if we come to five years of what will be next after MiCAR, it is not MiCAR 2.0.
What is next after MiCAR is to find a meaningful approach towards decentralized infrastructures.
And that is something where traditional financial regulation has no role to play because that requires intermediaries, that requires the traditional approach on how you formulate that.
And if look at DeFi, DAOs, other areas, you do not have that, which is the reason why it is excluded.
So for me in five years, we will have a much more informed discussion on what governance in a decentralized context really means, what is possible, I would say, outside the traditional regulated domain.
But also all these hard horizontal questions that so far we do not ask, for example, on product liability.
Product liability in the financial domain is something completely different than it is in the real economy or also in the decentralized domain.
We’re basically in a normal environment that I’m now discussing in terms of DeFi, DAOs, NFTs. We do not start with KYC first and what is the risk assessment and who is to blame when things go wrong, but we start with collective innovation that is simply not seen unless they do something which perhaps results in a product or service that competes in a regulated market.
And that is a bottom-up approach which needs new forms of regulation. We don’t know yet what can be embedded, can be, let’s say, given by the sector itself, can be other solutions that is for discussion, but it will not be traditional regulation.
Ian:
So you wouldn’t say that in the process of creating MiCAR and refinancing and so on, there was ever a discussion that certain players in the EU, but also globally, whether brokers, exchanges, whatever, “We need to make this regulation such that they change how they operate in a targeted way so that it becomes more professional or more safe in some sense.”
Joachim:
This is, of course, one of the dimensions.
And there are a lot of people that focus specifically on this dimension. That is a bit the traditional approach that, yes, it is my money, but I prefer to give my money to an intermediary and I want that this intermediary is completely safe and that the risk is completely limited.
And when then there is an investment that consumer protection comes first and all of that. And I have no objection to that system. It is just not my system.
So what I mean is that we all have different preferences as individuals.
And I think that there should be an area that plays according to these rules, that should professionalize, that should be more transparent, that should also meaningfully use innovation, but in a well-structured and definable way.
But that is not the potential of the technology. The potential of the technology is disruptive regarding self-organization.
And that means there must also be a space which is much more radical, which is basically driven by experimentation.
When I look at my money, a certain part of my money goes into things that are much less secure than I would say traditional investments, but that is because I think it’s for the good cause. That can be for small things like some peer-to-peer platforms that do something useful in my opinion, or that can be for new business models where I think that’s exciting.
I would like to support them a little bit or whatever.
And I think, and that’s the bottom line of it, it’s my right to do so.
I, as an individual, completely object that I need to ask anyone, whether that’s the state, whether that’s any sort of, let’s say, security operator or whatever, for permission. I do not need to ask for permission.
It is my money, it is my resources, it is my life.
And that I want to see depicted also on regulation. Regulation must limit itself to the bare minimum and the rest must be possible to do.
So in that sense, I would not say we’re trying to educate the world as such, but it is very important to educate in a way that all these things have the right to exist next to each other.
It is for you, for me, for anyone out there to decide in which world they would like to live. But I don’t want my way to be corrupted by other ways simply because other people like it.
Ian:
And with MiCAR as a regulation for, as you say, 30 countries altogether.
That is quite a big scale. How do you think this will influence regulation in other areas?
I mean, we talk about first mover advantage. Maybe some people could say it’s first mover disadvantage since others will be able to observe what the EU comes with and say, well, we will adjust to make our place more attractive.
How do you think that will play out in the next years?
Joachim:
I think it’s a nice question because that again gives us the beauty of a multipolar world.
I mean, I know and I agree that a number of countries out there, and it’s not the traditional countries, we all know that by crypto basically the whole world is experimenting and using that, which is very good.
A number of small countries are more innovative than we are. But you mentioned the size. I mean, we are a very big jurisdiction and we perhaps add to that discussion a new element.
We are not the most innovative ones, but we are meaningfully big enough in order to contribute to the development of crypto markets, but then perhaps in a safer or more structured way.
And again, the choice is out there where you go.
I mean, I like the approach in Switzerland very much. Switzerland has a credible tradition of being independent, but at the same time very much focused on institutional players and on safety and security, which is nice.
There is Liechtenstein. I like it very much, which is very innovative as a small place. They can be more radical, like with the token law, than we are, but at the same time, our rules apply to them.
So they have to find a balance, which is a very interesting case.
There are other entities out there where I would say – in Asia, you have a number of countries, for example, where we know how innovative they are, but would you bring your money to Hong Kong? I’m not that sure, given the political situation or whatever.
I think we have certain benefits in Europe, where you have a safe place to be, but you can also be innovative.
So what I’m saying is, everywhere in the world, the package is slightly different. And that is what I actually love about regulation. I said that I’m not considering myself as a regulator. I don’t like regulation too much because…
I always see the political process and the end result is certainly different from what you want to put in.
But the nice thing is that competition does not only exist between private companies and business model, competition also exists, of course, between countries or between legislations.
And this is nice to see because coming also back to your question, what will be in five years? In five years, we will also know where the money is going.
And actually, to give you the example, everyone’s discussing their twisty elections in the US. I mean, a lot of US companies came to us over the last one or two years basically I would say to hedge their risks.
They didn’t know what was coming so if it goes too much wrong in the US maybe to have a foot in the door in Europe is not too bad.
I wouldn’t say I see too much of that anymore with certain exceptions but to have mobility in the world and see what also can work is a nice thing to have especially if you combine it with experimentation.
So just try that out if you don’t like it okay go somewhere else and that is an interesting aspect that relates back to another question you asked.
Is it really for Europe?
I mean, if I would take the industrial policy of competitiveness hat that somewhere is also sitting on my head, I would say that it has all to be in Europe or in the EU. But I don’t see it like that because I see the technology as really beneficial to potentially every human being that is on the planet.
So it is much more important that we develop the technology in the various use cases than that we fall back into this rhetoric of I want to take it away from you and I want to have it here.
The crypto space is still so small it can massively expand and then there’s place for everyone.
So that is I think what the ambition should be.
Joachim:
And do you expect, I mean we’ve seen in the past with regulation from the EU GDPR is one example where it does start in Europe and then emanate out across the world.
Is there a possibility that Europe does really lead the way and exports it to other countries and people more or less fall in line or do you really expect there to be quite differences?
I would say it really depends on what will now happen on the basis of MiCAR with standards and that’s an exciting question.
If we manage to, I would say, “ring fence” the negative repercussions from certain Level 2 Standards and really focus on the core of MiCAR, which is a positive one, then I can think it can be an attractor.
But if we again fall back into the logic, which I see in some parts of the market, that people are starting to say, let’s go back to MiFID because at least we know what we’re dealing with, then that’s certainly not the purpose.
So for me, that is an open question of the direction that it is going to. But in general terms, I think that the sector will massively expand simply because it is in the interest of people to have these tools available and self-organize themselves.
To what extent that is beneficial to Europe at the end of the day in our hands.
Let me just say a few words on GDPR because you mentioned it.
I mean, I still know the time when we drafted GDPR and when I was responsible for SME financing and I had the whole year, nothing else to do than have angry small and medium sized enterprises coming to me.
Because basically they wanted to complain about GDPR.
That’s a typical example of a regulation where I fully appreciate that it has a lot of things that people at first sight find terrible and that they find as intrusive and full of bureaucracy and stuff like that.
But let’s not forget the core idea of GDPR, which is also why I think GDPR is actually the first crypto regulation, not MiCAR.
GDPR is a regulation that directly looks into the direction of Web3 and not Web 2.0.
Web 2.0, in my opinion, is a completely corrupted space from big techs that basically take your data, which should belong to you, make the business case out of you, become stinking rich, and at the end of the day, you have the peanuts.
Whereas we have the opportunity to, with all what we discussing here, develop a much more democratic and decentralized Web3.
But that requires autonomy on data and the possession of data by the individual.
Now, I see the individual, or perhaps we see the individual, as a sort of fragmented thing that forms part of different communities, where a part of your identity, also digital identities, in these different communities.
You own your data.
Actually, the data starts to exist normally when you have interaction with others in transactions, and it’s for those communities to decide what to do with this data.
That requires a fundamental and radical approach towards data ownership and ultimately data transfer, which is embedded in GDPR.
So GDPR has a good core, but again, in all these processes has become a little bit complicated. But it’s completely consistent with the discussion that we are having on crypto, because the whole difference between what we try to do in Europe and what happens in other parts is that we want to base the decision making on the autonomy of the individual or of the collective in the decentralized space and give them the rights and not give that to a part of the space of the intermediaries that basically have completely different interests.
Ian:
We’ll get back to the Level 2 implementation topics and so on and some of the challenges around that, but let’s dive down a little bit into some of the implications, not to go one, two, three, four through the text of the law, so to say – but some of the things that are perhaps important to players in the space, perhaps even to us at RULEMATCH.
There is a term from traditional finance which also applies in some sense to crypto markets, “best execution.”
We had a guest on the podcast recently who I asked about this, Kevin de Patoulle from Keyrock, and his comment was “It is basically impossible” to offer best execution in crypto markets just because of the fragmentation of liquidity all around the world.
MiCAR addresses best execution to a certain extent.
Can you just give us some background on the thought behind that and the potential for implementation around that?
Joachim:
I will be happy to do that to talk a little bit of the background and how I see that. I would not go into every technical detail because also these discussions are ongoing and indeed as you say and also as you said, your guest rightly said that this is a very complex thing.
In my opinion, we have to start from the facts, which is basically also the technology.
And if you look on the one hand side at the liquidity or not of the market of how that is organized with emerging market structures, with the question of what are platforms actually doing?
Are they pulling liquidity or are they only giving access to liquidity then there’s a time lag behind these things.
And if on top of that you consider blockchain technology, let’s consider traditional blockchain technology, where you take individual transactions, but then you pool transactions into a block.
So you have a time lag in these things. And then only when the block is full, so to say, the hash comes on top of it and it is being done.
It gives a certain discretion, of course, when it comes to best execution.
And of course there are two different perspectives.
There’s what I would call a traditional regulatory perspective that always looks at the worst case, where basically they would probably argue that what we discuss on liquidity, but also the technical working of the algorithm and the process of putting that on the blockchain gives scope for perhaps manipulation, if you would like to phrase it like that, or for ambiguity as regards to whether best execution is met or not.
I think it is very difficult to dismiss that from a theoretical perspective. It’s the question of actually what you want.
I think that when you look at best execution, crypto markets offer much better solutions than traditional markets in many different ways, but there are not and cannot be a full guarantee that it actually works.
So it’s a gray zone in a sense.
The question is how do you approach a gray zone? Do you approach that from a very rigid perspective of “Now, everything is a mess, but now we have something new, so we want to prevent that anything is a mess.”
I don’t think that’s a realistic option.
Or do you say that, “Let’s see how they develop their business models and how well that can be done.”
And then we see how it works in practice that I find a much more productive approach. But indeed, if you want to prevent any form of abuse that comes from this type of innovation, I think it would be probably nearly impossible to do.
I don’t want to live in a world basically that has zero crime because a world that has zero crime means that it is completely totalitarian, that it’s completely stipulated in advance of who does what.
I think that a technology comes with certain risks as long as the risks are small and we know that the risks are smaller than in traditional capital markets. I think that this cannot be the key issue.
But as said, there are certain discussions going on. I do not want to influence these discussions. It is my take that certain topics are massively exaggerated and for me best execution is a topic that is actually much exaggerated in the discussion.
Ian:
So that’s an ongoing discussion involving also from the perspective of financial institutions in the EU who will then be potentially offering these investments to their clients and then would fall under some rules for best execution.
Joachim:
It does. I mean at the end of the day I don’t know and I will not name now any specific companies but at least my personal experience with CASPs when I trade tokens is that it is and remains to a certain extent trust-based.
I mean, I understand the technology, I understand the business model.
Business models are different at the end of the day.
By way of example, if I trade Bitcoin there are price offers, there is a certain time lag.
There is a difference in the price that I ultimately pay than when I see it for the first time and start the transaction because just of the little time that is in between, as long as that is not massive, as long as it is part within the spectrum, I don’t have a problem with that.
I mean, if I go to my traditional intermediaries and I buy funds or whatever, what do I pay? 3.5 % or whatever transaction fee. I mean, that is not what we’re talking about here.
I think we should put things into perspective and not exaggerate certain small items.
Ian:
Understood, understood. On the back of that then there is the topic of liquidity and you mentioned fragmentation of liquidity.
Now the EU brings in MiCAR and makes some pretty clear guidelines about operating within the market and sourcing liquidity and so on.
Some people have said this is kind of like “putting a wall” or so on around the market.
Do we understand that correctly, that market intermediaries in the EU will only be able to source liquidity within the European Union?
And how does that play with a global crypto market?
Joachim:
I think that is not per se a consistent MiCAR aspect, but that relates to parts of MiCAR.
I mean, again, if we look at what MiCAR actually was supposed to be in terms of utility tokens, I would say non-stablecoins to put it in a simple non-technical term, then that consideration cannot play a role because that is a truly global market where basically you try to develop business models.
When you look specifically at stablecoins, this is indeed part of a political discussion that creeps in where, at the end of the day, the legislator has decided that the stablecoin provisions are also used for promoting the euro.
And that is something that we actually also have on the digital euro or other files.
So basically on stablecoins, as we know, there are provisions that part of the reserve have to be in specific locations in euro, et cetera.
And that you can say is a competitiveness angle. Now that is an aspect that, of course, you also have in other jurisdictions.
I mean, if I look at likely developments in the US, regardless of who will win the election, stablecoins will be very high on the agenda.
But I think, that is an expectation by many people, that they will use stablecoins as a competitive advantage for the US.
And the basic background for that is that the role of the dollar as the world reserve currency is massively diminishing.
We are below 60 % now from much higher values before. We know from economic history that every 80 to 110 years, there’s a different lead currency in the world.
We now see that with the dollar, the dollar will disappear as the world reserve currency within the next 10 years. I’m fully convinced of that as an economist because we see many alternative projects coming up.
And they realized that 99.8 % of the markets in stablecoins are dollar denominated.
So they will probably come up with something relatively liberal, but dollar denominated to bring that here.
And in that regard, I find it legitimate that we in Europe are saying “We have a euro and we also want to strengthen the role of the euro.”
And this discussion is evolving.
At the beginning, everyone was saying, well, are you stupid or there are no market cases or we have Monarium, of course, which is very good, but few others.
Now I see an increasing interest that the rules are there in order to develop that further. And that’s an interesting effect also of MiCAR that you have been asking about. mean,
There’s a massive difference between rhetoric when things are not yet in place and when things are in place and you just have to deal with that.
And I think that also creates new business models that will also result in more licenses.
We are seeing that.
I mean, that’s a recognition of facts that will then exist. And that is better in a way than having no regulation at all, because with no regulation at all, we wouldn’t have any development basically in Euro denominated stable coins and now we’re seeing it.
I’m not saying that this is the future. I’m not saying that it will be massive, but at least I’m saying it’s more competition and more competition is always good.
Ian:
So you’re saying that the stablecoin regulation does kind of have that ring-fencing objective or, I hesitate to call it protectionist view, it lines up with that somewhat.
Joachim:
It does in a way, but it is very interesting, I would say, from an intellectual perspective, Ian, because if you see the timeline, and there’s at the moment already scientific research emerging on actually how was MiCAR designed, and it’s very interesting along these six or seven years, this consideration is not included in the original proposal.
This consideration came later through the political process.
So that’s again the thing when you do have a political process. You have a financial regulation, but a financial regulation will always be used for other policy objectives as well.
I mean, we had this, in my opinion, utterly stupid discussion on the energy consumption of Bitcoin.
In my opinion, proof of work is the absolutely best consensus mechanism that we have because it’s the most democratic one.
We know that it uses more energy than other things, but I mean streaming and all sorts of stupid things also use massive amounts of energy and no one is discussing that at the end of the day.
But that is something that you get. You get all sorts of other policy considerations.
I mean if you have a European Parliament where in these committees you have from the far left to the far right and everyone in the middle sitting there, they all want to have their ideas in every form of regulation, which is why you have that type of result and then it creeps in.
So yeah, there are also competitiveness things in that. I find that okay.
If you can really demonstrate and I think that’s the case that it is for a small segment of a regulation that is also a small segment in the crypto space.
So to have these rules, I don’t find problematic.
If you don’t like it, go somewhere else or don’t care about it at all, like tether or do whatever you like, you have choice.
Ian:
And when you think about Europe and in the global setting, mean, there are global players.
Some based in the EU operate in other places, some from the US operate in other places, some from Asia operate in everywhere.
And I’m sure in the conversations you’ve had with them and others, people are considering, we continue operating the same way or do we, yes, come and really set up in the EU for these reasons as the political discussion develops?
Do you think that will be the end result that there will be a Company A (US) Company A (Europe) Company A (Asia) and so on or…?
Joachim:
That is, I would say, problematic from a certain perspective because as said, there’s always a massive difference between the narrative that you get and what they’re actually doing.
I mean, I’ve worked long enough in industry and was also involved in state aid control and things like that.
I know that when you have a company that, for example, wants to build an industrial plant somewhere in Europe.
They all come with all sorts of threats that I’m only going there if I get half the money from the state or if you build me a power plant or if you do these things at the end of the day.
This is rhetoric. This is a negotiation.
I mean, if the whole deal is not good enough that without some meaningful support, whatever that is, you come to Europe, then stay away of Europe.
This is not really something where we are desperate about companies coming to us. We have tons of companies in Europe.
I would be very happy if people would consider us as open and an interesting place to do business.
But specifically, sorry to say that bluntly with stablecoins, I couldn’t care less where stablecoins are located because I think that stable coins are a transitory phenomenon anyway.
I think that there are much more interesting parts of the crypto space, also not necessarily CBDCs, but tokenized assets, tokenized deposits, et cetera, where the long-term trend is heading towards.
Furthermore, if you really have a meaningful stablecoin, then probably it should be designed in the way that is not really an e-money token that packs you against one fiat currency.
Honestly, why would I need crypto if I operate with a stablecoin that is purely dollar or euro denominated?
I mean, then I can use dollar or euro myself.
I don’t have certain functionalities, of course, but that for me is not really crypto innovation.
So I see that some people like it. I see that some people want it fine, but this is not the mainstream of crypto innovation that I’m seeing and therefore let them be where they’re happy.
I can say that because in the public domain, when we started designing the stablecoins rules, there was a letter from five big governments in Europe that’s in the public domain that “You have to prohibit all of that.”
MiCAR prohibits nothing.
But MiCAR makes a couple of statements indeed, which I find meaningful on governance, on compliance, on reserves, and indeed on certain things like Euro denomination on parts of that, which in our opinion makes sense.
But again, if you don’t like the package, then don’t come here.
Ian:
Very, very clear. Let’s move on from stablecoins. I think you referenced it before, but we won’t have to go down that road too much. That stablecoin bit in MiCAR was perhaps a reaction to Libra and there was a strong political will to focus on that as well, maybe made, shall we say, the package bigger and more complicated.
But another part of the package that is still a bit complicated is tokens which aren’t necessarily utility tokens, necessarily stablecoins, things that are more tokens deemed securities that don’t fall under MiCAR, kind of a gray zone.
What is the thinking about them and how they should be treated and how they will develop or how Europe will be ready for development in that space?
Joachim:
I think that is again a learning curve where it’s actually not only confined to MIFID and MiCAR, but you also have that in the European crowdfunding service providers regulation where securities can be launched by them, but they don’t have the possibility to create a secondary market.
So there’s a lot of questions in these quarters also now going on, of what that means.
All of that has been intended as a liberalization because we have the traditional financial instruments, we have the securities that are financial instruments.
We don’t, as you know, have a coherent definition across Europe of what a security is that differs with practical consequences.
And now we said, “Okay, you have new forms of regulation for other segments. And there’s also the opportunity to let’s say have, we would say crypto assets, not financial instruments, but you also have asset securities for the crowdfunding platforms, et cetera.”
Then you design these regulations, you look at the practical cases, and then you see that it conflicts with certain, very often minor provisions and other regulations.
So we have these examples where if we see something and then the market person comes to us and says, “Huh, sounds nice, but this one sentence there over there, which is a problem then you have to deal with that.”
I think one way to practically deal with that is actually to institutionalize this learning environment that we talked about.
So that’s basically sandboxes. So we have that.
One very good example in theory is the DLT pilot regime, where we said that, “OK, as part of this digital finance package where MiCAR is in, and Dora and other things, we also have the DLT pilot regime,” where we say that, “Let’s look at MLTs and infrastructures basically to develop that.”
There was also sort of last minute political idea, which I think was very positive, but the design of that is not good.
And we all know that.
I mean, we can speak about that. We have very limited demand for that.
It has uncertainty as regards to timeline. It has size restrictions, like that.
So it needs to be massively improved, but it is an example of a co-learning space, like also the European blockchain sandbox that we have that looks at crypto models that looks at DAOs and other things on how they can be developed.
And then you identify these problems, these issues, and then you can eradicate them.
That should be a normal process.
So I understand and I respect the frustration in some parts that securities in a way is an ambiguous exercise.
The only thing that I can say on this is indeed be very clear on the concrete impediment that you have.
And let’s find a way of addressing this either through sort of softly a soft law requirement or through a review process of the regulation when it is then coming on.
Because my experience with regulation that includes securities, unfortunately, is you can be as meticulous as you want.
That’s like drafting a text. I mean, when I draft an article, for example, I read it 10 times and I can guarantee you the first time I read it, when it’s online, first thing I see is a typo.
And that’s what you also have as a regulation.
So I see the frustration, but it shouldn’t be seen, it should never be seen as something that is deliberately put there to annoy people.
It is simply something that, okay, has to be worked out in the next iteration.
Ian:
And you said personally, you believe in the potential of tokenized assets and the liquidity that can come out of that and the potential for other use cases.
And how will that fit, how will that develop in the world of MiCAR, MiFID and in between and so on?
Joachim:
I would say the real potential of tokenization and tokens as a container of value for all types of assets, real world assets, deposits, et cetera, we have not even started considering.
I mean, if you take Web3 really seriously and they do that as basically the guiding light when you have the immersive combination of the offline world and the online world.
And you accept that at the end of the day, a token is a value proposition, like money.
Money is not something that is cut in stone.
It is basically a promise. So it is a value. So you take these values, you give it a form, which is a token, and you make that safely tradable.
Then at the end of the day, we’re talking about the integration of a financial system and a real world system because finance at the end of the day is only a service for the real economy.
And that means rules where basically you can take a note, you can tokenize everything.
You can safely trade that on decentralized platforms and where you have the flexibility of combining that with, let’s say, all sorts of things that you would do.
Things like – we now discuss gold denominated stablecoins or diamond denominated stable coins.
So there’s of course a discussion on, for example, commodity based stablecoins where the commodity doesn’t even have to leave the ground.
I mean, imagine that you can give a value to something that you don’t even see that is somewhere. Someone tells you it is there.
You build your tokens on that and you can freely trade that.
That is the vision that I’m having. And it’s not taken so far away because if you look at offline tokenization that has been there for thousands of years, if you look at examples like the stone money of yap where basically a society agrees on the carrier of a token even if in that case the physical token is washed away by the flood or whatever, it still exists and has its value.
You don’t even need a physical thing as a proof of value. What you need is a verifier.
You need something that in your opinion in a trustworthy way – a way verifies the existence of the underlying item.
A little bit the same discussion that we’re having in Germany always with our gold that is lying somewhere in the US or so that some people are saying the gold isn’t there.
So a little bit like Schrödinger’s cat, I mean you have to look and open the wall and see is it actually there or is it not there.
That’s the type of things, how they are designed.
This is such a massive potential that you don’t find that in MiCAR, it’s not covered by Level 2 Standards. You don’t find that in any other piece of existing financial regulation.
But people in an automatic way do that.
Intellectual property is a very good example. At the end of the day, value can be money, value can be ideas, value can be anything, and people already have found very creative ways of trading these values.
For that, we need a stable, I would say, environment.
I’m not necessarily saying regulation, and we are miles away from that. One example that I always like to use, although it’s not primarily, of course, related to stablecoins or whatever, is Tornado Cash.
I mean, Tornado Cash, the judgment, in my opinion, is a scandal, but it reflects the complete dichotomy between reasoning in the financial domain and reasoning in the real economy domain.
We all know that bank robbers regularly use fast cars, mostly Audis, BMWs, go to the bank, rob them, drive back.
You could immediately prevent that.
I mean, with all the technology, every car can be located at every moment.
It’s built inside the car. It’s mandatory.
You can have cameras, you can have access controls, etc.
No one bothers. No one comes to the idea that when you arrest the next criminals that drop these banks, you go to the board of BMW and arrest the CEO.
But that is what you tend to do apparently in the financial space.
So what I’m saying is for this type of economy that we’re moving towards, if we talk about tokenization, we have a completely different approach in the financial domain than we have in the real economy.
And that is the underlying problem.
So what we’re discussing with MiCAR is very intense, it is already very detailed, but it’s tip of the iceberg where we’re actually heading to.
So there’s a lot more to come and we’ll need a lot more work before we actually…
Much more to come, much more to come, but not necessarily in form of regulation.
Ian:
In that sense, are you a bit jealous of Switzerland and some of the regulation that we have in place already here?
Joachim:
I’m not jealous of Switzerland. I’m actually not jealous of anybody, but I like Switzerland for many reasons.
And one of the reasons is actually an approach to regulation.
I don’t like everything that Switzerland does on regulation, but I think that Switzerland has been and is innovative and pro-market when it comes to better access, for example, for small and medium-sized enterprises when they’re raising capital.
I think that they have lean and productive rules in place. And I also think that Switzerland is a very good example of an integration of decentralized crypto technology with a very institutionalized banking sector with safe banks also.
But that for me is a useful contribution as discussed before to a space. It is not necessarily the default. I think that for my personal liking, the rigor that Swiss banks apply in onboarding people for me is too strict.
That’s just for my personal liking. I think there’s an overkill. I know why they do that and it’s competitive advantage in a way.
I also very much like that they now seem to see it as normal that people as part of their portfolio also hold crypto assets in some form.
I think that’s a very meaningful way forward. If you go to your bank and advise as a client that you should invest in this space, this is very positive.
But I think that there are tons of crypto business models out there that might better be served somewhere else.
So I think Switzerland has found a place which is relevant, which is beyond the size of Switzerland. That is very positive.
But I think I said before that the world is big enough also to allow for other reasons and whoever wants it to come to Switzerland to come to Switzerland.
Where I like Switzerland very much and that’s indeed something that I envy is on data protection actually, and on my privacy.
Because indeed they are very limited as we all know of giving access on demands of for example your private communication, et cetera.
When you are with a Swiss provider (I am with a Swiss provider) and that is something which I appreciate very much.
So number of positive things, whatever is only positive in the world.
I think if you look at other examples, Barcelona thrashing Young Boys Berne yesterday evening, probably Switzerland is less…
Ian:
Well, please. we won’t get into the football!
Joachim:
No, we don’t talk football.
Ian:
Okay, then we don’t talk football.
But just back on the tokenized assets, I mean, we have a DLT law in Switzerland that lays things out pretty clearly, and of course, obviously, making legislation in Switzerland is a much different exercise than in the European Union, but you can have a tokenized asset, it can be processed and exchanged through a smart contract, effectively replacing the CSD, whereas in the European Union, as I understand that, would not be possible.
Is there work at considering exploring this for the next, I don’t say MiCAR 2.0, I mean this is not going away.
So is the European Union considering this and how to deal with this? We are exploring things at a technical level.
And I think that is very important.
So I don’t want to engage on political discussions. These are complicated enough. I can only speak for myself as forming part of a technical level where we would be stupid if we were not studying what is happening in Switzerland.
And there are very good examples, I would say, how to deal with that.
Take, for example, also the role of blockchain as ensuring the integrity of documents.
I mean, we all know Fabian Schär from the University of Basel, and I had a couple of discussions with him over the last couple of years, and at a certain moment, we organized a few workshops.
He spoke on one of them on, for example, how Swiss universities can detect fake diplomas, which for me is a key issue because we’re working on European systems on detecting fake products also with a view to the digital product passport.
And there’s a very elegant system in place, whereas we take a little bit more time. It’s also one of our use cases, but for certain restrictions we have in Europe for existing regulation, it’s not that straightforward.
So Switzerland can meaningfully show new ideas and how use cases work.
Again, and that is what we also discussed before, and that’s not, of course, the fault of Switzerland, we are dealing in Europe with the necessity of combining the technical element with the political environment of having all these different players, and that makes it complex.
I mean, I’m regularly in Switzerland, I discuss that with my Swiss friends, and my Swiss friends tell me, I don’t know if that’s true that basically in Switzerland, the opposition is embedded in the government itself through the rules.
So basically we have a sort of consensus and we do that where we don’t have that in Europe. So in that sense, obviously it’s a more difficult environment to operate in. But there are thoughts and hopefully the political will move in that direction.
Ian:
Let’s cover just two more areas, maybe specifically around things in MiCAR. When you mentioned NFTs, not included really or not covered in MiCAR and now – I mean, beyond the use cases of art and things like that, which are interesting, of course, there are also financial use cases around unique tokens for certain things to be traded or held or used as collateral and so on.
Do you think that is something that will eventually be addressed and is there potential there?
Joachim:
I think there’s a big potential there, but everywhere. perhaps allow me with two preliminary remarks.
First, we are already now ourselves, massively using NFTs.
So we have a system that we developed over the last five years, which we call the anti-counterfeiting blockchain infrastructure.
That’s an open source infrastructure where we can onboard industry solutions to detect fake products.
And this is operational. We tested it. We are now developing the pilots. It’s there.
What it basically does is the moment that you produce something somewhere, you create a digital twin. And when the physical product takes the journey through the different countries into the EU until the end consumer.
The digital twin moves as well and the information exchange between the two is done through NFTs that basically include document where the key data is mentioned and the customs authorities and others get on a need to know basis so they cannot read everything.
The information, whether that’s an original product or not or what else you have to safeguard. So basically like a sort of COVID passport, it’s green or red, but you don’t know details.
That is something that is a massive use case.
We see also the use case, as you mentioned, we see that in the arts, we see that but also in the industry, in the luxury brands, for example, take the Metaverse where basically you can use your NFT to add a value layer on top of your physical product.
Again, here Swiss enterprises, but also others are leading in that when you have a car, when you have a watch, etc. Take that to your avatar and call the experience of that.
We have many of these use cases. NFTs are something very positive.
Second, preliminary remark is there’s a difference between criminal behavior and stupid behavior.
We can all discuss the broad apes, but at the end of the day, it’s not criminal. It is something where probably you and me would say, don’t invest in that or we don’t see the purpose. But if someone sees nice, mean, it’s not prohibited to invest in stupid things and lose money if you want to do that.
The question is really what could be NFTs that would primarily fall into the financial domain.
We thought when we were designing MiCAR that we should exclude it.
Not because we cannot think in the back of our head of some cases where that must be the case. But a regulation is not there to prohibit everything, especially when the market is very small.
Regulation should be there on meaningful market sizes when you have substantive risks.
We see in NFTs. we know the discussion with the famous recital that crept in on what that is.
That reminds me a little bit of stamp collection. So now it’s an open discussion that you had basically take a couple of stamps. Now let’s not consider the case that there a lot of identical stamps, but imagine you would only have one stamp of each type.
You put that in a collection, you put that in your album.
Does that have more value than the individual parts taken together out there? But there’s a lot of considerations in that.
I would not see the necessity for a regulator to really deal with these simple things.
I mean, we can of course discuss consumer protection. That is very important. There needs to be transparency. There needs to be basic information, et cetera.
But at the end of the day, when it goes beyond that, NFTs are not really something that are a massive harbour of fraud that needs to be addressed in my opinion. And therefore, I think for good reasons, they were out.
If I look at the uptake now that NFTs have where there is in part a financial element, but that could be ancillary.
I mean, that’s the same with the utility tokens. The utility token, of course, has a certain value element, but perhaps we should better talk about value and not really financial because that’s what Web3 is about.
If you take every type of token that somehow has value of financially percussions and you will make a problem out of that, we would be in a very bad world and that is certainly the last thing we want also with MiCAR.
Ian:
And now perhaps one of the more difficult topics or more controversial topics, maybe not controversial, but there are quite strict laws or provisions in MiCAR around reverse solicitation.
Can you talk a little bit about the thinking behind that, the practicalities of that and the implications of that because I think that’s maybe one thing that for companies wanting to do business, continue to do business in the European Union or in the future is very top of mind for them.
Joachim:
Look, I’ve seen the draft standards. I know a lot of discussions about that.
I had actually a lot of discussions on that earlier today. If you want me to explain the logic behind that, frankly, I can’t because I don’t understand it.
I mean, I have a certain understanding where it comes from, but let’s…
Let’s start looking perhaps again from the real economy perspective, which is mine, and also put that in context.
We have very strict rules in Europe, which we will probably strengthen to prevent any form of geo-blocking.
We think that geo-blocking should not prevent consumers, especially if I translate that into financial terms, retail investors, to have access to goods and services in other countries. That specifically applies to the European Union.
But I think you can make a case, especially in a digital domain, where you have a global internet, where you have a fantastically easy use, I always do, of a virtual network, where basically you have all the means there to prevent anyone seeing from where you are, and then get access to all sorts of websites or services and deal with that.
So that’s a reality, especially in digital markets.
Now I think we must distinguish, and there must be a line between that, I agree, between blatant abuse of the technical means with fraudulent intent.
So when I set up fake websites or when I directly target European consumers, especially inexperienced one with very strange ideas, there must be minimal requirements.
I completely agree to that. But to go as far as basically saying that everything that you do, if you post something on social media, if you make a road show, if you see a sports event somewhere in the world and there’s some advertising on crypto or whatever, that this needs to be prohibited, that goes way too far.
I mean, we should not treat consumers as utterly stupid.
And I think it’s a fundamental right to have access to services, even if your regulator doesn’t like it.
That includes, by the way, privacy coins very much.
So I think that there is an overkill in this regard because that doesn’t meet the reality of digital markets, especially if you the technology to disguise all of that.
Where is the realistic twist in these things?
So regulator would be well advised to minimize the impact on having very clear guidance on a few things that give really rise to big concerns and then find a way to deal with that also in a positive way.
Rather than just take the traditional approach of making a massive washing list of all things that can be seen as branding.
And then say that, okay, that’s reverse solicitation that we don’t have and this gets out.
This is, first of all, it’s bad as an overkill.
And second, it is meaningless because you can easily avoid that.
Ian:
So that’s one example of these standards and things that are being brought out. ESMA is still working.
Yes. We are now in Q4 of 2024. 2025 is around the corner.
How do you feel about the pace of things?
And of course, that is also consideration for listeners and viewers of the podcast and MiCAR, you know, some things are clear, maybe stablecoins are clear, other things less clear.
How is it going to develop and how can you expect to be operating and doing business in the next months?
Joachim:
I think, and that is…of course, is very easily said, but I still would like to say it.
I mean, your factual description is right.
We are at a moment where we have many, many more unresolved questions on the table than probably we had one year ago, because one year ago everyone was saying, okay, MiCAR is coming and it’s nice or not, but let’s see.
Now we get into the nitty gritty of the details, having to apply it, et cetera. And then all these questions emerge.
It should always be in the world that the dog wags with the tail and not the tail with the dog.
What we see at the moment is that the tail is wagging with the dog because from some part of the regulatory sphere, proposals are out on standards that go way beyond the basic idea of the MiCAR regulation.
Now the question is who is the dog here and who is the tail? In my opinion, the dog is always
the economy, it’s businesses, is citizens, it is the reality in which we live.
No one needs to apologize for being there, no one needs to apologize for trying to make a business case of that.
So, I think the legitimate expectation that people can have is if you are a business, that you are proactive in identifying certain risks that might emerge from that and propose a solution.
That is what I would like to see.
In terms of things on which you complain. But then it is completely legitimate and I think also required from businesses to be assertive and saying that if this is the problem, if you don’t solve it or give me a practical answer, this is what I propose working around this and this is to the best of my knowledge what I should do.
That is actually the idea behind the reversal of proof on utility tokens in the starting part of the MiCAR regulation that we talked about.
Reversing the burden of proof means that “the dog” is the issuer of the token and only in very well-defined negative cases you can be prevented from doing so and it’s basically the same here.
I think that we have a very unhealthy focus now by everyone on a couple of standards and there are many from them also on sustainability and other things where I think that goes very, far to put it mildly, but that cannot be the last word.
The last word needs to be a democratic dialogue by everyone involved to improve things and not by a technical element within a chain of command, to put it like that, to determine what the market has to do.
That would not be democratic.
So businesses should still be very vocal and very active. vocal, self-organize yourself, get together.
I observe that more and more.
Bring your proposals, educate the regulator, make clear why you’re doing certain things, show at best example somewhere.
If nothing works, consider dealing with other people, but work first and foremost in part of the world, in your regulation where you are located within the you are outside and try to make the best out of it.
My experience is that the largest part of regulators are actually positive people that can be convinced, but you have to understand that they have their own line of thinking.
They have their own language. They have a certain mandate. Their mandate is not to make you happy.
Their mandate is basically to apply rules that they get from hierarchy.
And if you accept these basics, then if you engage, think that in a lot of examples, not every example, you can improve the situation.
Ian:
And obviously there are many companies preparing for MiCAR in various countries, Liechtenstein, France, Germany, all around. Quite a few CASPs who have been active up until now, got national registration.
Now MiCAR is coming.
Would you have any idea kind of generally how many legacy CASPs there are now going to be in the first wave of MiCAR?
Joachim:
That’s an interesting, interesting question.
I mean, what I would say is we are probably seeing a curve.
I mean, I might be wrong on that. just my perception, but probably when we look at now the first part of MiCAR that is now applicable – we see perhaps, and I don’t have the full overview, less applications and less licenses than we might have hoped for.
But we see an evolution towards, in some areas, now increasing interest and also an increasing number in licenses, for example, on euro-denominated stablecoins than we might have thought before.
So in a way, that reflects in what we discussed before. There was a wishful thinking world before the application of MiCAR.
Then there was a shock element that, always with regulators, when you want to do certain things and it’s not really 100 % clear, it takes longer than you think.
But now perhaps comes a sort of normality that now that this is there, people accept realities and work around that or work with it and you get more.
So in that sense, I cannot, of course, give you a very clear number, but I think that after the first disappointment of the numbers, I think that now there are more than I actually expected we’re getting there.
Ian:
Okay.
And maybe just last question as we look forward into the future.
I mean, obviously this is a big exercise to bring this legislation and then apply it across countries.
We have heard also from different guests on the podcast. There are still various levels of understanding among national regulators.
How long do you think it will be until there is a harmonization of understanding and then application within different countries?
Joachim:
In my opinion, what we observe is a very well-known anthropological fact that this is a question of time due to basically generational issues.
I mean, that is not exclusive to crypto.
We’ve seen that 30, 40 years ago with the collapse of the Soviet Union and satellite countries and the question of how to get market economy in these countries.
And I’m not discussing the question of whether it was sensible or not.
I’m just saying it was just the fact at the time that people were trying to re-educate people in the eastern countries.
And I was involved in that at the time and we tried everything and it didn’t work out.
Why doesn’t it work out? And that is very well known from institutional theory and from a lot of, I would say, research.
Basically people have their value systems, they have their belief and you just do not go there with a few facts and convince people that have their whole life held a specific belief system.
What happens is that old people die and young people come in.
And this the effect that we observing now. We now have a new European Parliament. I’m not saying that they are through DNA more intelligent than the previous one, but they are on average five years younger.
They know more about the digital economy.
They have themselves more experience with things that we are discussing. In the regulatory offices, it’s exactly the same.
You have very big ones, where the hierarchy is usually relatively old where have young people that know how to do stuff, but they are intimidated by the hierarchy or don’t know how to organize or whatever.
So that is a tanker that is difficult to change course.
You have the smaller ones that are normally more open and innovative, at least some of them, but that are not really with that much leveraging power in the international discussions.
But there again, it is a question of time on how that creeps in. At a certain moment in time, we have a young generation, we have 4 billion gamers worldwide.
They all live with digital tools with metaverse, with crypto, with tokens, they know that much better than we do instinctively of what there is.
At a certain moment, they will have the power to decide in their various environments and we will have all of what we’re dreaming of now will be a reality in 20 years.
The only little question, Ian, what do we do these 20 years? We have a process going there. We can make that process difficult. We can make that process a little bit more easy.
But at the end of the day, we are all dinosaurs staring at the meteor and saying, what a nice meteor and how nice life is and boom, at a certain moment we will be gone.
That’s what it is. So I think for me, that’s a very positive end note. I don’t know about you or anyone out there, but I think time is playing massively in our advantage.
And that’s something that I always also say to investors.
I mean, I know how hard the business is, but at the end of the day, if you want to stay in business, it is not about being the fastest swimmer. It is about being the last man to drown.
And if we can do that, then time plays for your advantage.
So stay in business, find your niche, do your stuff.
You will not be happy with everything, but as long as you’re in there, go with the flow. think that really time is very much bringing forward an even more massive momentum on crypto innovation.
Ian:
That’s a very, very interesting way to finish up. Very, very insightful. Thank you very much, Dr. Joachim Schwerin for joining RULEMATCH Spot On. Your insights have been very valuable.
Perhaps we’ll have you back again in five years if we have the chance to have this conversation again, evaluate MiCAR and some of the effects, wait and see.
Joachim:
Thank you so much for hosting me and I take you by the word because I think that everyone who is making prediction should eat his words.
So I’ll be very happy to look back in the world in five years and explain you precisely of why it has turned out completely differently, but I knew already why.
He used to be a rocket scientist in South Africa, but now James Kilroe and his co-founder Geoffrey van Ryneveld run Tendex, a market neutral crypto hedge fund with a focus on medium- and high-frequency trading strategies.
Spot On host Ian Simpson and James discussed the background of Tendex’s activities in niche crypto markets and its transition to more sophisticated strategies. Along the way, James explained what he thinks of the “financialization” of crypto, the weaknesses with current market infrastructure, market making strategies from TradFi and crypto and how they overlap.
Episode show notes:
He used to be a rocket scientist in South Africa, but now James Kilroe and his co-founder Geoffrey van Ryneveld run Tendex, a market neutral crypto hedge fund with a focus on medium- and high-frequency trading strategies. Spot On host Ian Simpson and James discussed the background of Tendex’s activities in niche crypto markets and its transition to more sophisticated strategies. Along the way, James explained what he thinks of the “financialization” of crypto, the weaknesses with current market infrastructure, market making strategies from TradFi and crypto and how they overlap.
(1:05) Intro to a rocket scientist crypto hedge fund manager
(3:32) The “financialization” of the crypto market
(6:39) The elements coming together for market maturity
(7:18) The backstory of Tendex
(8:12) Early arbitrage opportunities
(8:55) The simple beauty of the crypto market in the early days
(10:38) The missing puzzle pieces at the beginning
(11:50) From Python script to advance trading venues
(12:16) Home-built tech is still the best
(14:07) Getting around the fragmentation of unstandardized tech
(15:35) Challenges and opportunities of being a market neutral fund in volatile crypto markets
(17:22) Overcoming the “flat and the crab” with unique market-making trading strategies
(18:19) How Tendex turns tens of millions 10x per day
(19:05) Plugging in “slow” strategies to the cutting-edge tech stack
(19:40) The decision to go after the biggest, most liquid markets
(20:22) The leveling of the market and “time-based” strategies
(21:18) Where is the “basis trade” going?
(22:18) Why faster venues like RULEMATCH will make a difference
(22:28) Why a price discovery venue is needed in Europe
(23:18) Cloud-based tech vs bare-metal infra
(24:15) The curious thing about latency in crypto trading
(25:26) The need for deterministic venues
(26:00) What happens when “flows” flow off AWS
(26:55) How risk management gets forgotten
(27:45) Two lessons from FTX
(30:17) How FTX highlighted exchanges playing “bank”
(32:02) Handling data and the tech
(35:32) The crossover between TradFi and crypto market making approaches
(37:44) Trying to determine true price in crypto
(38:22) A TradFi strategy that isn’t “here yet”
(40:31) Post-trade settlement enhancing the role of a prime broker
(41:55) How the PB market is changing
(42:15) The tricky thing about custodians
(43:36) The diverse array of custodial service providers for institutions
(46:59) Prime brokers face off against exchanges
(49:24) How Tendex is set up with crypto service providers
(52:11) Sitting at the heart of Europe
(52:25) Understanding crypto investor sentiment and attitudes
(55:35) Looking out for stablecoins and digital identity
And so you’re very focused with what you do. Also, if I can just ask you straight out, not a huge fund, right, as far as AUM?
But trading very, very actively.
Can you put some numbers on that?
James:
Yeah, sure. So we trade in the hundreds of millions a day. The funds is in the tens of millions.
So it has a very active role. It’s a very busy fund, shall we say.
It’s obviously completely automated. You can’t put that number through with sort of…over a UI that wouldn’t really be feasible.
That gives us a lot of advantages that we think that some of those more high-chains strategies can level out the P&L, increase the sharp ratio if you want to get into some more technical stuff.
And it’s forced our technology stack to be cutting edge.
Ian:
Hello and welcome to RULEMATCH Spot On, the only podcast focused exclusively on the institutional crypto and digital assets industry.
I’m your host, Ian Simpson. And if you want to know what banks, hedge funds, asset managers, trading firms and others are doing in crypto and how they’re doing it, this is the place for you.
My guest today is James Kilroe, director and co-founder at Tendex, an algorithmic trading company based here in Zug with a market neutral crypto fund.
Fun fact, James got his degree from the University of Cape Town in mechanical engineering, where he also studied “space studies” with a master’s that focused on a device to deorbit satellites.
James, welcome to RULEMATCH Spot On.
James:
Thanks for having me.
Ian:
Is it fair to say – just to start out – with that we could call you a rocket scientist?
James:
I think my team might disagree.
No, yeah, it was a very interesting master’s I did in the University of Cape Town, looking at, I guess, satellite technology, designing a part for a small satellite to deorbit it.
It was a very interesting time, quite cutting edge, and always fascinating.
I think I’ve got a huge fascination in that area. And then I did another master’s at the University of Cambridge at the business school in technology policy looking at regulating new technologies.
Uber was very topical, but so was blockchain, which was funny. That’s sort where I fell into with my career and have been involved in this space since 2016.
It’s been a very, very interesting journey so far and lots of up and downs from token economics, ICOs. In the early days, I worked at a venture capital firm for a couple of the guys who were
in the Bitcoin Foundation and one of them was known as the Bitcoin Oracle at the time.
Maybe that is still his name, so his nickname at least on Twitter.
So it was a very interesting time and that was when there was only one or two or handful of digital assets.
Now there are obviously tens of thousands. And so it’s been a very, very interesting journey in the space and I guess some of that history gives me bit of knowledge and helps me in my day to day with Tendex.
Ian:
Super cool.
Thanks for coming on the podcast.
James:
Thank you. Thanks for having me. Excited for the conversation.
Ian:
You know, we’re going to be getting to many serious topics, diving down into the weeds of what you do with Tendex – with the trading, the setup of the fund and all of those things that you do around that with the tech.
But just kind of high-level..
Crypto funds now have become more and more of “a thing,” developing in different ways with different strategies.
At the same time, we have in the US ETFs now a big, big milestone for crypto – ETPs in Europe – for quite some time.
Just from your perspective with the fund and also being in the space, where do you think we are with the financialization of crypto?
In other words, crypto assets as underlyings in financial products?
James:
Yep. I think it’s actually quite interesting because I’ve been involved in the space since 2017 where there was, well, actually almost 2016 and sort of one of the big topics then was Ethereum had just launched.
And so it was Bitcoin, Litecoin, I think maybe Ripple and Ethereum.
So it was those four and there wasn’t this imagination of the thousands of products we have now.
The ERC20 standard that was launched on top of Ethereum was really the beginning of the “opening up” the ability to, you know, the ICO boom and all of these mechanisms which investors sort of grappled with and understood, and a lot of money was thrown at it.
A lot of money was made, a lot of money was lost.
But I think that happened in isolation where the rest of the world wasn’t paying attention, or maybe it sort of hit the front page of maybe the back page of the FT, I would say.
You know, not nearly front page stuff at that stage.
And that was maybe a bit ridiculed and laughed at by more sort of serious investors.
If we look, you know, seven years later, it’s completely changed.
And I think that the traditional ecosystem, or maybe TradFi, is entering in and undergoing a very similar process, maybe on an accelerated speed.
For example, it sort of makes complete sense to me that the first asset that had a spot ETF in the US has been Bitcoin.
It’s the one that’s been around the longest one that people can understand. The next one was Ethereum, right?
That kind of mirrors what happened 10 years ago. And I think that that will keep on happening at least for the top 10 or maybe 20 assets.
When you start to get into much longer tail of assets, liquidity problems, structures, etc it becomes of an issue.
But I definitely think that this financialization has only really just begun in terms of… If you just consider how few assets are open to a regular US retail investor through their retirement fund.
Coinbase has obviously offered them more earlier, but I think now is the time when the institutions are only beginning to look at the space in more earnest.
Obviously there’s maturity in the market, right?
Liquidity and all of those things for those top assets. Exactly. And I think that was required, right?
And I think regulation is a huge one as well because without the SEC and a lot of maybe the crypto ecosystem.
Bitcoiners are very anti the SEC chairman and maybe have some strong views around what the SEC’s done in the space.
I think it’s…without the SEC approval, no one who’s more serious in the US or institutional in the US can have a look at it even really if they wanted to, right?
It’s a huge endeavor for them to get access to this space. That’s changed.
Ian:
You’ve come along with Tendex and developed now with the fund and with other things.
Just kind of walk us through the process, how you got to where you are today.
James:
Sure. Yeah.
So in 2016, I started an internship at a venture capital firm that was in the blockchain space technology policy background, which was sort of looking at more regulations.
I thought it was very interesting and got going.
That was the beginning of a bit of a journey. I did some ICOs for some portfolio companies.
Some of the partners are still very involved in the space. It was a growing venture capital firm.
It was very exciting, that whole 2017, let’s say, cycle. In that cycle, I realized that these tokens were trading incredibly inefficiently, that there was a huge opportunities.
I frankly… I was at the time based in South Africa, and I am South African, I was based in South Africa.
There was arbitrages that appeared inter-country, there were arbitrages that appeared across venues.
There was really just the beginning of the tokenization in terms of more assets were being launched.
That 2017 was really that period where we saw more and more assets.
And so then myself and my partner Jeffrey, who is an old school friend of mine (university-friend as well, we’ve known each other for a long time).
He was trading commodities at Glencore. I was maybe more in the weeds in the blockchain stuff and we got chatting about how could we do this?
And we got going in sort of late 2018 with just some development of some trading strategies, very, very simple code.
That was really quite the beauty with the space because these exchanges were API enabled, so they allowed maybe much smaller players to get involved initially.
That had some good success.
Then we went and we raised capital from investors through a fund structure that was started, probably started about June 2019.
We could show them some of the results and grew and then in Jan 2020 we launched the fund that was Tendex with the aim of being market neutral.
I think it was our first fund.
We were very open about that with investors and I think what was important is that they could understand some of these strategies.
At the time, if I’ll be frank, a lot of them were very skeptical of the asset class.
They maybe understood it was an asset class, but they kind of maybe some of them believed and maybe some of them still do believe that Bitcoin was going to zero.
I think the COVID shock and maybe the money printing associated with COVID after that changed some of those views, but that was very much the dominant view.
And that allowed us to get going and drive a bit more quantitative strategies and try and be the smart, more sort of maybe cool-headed money in the room as you go through these cycles.
And yeah, that was over four and a half years ago.
Lots happened since. We’ve grown the team. We’ve refined our strategies. We’ve really nailed down what we want to do.
And it’s been a big journey and lots of learnings, but a lot of fun.
Ian:
And when we talk about building it, we’ve had some others on the podcast talk about “in the basement.”
You said you and Jeffrey got started just kind of building some things yourself, so basic to start with and then grow in from there.
What maybe was missing, or what were the things that you had to put together in order to get started and launch with the strategies that you started with and then developed?
James:
Yeah.
Really, if you wanted to get going, you needed to code everything from the API level up, understanding what the asset classes were, how different …
Because at that stage, it’s all different venues, and they still do have very different technical interfaces, how all of that works, how to safely send assets between exchanges, what that meant, what a custodian would look like, how that fits in.
All of those pieces were missing down to access to bank accounts as an account.
There was a long journey of being able to put all of those together.
I think we were lucky in the sense that we could keep it simple and simple strategies were sort of sophisticated enough to make money at the time. Those strategies wouldn’t work now.
That in itself has raised the barrier to entry because if you wanted to launch now, you would need more capital and a couple of years of development.
I would think to launch at the cutting edge. Of course, there are more venues coming in that require latency then, could have been sort of a second….
A Python script could have almost done some of the trading that you needed to do now. We talk about micros. Not even a milli down to a micro.
It’s changed drastically, and that puts huge burden on the teams that keeps teams driving forward in the ability to need a certain speed to trade.
Ian:
We’ll talk about some of the strategies maybe a little bit later and some of the tech and so on.
Yeah, speed has become quite a thing. You built all this tech and now you also sell it to others or you make it available to others?
James:
So we work with a few very exclusive partners and we assist them with some of their needs.
It’s not a retail offering in the sense that there are very big companies in Switzerland, a few come to mind, that do this professionally.
That requires a whole different suite. We’ve been lucky enough that the technology suite we can refine to our trading needs. We’re on version three of it now.
And being in version three, we have both built a generalize enough that we can adjust as new strategies come into the system, but also have made sure that it works incredibly well.
We’ve put a significant number of orders through it every day, every minute.
And that’s been really, really interesting as well. So we’re very happy with it.
And we did toy around an idea, should we sort of outsource this, but there are other well-capitalized players in the market that provide this.
To be honest, the people that want that sort of system are OTC desks or other providers that you would require quite a few other pieces to do it.
We think it gives us bit of an edge on tech, and so we’re holding onto it.
Ian:
…for yourself.
James:
Exactly.
Ian:
You talked about at the beginning with the different exchanges, shall we call them. We have maybe a different view on that word, but anyway.
All of those different standards and the different things that you have to build kind of custom here and there.
I imagine that was quite a challenge at the beginning to connect and do all of these different strategies when nothing is standardized anywhere.
Nothing is really built at the beginning for institutional kind of strategies, right?
James:
Exactly.
And I think a lot of the learning in the firm, if you call it sort of the institutional knowledge or the firm’s knowledge, is understanding the patterns that are required so that we can spin up “venues” or whatever word we want to use, into our system, being able to take the product that the venue offers, whether it’s spot or a future of whatever form or an option.
And then break that up into well-recognized, understood risk categories, how we ingest it into the system.
All of that needs to be standardized. that was a very time-consuming thing to design.
The nice part now, at least the way we believe it, that it’s generalized enough that when …
The one thing about crypto is you can always be sure that another thing is going to come along.
Even the biggest instrument, which is the perpetual future, is not something that is TradFi. It’s a novel instrument relative to TradFi.
We’ve built it in a way that it’s adaptable and changeable as new interesting products come along.
Ian:
Let’s talk just a little bit about the fund you mentioned, the market neutral fund.
With volatility in crypto, this is quite an interesting thing, as you alluded to before. There’s maybe challenges with being a market neutral player or opportunities.
Just kind of walk us through how you see that in crypto versus maybe TradFi as well.
James:
That term can encompass a lot of different funds. And I think it’s quite difficult for investors to work out exactly what type of fund it is and then speak to the manager to understand.
I think something like 2022 showed us where yields began to dry up and some funds, understandably, but maybe increased their risk profile, started to take risk that maybe wasn’t necessarily in the spirit of what investors understood.
The way we understand it is it’s a fund for all markets.
We limit our market exposure, our “deltas” quite significantly, while within the parameters that the fund and we share with investors.
And that allows us to, on any particular asset, that allows us to generate returns in all environments.
Of course, typically volatility and a bull market brings a few things.
So, you know, the sort of old analogy of up on stairs and down on a ladder.
There’s a lot more volatility and a lot more sort of movement in a bull market.
There’s obviously more trading volume as well. Maybe they’re also less discerning fundamental investors that are willing to buy at any price.
You know, as a market neutral, you can help facilitate that with them as providing liquidity.
In a bear market typically, it will move quickly in those days, can be very profitable, but then it can be flat for a while afterwards.
The flat and the crab can be a little bit more challenging.
We’ve spent a lot of time understanding the market: our strategies, of micro market strategy, the broader market strategy.
We think we can offer investors quite a unique proposition because I think more…well, there are many different ways of doing market neutral.
We’ve lent more into the mid-frequency, some of the more high-frequency, almost market-making stuff.
It’s actually quite difficult to get access to those strategies in traditional finance.
Traditional finance, market makers, and increasingly this space dominated by other big investors and other big shops, you’ve had some on [the podcast].
And you can’t necessarily access those as an investor.
It’s nice to be able to offer that sort of strategy to interested parties.
Ian:
And so you’re very focused with what you do. Also, if I can just ask you straight out, not a huge fund, right, as far as AUM?
But trading very, very actively.
Can you put some numbers on that?
James:
Yeah, sure. So we trade in the hundreds of millions a day. The funds is in the tens of millions.
So it has a very active role. It’s a very busy fund, shall we say.
It’s obviously completely automated. You can’t put that number through with sort of…over a UI that wouldn’t really be feasible.
That gives us a lot of advantages that we think that some of those more high-chains strategies can level out the P&L, increase the sharp ratio if you want to get into some more technical stuff.
And it’s forced our technology stack to be cutting edge.
If we want to and we can and we sometimes do bring in more slower mid-frequency or sort low-frequency strategies.
Those can plug into that same strategy set very, very easily.
We took a view in 2020 and 2021, we were training much more niche markets.
We had some great success, but in sort of April 22, there was a big market reset.
Volumes went way down. And in about June 22, kind of, Jeff and I had a discussion.
Do we take the money? We return the money we’ve made for investors, return the fund. We’ve done very well.
Or do we take all the profits that we’ve earned from that time and build out a team and really go after the biggest markets in the most liquid instruments in the space?
And we chose to do the latter.
So it was a bit of a building period as we desperately and as quickly and efficiently as possible try to retool our systems.
We did that in ‘22 up until the end of last year.
And we launched that in December ‘23 right into the beginning…I’m hesitant to say…I don’t necessarily think this is a bull market like everyone else’s.
This strikes me a lot more like 2019, but that’s been very successful.
That cutting edge version three of the system, we think it’s got a significant durability just because of the flexibility, the flexible nature of it, and the speed and reliability that it trades at.
Ian:
So always adapting…. That’s very, very interesting.
Because as you mentioned in the early days, there was quite some differences probably in speed across venues.
There was differences in liquidity, price, so on and so forth that you could take advantage of. Now things have kind of leveled out. We’ll talk about the fragmentation in the market, which is also an opportunity. I think some of the strategies you employ are time-based, in other words, futures versus spots and those kinds of things.
Derivatives have been very popular in fund strategies up until now.
Is there something that would shift things towards spot or what do you think it would take for there to be kind of a change in some of that?
James:
I think that the strategy that most, a lot of market neutral funds, right, it’s not secret, is the basis trade. That worked very well at the beginning of the year and it has its moments.
It worked very well in 2021.
I seem to think now that with sort of Wall Street level of capital and being able to access the CME and the spot, I’m not necessarily convinced it’s coming back to the same degree.
Just in the sense that the second it becomes attractive again, any fund on Wall Street can put the trade on and there’s enough liquidity there to crush that.
And so we’ve worked quite hard to make sure that that isn’t the only fund that we have in our in our system.
Obviously, if it’s available, we’ll take it. Why would we leave it out?
But we’ve worked hard to make sure that we can perform around that.
That was the spot, some of the spot versus the basis.
I think in traditional finance, if you look at maybe FX, FX spot versus FX forwards or derivatives on stocks, there is always an order of magnitude more trading on the derivative side because your margin requirement is much lighter.
What I do think is interesting though is that more venues like RULEMATCH are coming out that are very fast and will drive, I think will drive price discovery and I think that’s quite useful because I don’t think that there’s a big venue in Europe that’s currently driving that.
So if you look where the flows are, at the moment it’s in Tokyo, it’s actually in AWS region of Tokyo if you want to get specific, is where the biggest venue in the space is.
And then on the US side it’s sort of in North Virginia, which is again the AWS region of the US’s biggest provider, but there’s nothing in Europe.
I think it’s quite important and useful as you look at the three different trading sessions and time that there is a strong price discovery that goes through Europe.
Ian:
Interesting you mentioned AWS. We like them very much. We use them for some things, but not for everything. Maybe in the technical weeds of things that has been one criticism or maybe among professional traders, a criticism of venues and the tech that it’s cloud-based, it’s slow, there’s different things.
Is that something that you see and watch and try to avoid or take advantage of?
James:
Yeah. I’m always a little, know, speed, if we get down to one micro, you know, let’s just say, I don’t know if it can go much faster if we get down to one mic or maybe eight to 10 micro.
Wall Street operates in about a 20-mic range, maybe even half of that now.
You will just have the players that can operate on that range will remain in the market and everyone else will fall away.
So in a strange way, it being a bit slower isn’t an issue because everyone just recalibrates that speed.
It does introduce probably more competition because smaller shops can still compete at that range. Different strategies will work.
However, what is very different in the cloud ecosystem that’s more frustrating is the indeterministic nature of it.
So under load, might not be millis, it could be hundreds or even seconds if something gets overwhelmed or that kind of thing.
That’s a problem.
And that’s a problem for anyone because your trade, doesn’t matter how fast you are there, your trade might not place when you wanted it to place.
So if everyone knew it was 100 milliseconds or one micro, the game would be played, who could play it might change.
But it’s the indeterministic nature that causes some issues.
Having said that, some of those venues have, they obviously are looking to deal with that.
And the technical side, we spent, and that’s maybe another bit of firm knowledge we’ve picked up over the five years, which is how to optimize some of that.
We don’t actually consider our edge speed. We just know we need to be fast enough because otherwise anyone could pick it up.
So we need to be on a level playing field.
But we don’t…we don’t think of ourselves as sort of speed being the thing that that’s going to give us an edge.
What is exciting is when (funny enough) you know venues become more deterministic, which is a big element that for us is actually much more interesting. Because bigger shops are probably better at working out sort of non-deterministic/first deterministic speed and how to sort of modify their orders associatedly.
That’s just another element that we wouldn’t have to worry about.
So “deterministic speed” for us is probably more important, kind of “at what frequencies” – a little bit less so.
And yeah, I mean, I think what will be interesting to see how flow off AWS into more sort of bare metal servers, you know, such as yourselves and RULEMATCH as the space develops and maturity grows.
Ian:
So obviously the end of ‘22 was the time of FTX – when that all blew up and it seemed like you at Tendex weathered that pretty well.
But due diligence and “know your venue” was pretty important. That continues to be important for you today?
James:
Yeah, that’s my primary job, I think.
You have to make sure. I think we are getting to a stage now.
It’s been very interesting because the space, maybe I’ve got a bit more of a track record, a bit more of a memory than others having been more involved in it, but in 2016, 2017, there were a lot of fly-by-night shops.
That’s where trades were happening, and people were very concerned about risk management, and probably because a lot of the hangover of the industry was Mt. Gox.
That was forgotten in 2019, 2020.
And I can distinctly remember in 2022 thinking the yield-
Ian:
Don’t forget about that.
James:
Yeah, exactly. 100%. Exactly.
And the yields that were being offered, you could lend money to certain counterparties that have turned out to blow up at yields that we weren’t finding in the market.
The risk was getting higher and higher. And so we were gradually de-risking throughout the year.
And that was just to make sure that we cut our exposure to as many venues as we could.
And I think with FTX, the lessons there are twofold.
One is that the market, I think, was a bit naive.
I think it’s become much more skeptical.
But also the power of the blockchain maybe wasn’t identified.
People could see the assets on the balance sheet in the sense of the deposits available on FTX.
Those wallets have been mapped by open-source investigators, if you want to call them that, or open source researchers.
So everyone knew what FTX had.
What maybe people didn’t fully understand was obviously the other side of the balance sheet.
So you could see the assets, but you couldn’t see the liabilities.
But when the assets started to dwindle, you know, the space was relatively slow to understand, and maybe more importantly, not just the value of the assets, the composition of the assets.
I think that that’s become quite interesting.
I know of one venue that, and these venues have all now fought to keep, there’s been a huge drive by fund managers to say, well, off-chain custody.
There are obviously a bunch of solutions that are trying to come in. I don’t think all of them have yet quite cracked that – not across the whole industry.
But I think that that’s something that’s coming.
But a bunch of the venues have also started to open up. I know there’s one that you can log in and you can see your balance, and you can kind of cross-check and reference that onto their deposit stack.
And the idea being that if any sort of assets being double-counted, people would work it out.
So it’s a bit of a crude method, but there they’re trying to give you not just access to the liabilities, sorry, the assets, which you can see, but also being able to link some of the liabilities.
And just to try and make sure that there isn’t a significant mismatch.
Yeah, it’s very interesting. I think that the space has got a little bit too… I think that after FTX, naturally, a lot of fund administrators, a lot of fund managers promised investors that they had good custody, they had good solutions, and maybe they fell a bit short.
But then on the other hand…
And so as a result, the market’s gone a lot more, almost too over the top in terms of trying to understand risk.
That’s maybe left quite a lot of off on the table.
And I think the risk at the moment is in the space is very low.
On the other hand, it’s driven a lot of good innovation and much more sort sophisticated players and venues coming along.
And that, I think, will already be a positive in the longer term.
And it’s made it easier for the regulator.
Ian:
So one thing that the FTX scandal probably highlighted, and of course people have talked about it and people are talking about it more and more, is the “separation of duties” when it comes to an exchange, a market maker, a custodian, somebody like FTX basically playing bank.
How do you see that?
James:
I think it’s important. I think we need to play …
Well, it seems like the space is going through financial history on a sped up time frame.
A couple hundred years ago, exactly the same set up would have been the stock exchanges, then things blow up, the regulator steps in.
It seems that the space is trying to adopt some of the best practices.
It does make sense to me. I can understand why Binance, for example, or other venues want to keep their assets because for them, if they just become a matching engine some of their … They may have to compete in just being a matching engine.
To be honest, that technology stack isn’t as good as … More of a commodity. Yeah. I think that they would struggle there relative to others.
They want to keep the full stack.
I think that the other thing is that a lot of the space is more retail at the moment.
It’s very hard for other venues to onboard thousands …
Well, not other venues rather, but other parts of the market to onboard thousands and thousands of retail investors. They had a different decision set that they chose.
For us who are more institutional, we’re desperate for those sort of solutions.
And as soon as they sort of become practical, of course we’ll adopt them because all that does is lower our risk, which sort of increases our risk adjusted returns by function of the fact that the risk is lowered.
Ian:
So probably two things looking just a little bit more under the hood here that are important for you at Tendex, data and technology.
And I imagine as a very actively trading firm, you use a lot of data, you process a lot of data.
How do you deal with that? How do you process it? How are you set up even technically to deal with that amount of data?
James:
So that’s where think cloud infrastructure is really good, right? Because you can scale databases, can scale instances or computers to process if you need to.
You can run time-based jobs that periodically scrape or fetch data from whatever source.
That’s another whole part of our technical stack, which is the data ingestion side.
It needs to take it and it needs to be reliable. That’s a given.
Then we need to both store it, process it, and then understand, push it onto a trader after verifying its integrity.
That whole stack runs in the cloud. Most of our stack runs in the cloud.
In fact, all of our stack runs in the cloud. And it’s been a very interesting part.
I think now the space is getting better, because a lot of that also comes down unstandardized.
Small examples, but candles. that’s open high, low, close, over whatever period, a minute, an hour.
Some exchanges have a different understanding of whether that candle’s of the open or the closed minute, right?
So even just is that candle, that open time referring to minute one or minute two?
You know, that’s just a small example that would throw off a lot of your backtesting.
So you have to go and check all of that.
What we are increasingly seeing now is, again as you would imagine, more sophisticated data providers.
There’s a whole swath of on-chain data that we have a very limited exposure to. That’s coming in.
Of course, there’s been the sentiment sort of X or Twitter or any other sort of maybe Reddit, any other sort of sentiment area.
That’s another whole section of data that we don’t really touch.
A lot of those, and there are professional shops that are doing those.
So we try not to build our tech if we can avoid it, but sometimes it’s required.
Ian:
And so you’re not putting any AI on this data to help you analyze and…
James:
Not at this point.
I think I found with investors, it’s quite hard to explain AI.
I mean, AI is a big box. I think AI is one of the few things that’s maybe at the moment very in vogue, and so people are willing to maybe take a risk.
But think there is a lot of more simple strategies still out there and not really required.
In time, that might change, so there are some sort of basic …
It is useful for some things, but at the moment there hasn’t been a huge need for us to execute a bunch of sort black box thinking.
Also it just becomes much harder to explain to investors where … That’s something that’s very important to us.
Ian:
It can go one way or the other or a million ways all at once.
James:
Exactly. And for us to ensure that it behaves the way we expect it to behave. It’s maybe a small part of the system, but it’s a part that could … Hey, why …you know, a small script, very different to how small scripts could.
Ian:
So obviously market making is a big part of what you do and part of the bread and butter, shall we say, of what you do at Tendex.
Of course, market making in crypto is a little bit different than market making in TradFi.
Some strategies overlap and can be used, but there are some particularities or peculiarities in crypto. Just tell us how you think about that and what you’re doing and how you’re approaching market making.
James:
I think a lot of those players have been around for quite a while.
I think some of them Jump Trading, made a lot of noise, you know.
They had a sort of crypto division that seemed to maybe backfire on when some of the sort of, you know, maybe the LunaTerra and they were sort of investigated…were a firm that on Wall Street made a lot of money by not making a lot of noise – tried a different strategy in crypto and maybe they’ve rolled that back.
I’m pretty sure that all the big Authorized Participants of the ETFs, Jane Street, I know you’ve had Flow Traders on here.
Those are all very big firms that are very involved in the space.
I think even more, some of them are even involved in DeFi, much deeper in the weeds than people would realize.
Yeah, I think for us, we can be a little bit more nimble, maybe a little bit smaller.
We can provide some strategies that are maybe more crypto specific.
We thought of this and we have the ability to build this in crypto sort of from the ground up.
And we think we can provide liquidity in a slightly different way to them and where their strengths are maybe being able to move significantly large checks at once. Maybe we can focus in on the other side, which is quoting as tightly as possible on sort of slightly different tokens.
So we’ve managed to find a decent edge that we think is durable.
It will only get more competitive over time. I think it is already.
If you look at the best data that you can find in some of the sort of spreads on the traditional markets, and then you look at the tops of the crypto markets, they’re not far off, to be honest.
I think that there is a whole difference in crypto, maybe closer to FX, is what is the true price?
Because there are a bunch of venues across the world that trade USD, Euro, much like they are the trade BTC, or BTC USD like RULEMATCH does.
And then the question would be, okay, well, what is the true price?
And that’s slightly different to a stock, right, which typically would trade in one, maybe in two places. so, you know, understanding that whole ecosystem requires more “FX way” of thinking about it.
Ian:
You mentioned some of the players in the space and Flow Traders being one of those that have come from traditional finance.
Maybe just to throw a question at you, is there some strategy, market making strategy in TradFi that you think definitely would not work when it comes to crypto?
James:
So some of the ones that are, I guess, interesting is that in the traditional markets, because of the role of clearing house and PB, you can leverage up significantly more.
Because that’s in the traditional space. In the crypto space, it’s 24-7 settlements.
If you take out of a large leverage position on a future and the market moves against you, even if you are hedged somewhere else, you need to margin manage very closely.
Of course, you could over-collateralize both sides, but then effectively you’re losing returns.
What you need to do then is be very cautious around some of the leverage.
I think a lot of the strategies that can be run in traditional finance, because you have that PB or the role to see both sides, that allows you to…
They effectively take the risk, and there’s a T+2 settlement.
They take the risk with a lot of your collateral management, and they can of see.
Obviously, we’ve had the credit space issue where PBs blew up and the damage involved with that. There is genuine risk for them there.
And they need to manage it well, but in the crypto side, the exchanges or the venues have this 24-hour settlement.
If you get into a liquidity zone and you get liquidated, that can happen to you.
And so I think that what will probably happen, and as other parties come along, RULEMATCH being an example, and because of your guys’ setup with qualified security firms, banks. Exactly…
I’m not quite sure what the regulatory term would be….
They can take the risk and so you can have more leverage.
I’m sure eventually, as you guys get more sophisticated spot, eventually maybe other products are offered where leverage becomes a thing. Those other providers can provide a key role in enabling that.
Ian:
Also, with post-trade settlement, that adds another layer of…
James:
It’s all pre-funded. It’s marked live. As a result, actually, a lot of these strategies that you run, you’re very, very conservative.
If you’re not, over time, you’ll be found out.
Moving that capital around, being capital efficient, effective margin management is another huge part of the game that maybe…
It doesn’t exist as much when you’re trading as a small shop. Like us, we would have a single PB that we would work quite hard to get a relationship with because we would be a small client for them.
But in this space, we do enough volume to have a relationship with multiple exchanges and have very good relationships with them.
But the one place they’re not going to give us any flexibility on is margin. That is something we just have to manage ourselves.
Ian:
Right, so you talked about prime brokers and obviously for a fund like Tendex there are many different pieces of the puzzle.
If we talk about service providers, all of those things that come together to help you do what you do.
You have banks, have prime brokers, you have liquidity providers, you have many other players, custodians as well.
Just tell us how that constellation looks for you and what you’re doing and maybe how it has developed maybe all.
James:
It’s ever-changing, which I think is a little frustrating because I spend a lot of time thinking about where the risks are and that constellation, what’s changing.
Obviously, a lot of these firms are still finalizing their product offerings.
Some of them, they offered one product for a couple of years.
They decided that that isn’t the way they wanted to go.
They pivot, so that affects us. I think it’s going to look more and more …
If the big money… The space will bend into what the big money wants.
I think the big money wants what it can see in TradFi and I think hopefully there’ll still be fast settlements, that kind of thing.
There’ll be some of the benefits that this technology stack enables with some of the more security that maybe more traditional finance has…a clearing house, a proper custodian.
One of the big challenges at the moment with the custodian is you can have a custodian and you can store your assets there.
But if you wanted to trade with those assets, it’s sometimes a bit harder, right?
So a venue like RULEMATCH is perfect.
You have your assets in the bank. The bank handles that part.
The trading venue trusts the bank. That’s no problem.
There are beginning to be other solutions in the space as the demand is ticked up. I guess maybe these venues are being leaned on. But it’s still not to the level.
And Switzerland has been incredibly in the forefront of this. And so I think that’s incredibly promising for the Swiss ecosystem within the space of being based here.
But I think that we’re still a way away from where we want to get to.
Ian:
So maybe just on the point of custodians, actually, it’s very interesting how things have developed in the crypto space. have, of course, exchanges who kind of play custodian – play bank in some ways, at least for retail clients.
Then you have technology providers like Fireblocks or a Metaco or others who develop the technology, then you have banks who are starting to come into the space and offer custody.
How do you think that’s going to develop and will that change?
Will it all move towards the banks or will we have some kind of maybe partnerships and crossover between one kind of service provider and the other?
James:
Look, I think you can split them into two.
I think you can split them into maybe using crypto parlance, both a hot wallet and a cold wallet custodian.
If you bought Bitcoin early, you sold two pizzas for 10,000 Bitcoin or whatever happened.
Ian:
Hopefully not.
James:
And if you sold them, if you got the 10,000 Bitcoin, you the trade of the century if you kept it.
So assuming you kept all of that and you’re now very wealthy and you’ve got your 10,000 Bitcoin, then there are a few banks that offer this.
And you want to be very sure that that’s secure.
So you need to put that away somewhere.
There is another element which the space is slowly beginning to question.
And I know a lot of people working this, which is how do you earn yield on that?
That is now an enormous sum of money.
The custodian will obviously charge fees. So is there a way of earning yield on that?
But parking that aside, that custodian is someone who you want to have a big balance sheet, a bank you want it to be safe – as cheap as possible secure, you know
Think Swiss Alpine vault, right? Sort of ex-military vault. I think there are a few providers that offer that.
The flip side is what we would want, which is sort of custodian, but also access to being able to trade because, you know, we’re on the other side of that.
So maybe more sort of hot wallet. There it’s going to require an integrating into every venue. You know, maybe the venues consolidate, but consolidate to three to five or 10, you would still need to integrate into those.
You’re have to be able to deal with each of those venues.
What does that mean? Where are the risks?
How do you ensure that the capital isn’t being double spent? All of that kind of stuff. What is the agreement with that venue?
Who has the right to the capital? When?
That’s not a legal question. Then that custodian needs to be big enough that we have comfort in it. It doesn’t need to be a very good technology stack because of all of the unlocking and locking of capital quickly.
It doesn’t need to be a bank with the Bitcoin that we’re looking to not touch in a thousand years.
And so I think that there will be role for two of them. It think that we got technologists that went to solve the custody problem.
So you’ve got firms that are very good technology suites that enable an OTC but aren’t qualified custodians.
And then you’ve got now firms that backed by big banks and that are more on the custodian side.
So it’s really about just trying to find your balance to work out exactly what you need as a firm. And because there are multiple needs in the market, I think there’ll be multiple service providers. Multiple angles.
Ian:
So you mentioned prime brokers, and obviously that is something that you use quite a bit and maybe even need as an active trading firm.
How can we expect those to develop? Do you think there’ll be more people coming into the space, broadening, deepening their offering?
Adding more services, will others also come into the PB space and try to take market share from others?
James:
Yeah, I think so.
I think some of the venues have been more hostile towards prime brokerages, which is interesting.
Ian:
For any particular reason?
James:
I think prime brokerages make fees competitive because if you just think of it in, I don’t know, strategy, company strategy – you suddenly have a thousand counterparties that are all quite small, or you have one big one, that changes the leverage power.
I think that there’s been a bit of a sort tussles around who deserves the fees, what that looks like.
And so I think that these prime brokerages need to really refine their offerings.
And it’s been interesting working with them as they go through some of these problems and challenges.
They’re very, very switched on teams, well-funded and smart, and obviously looking to do that.
It’s not just been a proliferation of prime brokerages, because I think the exchanges are, for lack of a better word, fighting back or saying, well, “Hang on, we can provide, also can provide fantastic access to these…”
Ian:
And so who’s going to win that battle?
James:
We’ll have to see. But I think that competition’s healthy, right?
That provides a better end user experience if we are the end user in that case.
The one thing that’s missing there is off-chain custody. So if one of the PBs could, and I think that they’re beginning to, but partner up and provide off exchange settlements, et cetera, then that suddenly becomes interesting and people are willing to pay more for it.
And I think the exchange can sort of understand some of the offering.
Ian:
So you mentioned obviously being in Switzerland and that’s a subject that we like to talk about, of course, quite proudly since we’re glad to be here and feel that Switzerland is a good place for crypto companies.
Not only because of legal and regulatory clarity, but because of the maturity of the market and the different service providers that you can find here.
Talk just a little bit about how you are set up, I mean, obviously as a fund, you have banks, partners, have operations maybe in different places.
Tell us how that constellation actually looks for you and why Switzerland is an important piece of that puzzle.
James:
Yeah, so we’re a regulated investment manager. We regulate under FINMA as a portfolio.
When we started, we were under exemption, and now we are sort of full portfolio manager.
That was back in 2019, so that was a long time ago.
And FINMA, I think, the regulator in general here has been very pro the space, and that’s part of the decision.
When we looked to launch this, Jeff was based here. I’ve been a bit of a bias to stay with he is a Swiss citizen.
Well, we could have gone inside back to South Africa, we could have gone to the UK, but the clarity that the Swiss… One, obviously the reliability of the brand. being in a risky asset class is nice to have the of the Swiss brand, which the countries work very hard on, of reliability and stability, et cetera.
But I think that the regulator is enforced that.
And I think that a lot of ecosystem players, it’s not just the regulator. There’s been a huge amount of work done with the ecosystem to educate the regulator.
Critically, there’s been a desire for the regulator to listen. that’s been, you that’s the death knell in regulation is when you don’t allow innovation, you put regulation ahead of innovation.
I think Switzerland’s really struck the balance well, at least in my understanding, and you know, you can see the crypto value, et cetera, of saying “what risk does this do to the more broader population? Can we tick off the most important things, so AML, KYC, all of those kind of anti-money laundering, all of those protections.”
So those are the non-negotiables.
Fine. So that’s done.
The next thing to say, okay, well, does this put the broader financial ecosystem at risk?
Is this putting very sophisticated investors at risk? Do they understand the risk? Well, they’re very sophisticated investors. They probably do.
So then we sit in a situation where FINMA has been able to say “Okay, well, let’s start to understand these digital assets.”
And then from there, it went to ETPs, et cetera. I think that’s been a huge credit.
So we sit with a Cayman Island-based fund and a Swiss investment manager.
The fund is all offshore. the investment manager’s here. It’s nice to be here because you get good access to lot of the exchanges and brokerages and venues that are sort of reliable in the world that have a presence here.
And you can access and have discussions with custodians and a bunch of things because this is a global financial center and so this is a critical mass.
Ian:
You’re sitting in the heart of Europe.
James:
Exactly. It’s a critical mass and it’s pretty easy to get anywhere else if you need to go sort of see a partner or potential investor or whatever.
Ian:
And so your investors are here in Switzerland or in Europe or all over? you say all over?
James:
All over, yeah.
As per regulation, we can only take qualified investors.
Ian:
So you wouldn’t be able to say something to the level of understanding of Swiss investors versus investors in other places versus more globally.
James:
So I think it’s been interesting.
I think it’s maybe broadly done a bit of a wave. It was initially a skepticism, but understanding, I think, the initial cohort of investors you could sum up with mostly senior professionals, typically maybe senior financial professionals that were skeptical of the asset class but understood markets, understood inefficiency that is in markets and that people can provide liquidity.
That’s been done for thousands of years and will continue to be done in a new market and do well.
Then there was a bit more “hopium”, sort of the hope around the sort 2020.
And then, obviously, I think FTX set a lot of the ecosystem back quite a few years.
And if you just look at when last the space was on the front page of the FT, well, was a lot of the 2021 stuff.
And then it was just the FTX trial.
Then that finally disappeared. And then it was the Bitcoin spot.
So investors are only now, I think, beginning to really wake up again to the asset class. I don’t think there’s been a huge amount of new capital raised more broadly in the ecosystem this year, other than maybe just the Bitcoin spot ETF, which is set into Bitcoin.
If you look at the outperformance, Bitcoin has outperformed other than maybe three or four other assets.
And normally it lags, right?
Because if you see it as the less risky of all of these digital assets, normally it’s the one that lags and it sort of outperforms in a bear market.
That hasn’t been the case. And that’s kind of partly why I’m a little bit skeptical that this is, you know a fully blown bull market just because we haven’t seen huge amounts of risk on exuberance within the digital asset space.
And I think investors are now beginning to pick that up.
Investors are sophisticated. Everyone has heard of this space and I think we don’t try and convince investors about the space.
Look, we’re lucky enough that our strategy is a little bit space agnostic. I think it’s tougher if you now, with the Bitcoin ETF to be honest…
You have some competition there. you’re a long-only trader and the question would be, can you outperform a very, very cheap ETF, let’s say effectively free, relative to your “2 and 20 fees”, I’m sure some funds believe that they can and maybe have shown that they can.
Investors can also think, well, I can park and get 80 % of the exposure based on this. So maybe investors offering volatility dampening….
Ian:
So the last question that we always ask our guests and I’m always interested to get the answers of those who come on the program.
Is there something out in the market in crypto or maybe even at Tendex itself that is coming up in the next six to nine months that we should watch out for that actually nobody is talking about yet?
James:
I think that there are two things.
And it’s, the one is maybe more spoken about than the others. I’ll start with that one first.
Stablecoins are obviously a huge topic, that’s, you know, anyone who’s listening to this will understand.
I think what people don’t necessarily understand is how much they’ve penetrated commerce within sort of Africa or in more emerging markets.
I think we sit here in Switzerland and, we pay for our lunch using Twint and, you know, money around is relatively quick and we struggle to imagine that.
You could be in a country where access to dollars or being able to send dollars is very hard.
Just an anecdote, last week a friend of mine was booking a fairly sophisticated or fancy safari, had the option to pay in USDT or Tether for this safari.
Ian:
In South Africa?
James:
Yeah, I think that was into Africa. But he’s based in South Africa. that gives you an option where this is a sophisticated, a couple of thousand dollar transaction that a provider would rather use than necessarily USD because of some of the challenges and that’s something that will only increase to grow.
I think that there Tether sits with a huge opportunity set because it is incredibly profitable, I think more profitable than BlackRock in 2023.
I do think it has, of course, a huge amount of regulatory challenges but they have a huge bankroll to solve a lot of those issues.
I think that it has deep market penetration so it’s going to be very interesting to see can the regulatory incumbents or “up and comers” sort of beat the less regulated incumbent or kind of reform in time.
So that’s the challenge.
And then the second one I think is maybe a little bit more on the crypto side, there will be I think an increasing, I think the first wave of crypto and AI was simply just, I guess, renting out GPUs and renting out computer software for AI.
I think the next wave might be look a little bit more around digital watermarking and sort of the other side, which is how can we be sure that a tweet was genuine?
Can we use some of the blockchain technology, is sort of digital scarcity, to marry with the digital abundance that is AI, to find the things that are true when they’re true?
And that might be through digital identity, so we all have some form of identity.
And I work with a few companies that do that.
So it’s quite interesting looking at that challenge.
And I think that that next generation of sort of blockchain and AI will be quite interesting as people are grappling with the problem of digital abundance that is AI and fake news, et cetera.
Maybe there’s a solution there for the blockchain. I don’t think it’s hugely, I don’t think it’s a massive profitable thing. I think it’s more just using the core technology in a way that it can be used.
Ian:
Very interesting. So with that, we’ll wrap up. Thank you very much, James, for joining RULEMATCH Spot On.
It’s been very, very interesting to talk to you.
I’m sure at Tendex you’re going to be staying right at the forefront of everything that is cutting edge in the space.
So maybe there will be an opportunity to come back and talk about things more in the future.
Thank you once again and look forward to future conversations.
Liquidity in markets is always key. What assets get traded (and price) is often dependent on how deep liquidity is across the market.
In crypto it is no different. Keyrock CEO and Co-founder Kevin de Patoul joined RULEMATCH Spot On to talk about liquidity and its development – along with the influence of different market models, the ongoing challenge for high frequency traders, as well as current (and future) bottlenecks in the growth of trading firms and market makers like Keyrock.
Episode show notes:
(00:41) Intro
(1:44) State of global liquidity
(3:03) The actual location of liquidity – geographically and spot vs options
(4:42) Breakdown of Keyrock’s business pillars
(6:12) The driving factors behind the founding of Keyrock
(6:40) Crypto as a proof-of-concept
(7:17) Where Keyrock got started – market making as a service provider
(8:53) Comparing crypto vs TradFi market making
(10:55) Why crypto’s retail history has hindered “the tech”
(12:54) Getting to more standardization and technical excellence
(14:18) How large orders from the world’s largest trading firms move through the crypto market
(16:07) Crypto ETFs as a sign of liquid markets
(16:52) Preparing for US Bitcoin ETFs
(17:50) Weekday vs weekend liquidity in crypto
(19:53) Stablecoins as a buffer
(20:14) State of play in crypto market models
(22:38) The fantastic speed of innovation in crypto
(23:44) Re-setting global capital markets
(24:14) “Pattern match” for TradFi players coming into crypto
(25:35) Why OTC?
(26:42) Non-existent best execution in crypto
(28:05) Standardization in trade settlement
(29:07) Waiting on Trade Cost Analysis
(30:14) TCA and transparency through regulation
(31:15) Adapting and implementing regulation in the light of technology
(32:30) Keyrock’s preparation for regulation developments
(34:48) Different plans for different scenarios
(35:25) The global (and regional) implications of crypto regulation
(37:42) Implications of MiCA for liquidity in crypto markets
(39:06) Paths to the reconvergence of liquidity and better capital efficiency
(40:04) Scary MiCA?
(41:18) Leading crypto countries in Europe
(42:00) Why Switzerland for Keyrock?
(43:11) Keyrock’s HFT ambitions
(45:03) The dominance of engineering
(45:18) Pushing the pedal on acceleration (and regulation)
So you have on the one hand, liquidity as one of the main added value of tokenizing assets.
At the same time, the actual liquidity on tokenized market is very fragmented because of the very nature of these markets and the tech that underpins it.
So putting it together, we launched Keyrock with the idea of building a system that would allow us to provide liquidity to all digital assets, knowing that for us, our view is that all assets will eventually be digital.
Full episode:
Ian Simpson:
Hello and welcome to another episode of RULEMATCH Spot On, the only podcast focused exclusively on the institutional crypto and digital assets industry.
I’m your host, Ian Simpson, and if you want to know what banks, securities firms, trading firms, hedge funds, and others are doing in crypto and how they’re doing it, this is the place for you.
My guest today is Kevin de Patoul, CEO and co -founder of Keyrock, a leading global liquidity provider, market maker, algorithmic and OTC trading firm founded seven years ago and he is our guest today in the studio in Zurich.
Kevin, welcome.
Kevin:
Thank you, Ian.
Ian:
Good. So today we’re going to be talking about liquidity in crypto markets, all about liquidity.
It’s going to be really interesting to get your take on some things across different areas of the market, whether it’s high frequency trading, whether it’s market depth, OTC trading, settlements – some of those things that are a little bit down in the weeds.
But maybe just to start with, what would you say is the current state of liquidity in the market?
Kevin:
Well, I think that thanks to our good work, it is getting better and better.
I mean, very clearly, there’s still a lot of work to do.
We are seeing in general, liquidity that is improving, of course, on the main assets, but also to some extent on the smaller asset, thanks to a lot of DeFi innovation that basically are very good to create that initial liquidity on assets that are earlier in their life cycle, I would say.
So I think that in general, we’re seeing clear improvement. However, it’s still in general, you look at digital assets in general, it’s still quite far from what traditional markets are, except for the most liquid pairs.
I think there’s also a tendency to underestimate how an asset like Bitcoin, how liquid it actually is, right?
In terms of spread, we’re talking sometimes it’s quoting less than one Bp for pretty good size.
So I think that on the bigger assets clearly there is strong improvement in liquidity.
There was two years ago, following the FTX, kind of a big dip. Also following the Alameda collapse, there was quite a big dip there with widening spread.
This is something that has been tightening and getting better very clearly.
So I think we’re in a good place, but there’s still some work to do.
Ian:
When we talk about liquidity, you mentioned DeFi, then – so like where is the liquidity, geographically, but also venue types…
You see that from a high-level perspective, I’m sure. I mean, there’s still…
At Keyrock, we trade centralized, we trade decentralized, we trade on spot, we trade on derivatives.
I mean, clearly the bulk of the liquidity still is in centralized exchange, maybe on perps.
Clearly, if you look at what is centralized versus decentralized, it’s like one to 10 more or less in terms of ratio.
So clearly, it’s still there.
However, that is quite different, of course, when we talk about the long tail, because it’s very, very easy to launch a pool on the DEX.
It’s not that easy to get listed on the centralized exchange. So you have a bit of a different focus on extent and different “value add” of both types of venue.
When you look at geographies, I mean, there’s a lot less in Europe than you would have in the US or Asia.
We still see that clearly for us, the pricing is happening in Asia, very honestly, and the rest is a bit more following.
If you look at most of the larger exchanges, there is a very strong concentration in Asia very clearly.
So if you look at the split between centralized, decentralized types of instruments between spot and perhaps mainly, options are still very, very, very small.
And I do think it’s a very big lever of growth in the future. I think there’s going to be a lot of growth there, but currently it remains very small compared to the rest. Then geographically, say Asia would be a bit more…
Ian:
So liquidity is your thing, right? At Keyrock, that’s what you focus on entirely. When we talk about “what you do and how you do it.”
Just give us kind of the high level of the different pillars of what you’re doing. Maybe how you started seven years ago, right – and then how that’s developed.
I mean, I can start with the beginning. So I founded a company with two co -founders in end of 2017. I started to be interested in digital assets and Bitcoin in 2014, 2015, more and more.
Basically, then, ICOs started and the main question for us was “Why are these so popular?”
Because ICOs back in the days is kind of a glorified Kickstarter campaign, right?
But the size of ICOs versus crowdfunding, was a very big, an order of magnitude of difference.
So the question was why?
And what we saw – our hypothesis back then is, okay, if you’re basically digitizing a crowdfunding coupon, and this makes it a more interesting asset because you have something that is potentially a lot more liquid.
Because you have something that is a lot easier to send around to trade.
So you have something, a lot of potential liquidity that comes with tokenizing assets.
At the same time, the entire market was and still is based on a decentralized technology, sometimes not decentralized enough, but that’s another debate.
But in general, decentralized technology, which means that you have quite low barriers to entry. have a lot of innovation because you have composability, of course, of those innovations as well.
You have liquidity that is extremely fragmented and it is really putting those two facts together that led us to create Keyrock.
So you have on the one hand, liquidity as one of the main added value of tokenizing assets.
At the same time, the actual liquidity on tokenized markets is very fragmented because of the very nature of these markets and the tech that underpins it.
So putting it together, we launched Keyrock with the idea of building a system that would allow us to provide liquidity to all digital assets, knowing that for us, our view is that all assets will eventually be digital.
When we look at crypto today, what it is – it’s a proof of concept.
It’s okay.
This is kind of the cutting edge showing what we can do when we represent value in a fully digital way.
Whether the value being represented actually has value, that’s another debate.
Many things are digitized and in my view, we don’t have a lot of intrinsic value, but still it makes sense and it shows a proof of concept of what can happen when you digitize value.
So eventually we believe that this will encompass all assets and that’s kind of where we got started.
So building a system that allows us to provide liquidity to all digital assets.
And that’s nice, you know, as an end goal.
The question is, you know, where do you begin?
And we’ve decided at the beginning, we start as a market maker. So really making markets, not as a prop shop.
Keyrock, the core of our DNA, is not to be just a prop shop.
It’s really as a service provider.
So we start as a market maker, working with token issuers, working with exchanges as well, to be a dedicated market maker, to be there providing service level agreements, providing a lot of transparency, showing them that indeed we are providing the service that we are selling you and really acting as a service provider.
And that is something that I always emphasize, because the core of what we do is to building a client franchise, building long term relationships and collaboration with our clients and not just a prop shop that does a bit of service on the side to source cheap capital.
That’s simply not who we are.
So we really started with market making as a service.
Initially, this allowed us to widen their trading horizon, both in terms of the assets that we’re trading, but also our connectivity to centralized exchange, decentralized exchange, spot perhaps, derivatives eventually as well, and be sure that we cover a big chunk of the market and focus on market making as a service only for the first, I think, four, four and a half years of the business.
We got to a point where we’re very satisfied with our pricing or execution capabilities.
And so, let’s make sure that others can benefit from the pricing as well.
And so we started more on OTC activities on the spot, but also on the option side with the option being our option desk.
We launched it in January this year.
So that came a bit later, but that’s basically where we started and how we’ve been evolving over the last six, almost seven years now.
Ian:
So really coming from the crypto side and now it’s bigger and the services are broadening out. When we focus just on the market making side, there’s some, and I’ll mention the name, Flow Traders, which has been big in traditional assets and then got into crypto as well.
I asked them the question how their strategies maybe mirror or don’t mirror what they do in TradFi.
Do you feel like you are getting closer to TradFi with your market making strategies as things become more liquid and more popular, or how is that developing?
Kevin:
It’s tough for me to answer because I never traded in TradFi.
Of course, we have lots of people in the company that come from traditional finance.
But so there are some things that are getting closer in terms of liquidity. There are some things that remain very different when you look at the fragmentation of the market, when you look at the technical immaturity also of part of the market.
You need to build into your pricing a lot more resiliency, a lot more redundancy than you would ever need in traditional finance.
So for something, there is some convergence on some of the topic, but I do think that inherently the markets are very different.
The way you trade, the capital efficiency that comes with speed of transfer, but the capital inefficiency that comes with the lack of credit lines many times across the industry, the fragmentation of the pricing, the fragmentation of the liquidity, the technical immaturity, all of this means that fundamentally there are still some very different ways of trading, of pricing and executing.
Even though in general, as the market grow, there start to be more and more similarities, mainly I guess with the Forex market, there some similarities there, but I do think they remain like the technical differences in the assets mean that you end up trading in a very different way.
Ian:
Just on the technical side and not on the technical sides of the assets themselves, but how you serve as the market maker.
Centralized exchanges we know in crypto came out of the retail space, not necessarily for institutions.
So connectivity and some of those “down in the weeds” technical things had to be developed over time. How have you built out your technical capabilities and what you do to serve clients?
Kevin:
A painful journey. As I say, we’ve integrated more than 90 exchanges, nine zero, so no standards.
There are starting to be some standards more and more kind of FIX connectivity in the industry as well.
I mean, it’s been tough and that’s where I think it’s not the same thing as building one very good connection to one pricing venue in TradFi.
It is different because there’s a geographical difference on where all those exchanges are. There’s a difference in speed between each of them, even though they will be trading the same assets, potentially giving very different prices for those assets.
There are differences in the tech, how often the tech fails, because it does happen – something that you would never expect in a million year to happen on a TradFi exchange – happens in crypto.
And all of this has to be built into it, that the resilience that I was mentioning in our systems and also in the way that you price, you need to take into account a certain buffer and certain expectation of failures.
And that’s been a lot of investment that’s been sometimes frustrating, but at the end I do believe it creates some kind of a mode as well because being able to do that now is potentially a lot harder than was when we started six years ago.
So yeah, it does create some challenges, but that’s why there are opportunities as well.
Probably the barriers for entry to market making in crypto and then the next level of digital assets is much higher today than it was
Kevin:
I would think so, definitely.
Ian:
When we talk about technical connections and those things, standards aren’t quite there yet.
Do you work with others to kind of get to those standards or what do…?
Kevin:
I mean, we work with every single one of our counterparties telling them what the benchmark of quality is in our eyes and what is of the entire horizon that we trade, what we see as the best, what constitutes the best, what our needs are, and hopefully, you know, as somewhat valuable customers, we are able to push that in the right direction.
We are working with them, but in the end, of course, we’re not the marketplace.
We work with marketplaces, but it’s in their hands to make it as best as it can be.
And we’re trying to influence that as much as possible by using the width of our horizon as a learning opportunity and we’re showing this is the best that we see.
“Please, can you do the same? Because that’s what is eventually going to attract more volume to your venue and make sure that we continue to trade here is because you get to a certain level of quality.”
Ian:
So give and take.
You telling them a little bit what you would like them to do and them telling you what they can do.
Kevin:
Exactly.
Ian:
That grows. You’ve grown to, is it 180 employees now?
Kevin:
A bit less than that, yeah, almost.
Ian:
So a lot of those technical people to build it out.
Kevin:
That’s more than half the company.
Ian:
Okay. Let’s just dive down into trading itself and from a high level.
Well, first of all, some people say maybe coming from TradFi, crypto isn’t liquid, you know, it’s and you mentioned the fragmented liquidity.
So that’s one challenge. But now let’s talk about the biggest trading firms in the world coming into the space and starting to do business.
If they come with these really large orders and they hit the market crypto being as big and global as it is.
How does that filter through the market, from the market makers that get hit across different venues, then maybe through brokers or smart order routers where the trades are split up to then to the hedging?
What is the ripple effect or the radius of something like that?
Is that still a challenge?
Kevin:
A challenge. It depends on what size, right?
Of course, the bigger it gets, more first the more counterparties will need to be involved.
If you look at very big, very good examples, recently all the ETFs, right?
And how much they’ve grown since the launch, the impact they had on price, if the market was super illiquid with such a big buying pressure, you would have expected everything went 10x, not the case, right?
So there is some liquidity there clearly.
If not, you know, this buying pressure on ETFs, it doesn’t just be dumped on books on central limit, all the books, right?
It does go through liquidity providers initially, and that’s where there is a lot of volume there.
But then, of course, these liquidity providers – and Keyrock amongst them – we’re going to be deciding whether we “warehouse the risk” for a certain amount of time or not.
Or whether that risk can be offset by other flow that we have coming from other clients and then partially be hedged as well on exchanges down the line. there is kind of that ripple effect.
When I look at the liquidity now, I think that the ETFs are a good use case to see that there is still some quite deep liquidity to be able to withstand these unilateral pressures we’ve seen since January in general.
And so yeah, you have kind of that split between first OTC and then eventually with some cris-crossing of flows and then eventually going forward to the exchanges themselves.
Ian:
Was Keyrock itself involved in the ETFs and in market making?
Kevin:
We are.
Ian:
And are you at liberty to say more about that?
Kevin:
No.
Ian:
Maybe can you say more about how you prepared for that or just what were some of the considerations when it was clear that this was going to come? Was there anything special that you
Kevin:
Of course. There isn’t kind of one specific preparation.
It’s more kind of…it’s a journey, right?
To make sure that you’re a list of things of things that you need to do and do well.
But even before the ETFs were a possibility, it was about okay.
You need to be in the game, right? So are you able to? Quote a type price. Are you able to facilitate trades at size and are you able to do both, you know, all of the above while maintaining full regulatory compliance and making sure that you do things well too.
Basically, that’s something that takes years and that is a continuous effort rather than how the ETFs are going to be in five months.
Let’s scramble to be able to do it, right?
It’s really kind of just a continuity of our strategy from since the beginning. So building the reputation, building the tools over time to be in that position.
Ian:
Just on the topic of ETFs, I think there was some research from Kaiko recently about about the weekday versus weekend liquidity.
Can you say something about that?
Is that a trend that you’ve noticed and something that you have to take into consideration now that the ETFs are there?
Kevin:
I mean, it’s not only ETFs. We’ve always seen that there’s less liquidity on the weekend.
It’s not something…
I haven’t seen the research by Kaiko and maybe it shows that this is even strengthened, that trend, right?
But that was the case before ETFs as well, would see always like more volatility on weekends because you have less liquidity.
I mean, much as like crypto in and of itself is 24/7, yes, but there are some very clear ties to the traditional world as well.
There is some ties to fiat as well, which is closed on the weekend and some people love to trade 24/7, others like to do something else.
So we’ve always seen less liquidity and more volatility during the weekends.
I would imagine of course the ETFs is kind of a traditional wrapper around Bitcoin in the case of the Bitcoin ETFs.
So I would imagine it just strengthened those trends because it just brings it closer to how the traditional market works.
To some extent, this might be a bit of a step backwards. I do think that ETFs are great for “a go-to-market,” but as a product, they make no sense.
Like an ETF from Bitcoin, I think it makes no sense at all as an instrument.
But as a distribution, it’s great.
Bringing it to mainstream, it’s great.
So for all of that, I think it’s a net positive.
But yeah, in terms of certain liquidity habits and weekdays versus weekends, it does bring it closer to how traditional finance works.
And then tied to fiat itself, whereas in crypto, we also have large volumes of crypto versus stablecoins.
Ian:
Exactly.
Kevin:
But I mean, still this provides the… Like all the stablecoins provide an additional buffer to separate crypto from fiat, but at end of the day, it is fiat backed, right?
So you still have that link at some point.
So when something happens there on the weekend, it’s more problematic than in the week.
I mean, Silicon Valley Bank, like that makes…there’s still that tie to the traditional system that does work five days a week.
Ian:
When we talk, you mentioned the OTC market and also your OTC desk that you’ve launched and now market models again with crypto starting with retail, a central limit order book type, centralized exchanges and you have DEXs then there’s OTC.
What do you think is kind of the state of play in different market models right now and where do you think it potentially goes in the next…medium term say?
Kevin:
I mean I still believe you know that central limit order books are a very efficient system.
And what is interesting is that there is the problem for some of…centralization.
It’s like, how can we go around centralization?
And so that’s where we start to have more and more of, four years ago, those AMMs, right?
So here we add decentralization, but then the problem is that to do that, given the technical capabilities four years ago, we need to not do just a central limit order book and go with these pools.
But then if you look at the subsequent kind of upgrades, getting closer and closer.
Like the more ranges you add to those pools, the closer you get to an actual central limit order book eventually, right?
So in terms of price discovery mechanism, I think a central limit order book works very, very well, honestly.
And then yes, you can, you may want to add some decentralized component to it for different reasons and purposes, some of which it makes sense, some others it doesn’t.
I do think that it’s a very efficient price discovery mechanism.
One thing that we follow very closely on the market, especially on centralized, on CeFi it’s quite straightforward, right?
But on DeFi, I think that everything around intent – a kind of, you know, kind of on-chain RFQ system is something that I think is very interesting.
And to some extent brings a lot of DeFi closer to what you would see in traditional market, but just with an additional layer of decentralization, which is good.
You get certainty and potential transparency around execution and how the trades are made, but also making it more accessible to a wider number, which is also a big chunk of the purpose of decentralizing finance in general.
So like intent markets is something that on DeFi, we follow very closely and I personally think has a lot of momentum.
Ian:
And you’re building to integrate and work with that also at Keyrock.
At the forefront.
Kevin:
Trying to be, yeah.
I think this point is a very big differentiator between digital finance and traditional finance.
The speed of innovation is absolutely ridiculous because if you have a market that is, not everything is open source, but you have a market that is decentralized, you have a lot of composability, everybody’s building on top of one another everywhere in the world, the speed at which things move is just absolutely ridiculous.
And so for us, like we’re a crypto native firm.
But still, it takes a very conscious effort and the actual allocation of resources, dedicated resources to make sure that we continue to be at the edge and we continue to follow because the speed of innovation is absolutely crazy.
And I do think that for trading firms coming from the equity market, that would be quite a shock to see how fast things move and change and now there’s a new financial primitive that emerges there and then all of a sudden there’s like hundreds of millions going there and then now it’s somewhere else.
Like this, the speed at which that goes is…
Ian:
It’s a little bit confusing!
Kevin:
A little bit.
Can be…
Ian:
Makes your head spin, I can imagine.
Kevin:
But I think, you know, I think that comes with something new.
If you, at the end as an industry, we’re trying to somewhat rebuild market infrastructure from scratch in a different paradigm…
Like hopefully, that’s kind of the goal. When you do that, for sure there’s going to be…
You know, you cannot go in a straight line to the goal, right?
There’s going to be some back and forth, left, right?
But that means a lot of new things.
And if you have that in a way that is decentralized, the speed at which it goes is really impressive.
Ian:
When we talk about institutions particularly, and that’s also a little bit the focus of the podcast and for us, thinking about operating, like you say, in those markets that are so new and changing all the time, do you think they come in and look for things they’re used to?
Like the central limit order book, they would come and look for that or maybe an RFQ model or OTC, where you can be sure of your counterparties.
That’s also something that’s big for institutions.
What do you see being more advantageous for those kinds of participants?
I mean, I think they definitely look for what looks familiar.
Kevin:
I mean, why do we have an ETF?
Ian:
Fair point.
Kevin:
It’s just because it’s familiar. It’s the same thing and it can be distributed in the same channel.
Like nobody, especially not for an economic purpose, you don’t look for change for the sake of change.
Right, it’s just like you, I guess as an entity, as an organization, you accept to go through change because the added value that it brings is so high that I’m going to take all the hassle of changing things.
But in general, if you can have that added value with something that looks and feel like something you’ve done 100 times before, you’re going to do that just because it’s a lot easier.
It’s lot easier to explain, it’s lot easier to understand the risks.
For sure, they’re going to look for things that look familiar.
Of course, what we need to strive to do is to bring so much added value with change that change becomes palatable and becomes unavoidable.
And that’s how we move forward.
But they would always look for things that look what they know.
Ian:
And on the OTC side, do you see institutions go in that route for the certainty of execution, of counterparty risk?
Kevin:
I think that plays a big role.
So if you trade with Keyrock, you have the liquidity of our entire system.
You have the pricing of our entire system. You go on one venue, you have the liquidity of that venue.
I mean, of course, just that already is like, okay, there’s a very broad scope.
So that’s definitely something that makes sense. Also you have a certainty of who you’re trading with, what they do, what the track record is, what is their legal status, their regulatory status, how compliant are they, what is the check that they put on their customers and so on and on and their counterparties.
So I think all of this is one of the reasons why OTC has gained momentum and even more so after FTX in 2022.
It has been like a counterparty certainty is something that became much more of a theme.
Credit risk is something that became a lot more of theme and so that continues to be the case, especially for institutions.
Ian:
Now I’m going to throw in a word that maybe some people don’t like or maybe some people pretend to know and don’t know.
Depending on where they come from, there’s this concept of “best execution,” which I imagine is also important for institutions.
First of all, how would you define that in the crypto sense?
Kevin:
Doesn’t exist. Doesn’t exist. Flat out.
Yeah. It doesn’t exist.
First of all, there’s no regulatory framework around it today.
Second, like the market is so fragmented that even if there was one, I don’t see how it could be enforced to be very honest.
So it just doesn’t exist.
This is just, it’s a game of trust now.
And to some extent, that’s where, you know, reputation and brand in OTC has an impact is that, your counterparties are going to trust and the more transparent and the more you can prove it, the better they’re going to trust that you’re giving them the best possible price with, you know, margin on top.
Depending on what business model you’re in. But today in crypto, there’s nothing that is…
It’s always “principle to principle.” There is no agency business in crypto.
And part of the reason for that is that best execution is extremely hard, close to impossible to guarantee, right?
So it remains in the big, trustless world that digital asset would like to create.
On that front, it remains very much of trust-based game.
Ian:
Yeah. I’m just going back on the OTC side.
When it comes to settlement – there’s probably still a lack of standardization on that.
How do you get set up for settlement on OTC trades?
Kevin:
What do mean by how do we get set up?
Ian:
I mean, how do your counterparty or how do the people want to be settled?
Kevin:
Very fast. Very fast.
So no up-front pre-funding, but very fast post.
It’s quite common for us with the OTC counterparty to settle in less than an hour.
It’s very, very fast. Has to be..
Not instantaneous, atomic, blockchain, but for something that I know, for OTC trading, so it’s not going to be just atomic swap, but selling in half an hour is quite a norm,
And in good size as well.
Ian:
One other term that came up in a conversation actually with Hidden Road a while back, “transaction or trade cost analysis.”
Is that still something that’s not out there being talked about or needed yet?
Is it talked about enough?
Kevin:
Probably not. There’s still a level of maturity that is gained on all the counterparties are active in the market.
Should it be talked about more? Yes.
As relevant as on other markets, given the volatility of this one, right?
So there is a question there.
But in general, I would think that again, for us, as I say, we build very strong client relationship.
The strength of Keyrock is the client relationship.
So for us, providing full transparency of the execution that we provide and the costs that are associated with it is something that is part of a good service.
And so I do think that in general, the industry is going towards better and better service and fairer and fairer trading.
Should it be talked about more? Definitely.
We’ll always be in support of it.
Ian:
Do you think it will eventually get into regulation at some point?
It’s tough. I think it’s interesting when you think about the regulatory frameworks.
They have been built over the last decades to basically address the shortcomings of technology.
Because the less technology you had in transacting, the more there was a need for people, for trust.
You cannot just trust, right?
So we’re going to put rules, verification.
And so all of this has been built to address certain shortcomings of the technology we didn’t have 100 years ago, we didn’t have 40 years ago.
And that changed year over year over year, right?
And now all of a sudden, we have technology that allows us to do a lot more.
And so potentially requires less pure regulatory controls because some of those controls should be embedded in the product or the service that is provided.
But so the question is how do we go about it? Do we simply try to adapt an existing framework at the margin.
So have marginal changes to an existing framework for something that is meant to be radically different?
Or do we start to rethink as, okay, wait, we have this regulatory framework, what is the purpose of that?
The purpose of that is to ensure protection of consumers, of investors.
Great.
How do we reach the same goal, potentially with a different framework, given these new technological capabilities?
And so for this, it is a question like, how are we going to go about this?
Should it be something that is a purely externally imposed regulatory framework?
Or should it be the markets pushing towards technological solution that allow you to have the same certainty without the need for that external control.
And I do think that the right answer is somewhere in the middle, right?
But I think that simply marginally adapting a legacy framework is not going to work.
I think that believing, let’s just trust the market, that’s not going to work either. So there needs to be something that is in between.
Ian:
You know, as this develops, and of course we know in some places it’s developing more and less, US versus Europe versus other jurisdictions, and people have their opinions about that.
How are you at Keyrock kind of preparing for what is clearly coming in the regulatory sense and what may come in different ways?
Kevin:
It’s very hard. It’s very hard.
But again, I think those types of challenges are what created the opportunities in the first place.
If everything was clear on the tech side, everything was clear on the regulatory side, there wouldn’t be the space to build new things.
But it’s very tough because first it changes constantly.
By the time something is on, it’s outdated.
I mean, look at MiCA. DeFi is not in MiCA.
When you think about it, that’s crazy because we’re talking about first – DeFi summer was four and half years ago.
MiCA is going to be live in January 25, right?
Not there. No mention of it whatsoever.
And then, so of course, it’s going to change.
I’m just looking at Europe, right, because it’s where we are.
But then you look at somewhere else, it’s different. It’s constantly changing. You look at jurisdiction that were forward-looking – all of a sudden, you know, take a very hard stance.
The US for the last two or three years has been absolutely ridiculous.
Now, OpenSea is getting sued as well. I mean, the things are changing so fast.
This is a very big challenge because you don’t have certainty of business. You don’t have certainty of business in terms of where can you do what, but it also has an impact on who can you do it with because it’s not being discussed a lot, but the challenges around having banking and financing partners for crypto companies is very, very tough.
Because all of a sudden you have something that changes on the regulatory side and nobody wants to touch crypto anymore.
So is a very big part of our operational changes as a firm.
Basically what we do now is that we have plan A, plan B, plan C, plan D.
And that means time, that means cost, right?
And it’s, by the way, we said that the barriers to entry now would be a lot higher than six years ago.
This is big chunk of it because if you want to have the right setup in place, you know, with multiple options.
That’s going to cost money every single time and you need to be able to afford it and to do it.
So it is, this operational burden is part of the barrier to entry, which of course we can only hope for.
You know, more clarity, more stability, but it’s not there yet.
So the only way we can prepare is that you prepare for everything.
We have yet to have multiple plans and when we consider a bad scenario is not whether it happens, it’s when it happens.
And just to make sure that we prepare for it.
When it does happen, it’s fine because we have redundancy and that’s really how we look at it.
Ian:
You mentioned MiCA, so let’s go down that rabbit hole just a little bit. Maybe first of all,
This is for the European Union. Then the US is in its state as it is.
We have Switzerland, which we’re happy to talk about as well.
But you see these different regional things developing as a company that’s globally active. Do you see that that might break things up or also provide opportunities within a region?
Will liquidity centralize in Europe in the United States and in Asia?
Or will it still continue to be global, but global players like Keyrock will need to really adapt and expand?
I mean, that’s a strategic choice, right?
You want to be a global player with the costs and challenges that come with it, or do you want to be a fully focused local player with therefore a bigger with more of a limitation on the scale that you can get at.
That’s a choice and each company will need to decide.
And we see, for example, on the exchanges side, you have different strategies. Some are, you know, we only do one geography, but we do that super well.
Others say, we want to be global. You can have both.
In general, I think that something like MiCA, it’s incomplete, right?
But in general, I think it’s good, right?
There are some shortcomings and lots of discussion around, you know, stablecoins.
What are the requirements? There are the two tough, not tough enough, like…mainly too tough generally is the consensus.
So there is clearly something that can be done better, but at least it gives something.
It’s okay for Europe, you have something that is clear that will need to be iterated on and we need to deal with the shortcomings in the short term, but at least it gives something that gives stability, that is clarity.
I’m all for having tough rules and make sure, tough rules that make sense and make sure that we abide by them, but they cannot change all the time and be different when you work 100 meters.
And that’s a bit what creates a challenge.
So I do think that the jurisdictions that will have the more clarity and the more stability will eventually win the most on the global scene, then what companies decide to do, whether to be in one or all, that’s strategic choice for each.
And maybe those jurisdictions that have the clearest regulation, let’s say Europe and Switzerland, then come closer and closer together, providing those bridges between the two.
That’s why I’m in Switzerland.
Ian:
There you go. Exactly.
When it comes to MiCA, I mean, thinking about the exchanges and liquidity in particular, because that’s what we’re talking about, global players who do want to be active in Europe and in other places, will they, for instance, have to split the order books and have a totally different system in different places?
How do you think that will develop?
Kevin:
So I think you need to have a… You need to have some level of fit, right?
Definitely, because if you’re active in one jurisdiction, you need to comply to that specific jurisdiction and therefore the risk taking, the risk decision, the trading decision have to be taken within that framework, which is part of the constraint.
You need to make sure that you can mix that with a certain level of global efficiency as well. But I think that definitely the more scattered the market, the less efficient it is – and the less liquid it is.
It is something that’s why I’m saying that we need to have a certain jurisdiction that have that clarity and that stability and that the bigger that jurisdiction, the better because the more fragmentation you have, less efficiency you have.
I do think that any subdivision and differences in frameworks will lead to fragmentation of liquidity, which eventually is negative for the market.
Ian:
And is there, besides firms like Keyrock, are there other ways that that liquidity might come back together, become more accessible?
Or is it DeFi? Is it something else? Is it prime brokers? What are the options?
Kevin:
I mean, I think there are many different options for different needs, right? I don’t think that there is a single solution. I think that’s, if you look at what are currently the biggest, I guess, constraints in crypto versus in digital assets versus what you have in TradFi is you the capital efficiency.
It’s even worse in DeFi, right?
That is…it’s very very bad.
So there’s lots of solutions working towards that – so clearly prime brokers, you know in the centralized part of digital asset they can play a very big role.
But that’s not going help the retail participants, right?
So I think that there isn’t one single solution, but we’re going to have you know multiple that you know act as bridges and you know our purpose as a market maker is to be part of that solution and provide liquidity wherever we see demand on the market.
Ian:
Is there anything else about MiCA and I just throw this out you can answer or you don’t have to answer that scares you in particular?
Or that you think is really bad?
Kevin:
No, I mean again I think it’s incomplete right?
I think that for stablecoins, for example, I think that some of the requirements are so strict that it kind of dilutes the actual added value of stablecoins to make sense because it ties them too closely to some, you know, traditional, the traditional system as well.
So there is…I think there is some stuff that are not perfect, something that is very bad and scares me, not really.
One thing that I’m keen to see is how the actual regulatory arbitrage is going to work as of January before…between the different European jurisdictions, because the question is where, you know, if you’re active in Europe, where are you going to apply?
Which jurisdiction is going to be ready to actually process an application, ask the right and the smart questions and actually be able to oversee activities?
That we’ll see, right?
Because Europe is relatively, I mean, it’s not that big, but there are many different regulators there and how is that going to play out? I wonder.
Does it scare me? Not really, but it is a question mark.
Ian:
Do you have a feeling, and not to put you on the spot, but one or two jurisdictions that are perhaps ahead or…?
Kevin:
I think France is ahead. I think they’ve been very proactive.
Unlike many…
I mean, there are others, right? But I think that France have been very proactive with the Loire Pact already a few years ago. They decided to be ahead of Europe.
They decided to be ahead of AMLD5. They decided to be ahead of MiCA and launch their framework first.
There’s a reason why we see like most of the large foreign players when they come to Europe, they go to France.
I do think that France is ahead. That doesn’t mean that it’s the one and only, right?
But I think clearly they’ve taken a very forward-looking positioning.
Ian:
And you said being here in Switzerland, that’s a good thing. What is it particularly about Switzerland that is attractive for you, for Keyrock?
Kevin:
Well, think it’s…are very clear in Switzerland, right? They might not all be right, but they’re very clear.
We find that the business environment is extremely pragmatic.
If you have something that makes sense, if it’s a bit different than what we’re used to, fair enough, you know, it makes sense.
And you know what we’re used to has to change that it becomes a norm because again, it makes sense.
And so I think that this combination of clarity and pragmatism is something that is extremely, extremely conducive to business and innovation.
So again, not perfect and there are, but I do find as well I think that the dialogue between the regulator and the actual industry is a lot better than what I’ve seen in many other countries as well.
A few months ago this whole discussion around staking, how do we consider there’s been this back and forth things change again.
You have clarity – you have pragmatic and I think that’s a very good combination.
Ian:
Very good point.
Very pragmatic and very open -minded – which we like to hear and we like in many different levels.
One topic that’s not mentioned too much yet in the crypto space is high-frequency trading.
I noticed you have a job ad out for a Head of Engineering for HFT.
What are you preparing for?
What do you see? What do you think is coming up in that area?
Kevin:
I mean, it’s interesting, right? Because we trade high frequency at the level of crypto, right?
Which is not really HFT.
It’s not the same thing as what you have in TradFi, simply because again, it’s not kind of hardware based.
A lot of it is cloud-based – it is the fragmentation of the market, which just makes it a lot slower than you would when you have just one venue and one price feed.
I think it’s just the nature of things to get faster and faster and faster and more efficient.
And this is going to follow.
I think before, I don’t think that the system that is as fragmented and as decentralized as digital assets will ever be as fast as a system that is 100% centralized.
Maybe some engineers much smarter than me would say – or would maybe contradict me, but I don’t think that if you look at the database, I don’t see how a blockchain could be as fast as a centralized database.
It has other strengths, right?
But it’s never going to be as fast.
So it’s the same logic for this.
You have a market that is a lot more fragmented, therefore is slower.
But in its own benchmark, it’s getting faster and faster.
And so this is something that’s going to continue, which I think is in the end positive for the market.
Like the faster, the faster price adapts, right?
It does benefit liquidity and it is something that eventually is beneficial for most market participants.
Ian:
And especially for people who are very good with the engineering, the algorithms and so on, like Keyrock.
That’s been something from the very beginning that you’ve been strong on.
Kevin:
Yes. I think that when we were 15, we had 13 engineers.
You know, it is…and now it still continues to be more than half the company.
So that’s always been a very strong focus.
Ian:
And what else do you think will need to be in place to accelerate things, not just on the speed of trading, but on the speed of doing business in the market?
Kevin:
I mean, that’s a broad question.
Many, many things, right? I continue to think that the biggest bottleneck in the development of this market is regulatory clarity.
Which slows the whole thing down the most.
And the reason why it slows things down the most is because we’re trying to fit a square peg in a round hole. Because we are trying to marginally adapt a model that is decades old to something that is a completely different paradigm.
And I think that’s the biggest mistake, which is what slows the whole thing the most.
You know, we’re approaching Christmas, so on my wish list would be regulatory clarity.
So that we could get to something where, now we have stability, we can really build things that make sense rather than things that you will have to change over time.
Ian:
Exactly. Exactly.
Kevin:
Every month, every… It creates ridiculous inefficiency if you want to be at a large scale.
And it prohibits people that decide to be on a narrower scale to actually grow big.
And so in general, I think it slows down the market a lot.
Ian:
One question we ask everybody before we finish up is just…
Is there something in the market or something at Keyrock that you see coming up in the next maybe six, nine months that nobody is talking about or very few people are talking about that our listeners, our viewers could perhaps look out for?
And maybe we say not MiCA, so something else that could be interesting to think about or consider.
Kevin:
I mean, lots of things are interesting to think about and consider. Is there something that nobody’s talking about…
I don’t have the arrogance of a…
Ian:
…a crystal ball.
Kevin:
Yeah, no, but not even the arrogance to think that I’m that much on the edge of everything on the market – that I’ve seen something that nobody else is talking about.
But I think that everything that is around intent markets and capital efficiency in DeFi is something that I think is extraordinary.
It’s extremely interesting. Yeah, but…
…there were presentations on intent markets two years ago at EthCC, so it’s not like nobody’s talking about it.
But it is slightly gaining more and more momentum, and I think it’s very interesting.
Ian:
Very cool. Very good.
Kevin, thank you very much for joining RULEMATCH Spot On.
Hopefully, we’ll have a chance to talk again sometime in the future when there’s more developments and things to talk about.
Swiss private banks are known for their long tradition of service – and in some cases their agility. Zurich-based Maerki Baumann Privatbank is an excellent example of this. As one of the first banks in Switzerland – and in Europe – to offer crypto services, it got a head-start on the industry in 2018.
But how did Maerki Baumann make the decision to do crypto? How did its service offering develop and what were the keys to success for the private bank, which has been in the business for 5 years and recently launched ARCHIP, a new brand, to support its crypto service offering?
CEO Dr. Stephan Zwahlen spoke to RULEMATCH Spot On host Ian Simpson about all this – and more.
Episode show notes:
(1:31) Intro
(2:22) The backstory of Maerki Baumann’s entry to crypto
(4:01) The original client target group and offering
(5:47) Evaluating the potential offering
(8:25) How the “bridge” between wealth management and crypto formed
(9:09) The positioning of Maerki Baumann among “crypto banks”
(11:42) The generational growth of crypto asset interest
(12:35) Crypto services as a growth driver for the bank
(13:40) Maerki Baumann as a “startup”
(15:11) Agility and partner banks as the key to growth
(16:07) The alternative to size for growth
(16:54) Crypto as a percentage of Maerki Baumann’s business
(19:30) Setting up processes for crypto business
(21:31) Building the Maerki Baumann core crypto team
(23:18) The advantage of due diligence
(24:15) Reducing friction for the end client
(26:39) Risk management with partners
(28:03) The value of partners beyond crypto
(29:01) The growth of Maerki Baumann’s positioning
(30:57) Widening the crypto offering
(33:47) The ongoing fiat/crypto topic
(35:30) Competition in the custody space – and beyond
(40:37) Looking back on the growth of the Swiss crypto ecosystem
We decided to bring together all our services under that new crypto brand Archip and we decided just to celebrate our 5th year anniversary.
We also invited the 25 most important Swiss crypto entrepreneurs.
People were telling me, “They don’t come and this will be difficult and so on.”
By the end, we organized that event. From the 25 crypto entrepreneurs, 23 showed up.
And in total, 700 people showed up for a party. And it was announced as a crypto party.
There were 200 or 300 traditional clients. There were 200 corporate clients.
There were business partners and so on.
And that’s the story I would tell my colleagues and also my critical colleagues.
We took that decision five years ago and it was also involved with a lot of risks I think.
That event with ARCHIP was for me the proof of that concept.
BEGINNING OF FULL EPISODE:
Ian Simpson:
Hello and welcome to another episode of RULEMATCH Spot On, the only podcast focused exclusively on the institutional crypto and digital assets industry.
I’m your host, Ian Simpson. And if you want to know what banks, securities firms, hedge funds, asset managers and others are doing in crypto and how they’re doing it, this is the place for you.
My guest today is Dr. Stephan Zwahlen, the CEO of Maerki Bauman Privatbank based here in Zurich.
For the past eight years, Dr. Zwahlen has led Maerki Baumann. He previously got his doctorate from the University of St. Gallen, where he is also a frequent lecturer on banking and finance topics.
He is also on the board of various industry associations and organizations, including the Zurich Banking Association. Dr. Zwahlen, welcome to RULEMATCH Spot On.
Stephan:
Thank you very much.
Ian:
So today we’re going to walk through kind of the journey of Maerki Baumann into the crypto industry.
And I think it’s going to be very interesting for our viewers and listeners to understand some of the process that you went through as a bank to start in this business, some of the considerations, and also some of the learnings that you had, which perhaps are useful for other people.
But first of all, maybe just to understand, where did the first idea come from for Maerki Baumann to offer crypto services?
Stephan:
It was actually quite an interesting story. It was a coincidence to be honest.
In 2018, I told my people we need to come up with a statement about crypto because the whole world was talking about crypto and I thought we need to explain what it was and what the position of Maki Bauman would be.
And we made a short presentation. Then there was also an interview that was quoted correctly and then another journalist misquoted the interview because he said that Maerki Baumann was the first bank in the world or at least in Europe to accept cryptocurrencies.
And this was not true at that time, but within a few minutes it went all over the world.
And we were approached by people from the US, from UK, from South Korea, South Africa, from Japan, from all over the world.
And there were actually several hundred requests. And what we did at that time was – we were overwhelmed and we started to analyze what people were asking for.
We identified two potential groups of clients.
On the one hand side, they were corporate clients that asked, “Can we open an account in fiat currency? We are in blockchain/crypto. No bank would offer us an account.”
And on the other hand, we had very wealthy individuals that asked, “Can we get access to this new asset class through your bank?”
So we realized that there was a huge demand.
And in banking, no offering at all.
And that was the point where we started to think about the topic.
Ian:
So you maybe didn’t intend to become famous, but you instantly became famous because of somebody’s mistake.
Stephan:
That’s true. This coincidence actually opened our eyes because we saw there was a huge opportunity, huge demand, and no offering at all.
So we started to read about the topic, but there was not too much to read about.
So we talked to more than 100 people, entrepreneurs, lawyers, consultants, and we identified a lot of risks, but also a lot of opportunities.
And we started to systematically deal with all the risks.
Finally, we came to the conclusion together with the owners, the executive board, the board of directors of our bank that we should go into that topic.
But as we do it always – through a clear concept and a clear strategy.
Ian:
Obviously, you have built up a certain offering and so on. We’ll get to that maybe in just a minute. But you mentioned the two things that people were asking for at the beginning.
How did you evaluate doing those two things for them at the beginning and what were some of the considerations around that?
Stephan:
Well, originally we thought as a responsible asset manager, we need to offer our clients access to digital assets.
So our expectation was after all these talks and considerations that in the long run, digital assets will become part of professional asset management and investment advisory.
So that was the main reason why we wanted to go into that business.
Then, as an opportunistic business area, we also sought corporate accounts.
We actually decided to start with corporate accounts because this was somehow close to what we are doing anyway due to due diligence with new clients and then offer traditional banking services.
But the original main reason to go into that business was to bring traditional clients step by step into the digital world by first investments in cryptocurrencies.
And it proved after one or two years that the other way around would be grow far more and grow much quicker.
These were the corporates, but also the young wealthy individuals that made a fortune with crypto and wanted to diversify and therefore needed access to the fiat world.
And therefore we saw after one or two years significant growth in that area, also in the traditional private banking business.
Because the individuals from the crypto community mainly approached us because they were asking for advice and comes to the structuring and diversification of their wealth.
Ian:
You could actually say that you came at it from the two sides, from your wealth management background, from the corporate services side and maybe learned and taught both sides at the same time.
Stephan:
Exactly. Kind of like a bridge.
That was also the reason why many journalists and also competitors approached me and they asked, “How is it possible and why do you combine as a traditional bank a very new business in the area of blockchain and crypto?”
It proved that we had actually became a bridge-builder between the fiat world, the traditional system, on the one hand side and on the other hand side, the digital world.
Originally, we wanted to bring the traditional clients to the digital world, but the other way around it happened as well. That’s actually the USP we could establish in the last five years to be one of the very only banks between these two worlds and bring people from both sides to one another. It was 2018 when that conversation happened.
Ian:
There was a development into the banking space with crypto…to crypto banks, Sygnum and SEBA, now AMINA Bank.
They have a bit different background, a different approach. And now, actually, if I understand correctly, there are 34 banks in Switzerland that have some sort of offering in the crypto space, which is quite a percentage, quite incredible. How does Maerki Baumann- we’ll maybe backtrack and talk about the development of the services – but how do you position yourself now from where you came from at the beginning, also vis-a-vis the other banks that have now come into the space?
Stephan:
On the one hand side, I would say all the providers from the crypto industry are not really competitors because the core competence of these institutions is actually crypto and they understand that.
And also technology-wise in detail.
We are basically an asset manager that acquired the necessary knowledge to serve clients also coming from the crypto community or serving clients that are coming from the traditional side and are interested in the crypto community.
If you have a look at our offering, it’s very comprehensive and most recently there was a survey, I think, by University of Lucerne and they found out that the Maerki Baumann’s offering is the most complete because it starts with the offering for private clients. You have trading custody of the major cryptocurrencies that we offer together with partner institutions.
Then you have advice when it comes to crypto and digital assets. This means we also have an opinion about the newly established asset class. The third element is we also have discretionary mandate solutions for clients who want to invest a part of their wealth into crypto.
On the other hand, we also have the corporate services. These are corporate accounts with payment transactions.
We give advice to our clients when it comes to liquidity management, when it comes to investment decisions and so on.
So it’s a fully-fledged offering.
What I have been expecting for many years is that banks will all, all banks in Switzerland that are in asset management will start to offer trading and custody of digital assets because they just have to do it.
On the one hand side, you have the longer…the more clients that are interested in it.
And mainly if you have a look at the next and over next generations, for them digital assets is just a normal thing.
I can give you an example.
I have a lecture at the University of St. Gallen and I ask each year who of the around 50 students is invested in crypto or has been invested in crypto.
And it’s usually more than 80 or 90%.
So if you have a look at that, it’s clear that banks also need to offer basic solutions.
If you have a look at the most banks that go into that business now, these are B2B solutions where you can in the meantime quite easily within two or three months offer these services to your clients.
And I think the difference is in our case – it has become a significant profit contribution in the whole bank and it has become part of the whole culture.
It starts with the owner, the board of directors, the executive board, the client advisors, all the departments.
We have a core team, the tech banking team that consists of 15 people. They are doing nothing else but dealing with people from the crypto community.
We have a lot of efforts in our legal and compliance department that would deal with this topic. In the management, it is a very important topic.
So it became part of our business model.
And it’s not just one of several offerings. It’s interesting, as a private bank, and you mentioned the board of directors, also the family and so on, behind the bank – quite a different level than some large international bank, of course, which has advantages and disadvantages as people sometimes know.
Really, you are operating much more like a startup, a sense.
Stephan:
A bank, but a startup that’s very agile and jumping into things. I think we used the last 10 years to transform our bank. We also were a traditional bank with a long history, more than 90 years, but we significantly changed the business model over the last 10 years and we became very agile and I think the cultural point was the starting point.
What you need to know is that our bank is not listed.
It’s a bank owned by a Zurich-based family – family Syz. It is basically two people, Hans Syz and Carole Schmied-Syz.
And they have never been operational bankers, but they are basically entrepreneurs. They are in office at our bank as chairman and vice chairwoman for more than 20 years.
And they give the basis for the entrepreneurial initiatives we take on an operational level.
We have a young executive board, everyone between 45 and 50 years old. We are very close also to the generation that is dealing with digital assets and with technology, but we also understand the old world, which is certainly and will remain the basis of our bank.
And thanks to that setup, I think that was the starting point to become an agile bank.
And what you also need to know is that in 2007, we founded the first transaction bank in Switzerland.
And the reason was that we came to the conclusion that a bank in our size needs to focus on core competencies, which is asset management and investment advisory.
And we wanted to outsource all the volume-driven, highly standardized processes to a specialized company.
And since there was no company that could take over all these processes for a bank at that time, we have founded that transaction bank.
And that gave us the opportunity to overcome that problem of critical size. And strategy advisors have been telling me for many years that a bank in our size has no chance of remaining in existence.
But I always said there is an alternative to size and that’s the business model – to change the business model.
And that’s what we did by outsourcing to this transaction bank because Maerki Baumann became the first client of that transaction bank.
And since then, we tried to innovate and further develop our business model. And in that process, we became as flexible as we are today. And the most important thing, I think, was to develop the culture.
Because on the one hand side you have the conceptual, the intellectual work that needs to be done, but the really challenging thing is to change the culture and change the behaviour and conviction of the people.
Ian:
Mindset.
Stephan:
Exactly.
Ian:
So now five years on since you started with the offering, can you give us a rough idea of how much the crypto business is of the overall business? You say it’s…quite a pretty good profit generator for the bank.
Stephan:
What I can say is that it is a significant part of our profits that comes from crypto.
It’s not so much trading and custody and the discretionary business nowadays, but it’s two revenue drivers.
On the one hand side, it’s the corporate business.
That’s very know-how intensive and it’s a lot of efforts to open these accounts, to do the due diligence, to do the monitoring, serving the clients, but it’s also highly profitable.
And on the other hand, we have the growth in private banking that is not directly related to crypto, thanks to the clients that approach us from the crypto community.
So it’s a significant part nowadays.
Ian:
And growing all the time, suppose.
Stephan:
I can give you two numbers just to get an impression.
We nowadays serve about 500 startup companies from blockchain and the crypto space.
We have more than 200 young professionals that are young investors that came from the crypto community to our bank in order to exchange crypto into fiat money, which requires certainly a lot of thorough analysis.
And we have an increasing number of traditional clients that would make a first step and make first investments in crypto.
Ian:
Okay, very interesting.
Stephan:
I forgot actually the most impressive thing.
We managed over these five years to decrease the average age of our clients by 12 years.
That’s something we had been trying the 10 years before as well with all these next generation projects as all banks would do.
But the problem was always that we could approach young people, but we wanted to approach young, wealthy people.
And thanks to the offering we now have in the crypto space, there are young, wealthy people that are approaching us because they need something that we can offer.
Ian:
So you are fitting very much into the market, product market fit, so to say.
Stephan:
Yes, I believe that that is actually the case.
Ian:
Taking a step back then to just look at how those processes went when you deciding to set this up for the wealth management and then for the corporate accounts.
The first part of the offering at the beginning, can you walk us through some of the steps that you took to assess the risks and the things that you had to think about?
We had recently one of the episodes with Cornelia Stengel from Kellerhals Carrard from the legal side and, of course, they have lots of experience in advising people about what things to look at, but I’m sure you have the first-hand knowledge of those things that you need to understand as a bank to put together an offering?
Stephan:
As I mentioned, first of all, we talked with a lot of people, also with lawyers. We worked together with lawyers and we wrote in depth reports about all the risks. We systematically asked ourselves how can we mitigate the risk or how can we avoid the risk by defining our strategy.
So collaboration was very important, collaboration with traditional institutions but also with the entrepreneurs for example in Crypto Valley and in Zug.
We also worked together with an experienced strategy advisor that had been in blockchain and the crypto business already for four years that also came from the banking industry and together with him, we took three months to work on a strategy that we also discussed with our board of directors and we had a lot of critical discussions and then we started to educate the people.
That was the first step.
And we also started to hire specialists. So mid of 2019, we built the core team of three people.
One was already with the bank, two came from outside. And then together with them, we started to implement the strategy.
Ian:
And there were also certainly technical considerations to offer on the corporate side but then also for eventually the trading and custody.
That’s a big lift as we say for banks to integrate in things.
Stephan:
We also actually as a private bank decided to outsource that to our transaction bank and since the transaction bank was not a specialist in crypto at the time, they work together with Crypto Finance that is regulated securities dealer that comes from the crypto space.
And we then went to the Swiss regulator to FINMA all together, Maerki Baumann, the transaction bank and Crypto Finance, and asked for approval for that first B2B setup in the Swiss banking industry.
And this outsourcing that we implemented already in 2007 reduces complexity a lot for us as a private bank since we do not have to deal with a lot of back office and trading related topics, not with the legal but neither with the technical elements.
And I think that’s also the way that many other banks are going now – through such a B2B setup.
However, what’s important is that you understand also the parts that you outsource very closely.
And this was also a process over the last five years.
We did far more than 1,500 due diligence on these clients. The nice side effect is that mainly if you have a look at these corporate clients, in the due diligence process, they will describe in detail their business models.
So we know exactly what people and companies are working at, what companies are working at technology-wise.
And that’s also a very interesting thing.
And we get to know a lot of extremely highly educated and bright people with a lot of drive and dedication to innovate our market.
It’s very exciting at the same time.
Ian:
Just thinking about the end client when you outsource to these different partners and so on, of course, that takes some of the burden off of you to implement and to integrate and so on.
That can bring different levels of complexity and perhaps friction for the end client.
Is that something that you thought about to try to minimize and how did you approach that?
Stephan
I mean the question we asked ourselves was “What is our differentiation potential or what is the key USP we offer to our clients?”
And to be honest what is difficult is if you have a client coming from the crypto community and he knows how to how to trade these crypto exchanges, he would usually not deal with us because it’s too expensive.
With custody, it has changed over time.
We also have clients from the crypto community that look for a high level of security and use our custody solutions.
But the USP of our bank, where it comes to trading and custody, is that we offer a private client
that is interested in the topic but that is not an expert, the service out of one hand.
And in the background we certainly have partners as we have in other areas as well.
However, the end client has only Maerki Baumann as a client and we would do everything for him.
We would open the segregated account. We would, if he wishes that, manage his discretionary crypto portfolio.
We would do the reporting, the tax reporting and so on.
So it is a service with a very high level of security since we are a regulated bank and it’s offered out of one hand.
It’s a little bit more expensive than if you do it alone.
But it’s the full package from an institution that the client knows and trusts.
Ian:
And when you were evaluating how to set this up fairly early on, if we’re quite honest in the crypto space, there weren’t many other regulated entities, banks and so on wanting to jump into crypto.
Obviously thinking about risk management and counterparty risk and some of those things – was that also a consideration to put one or two levels between in order to minimize the risk for yourselves and for your clients?
Stephan:
It was impressive actually when I announced that we would implement the crypto strategy, reactions were very different.
Reactions from politicians were quite positive. This had also to do with the fact that several entrepreneurs and also industry bodies that had been established quite early started to educate politicians when it comes to the topic.
The reactions from the regulator were neutral, but reactions from competitors were negative or very negative, I have to say.
They could not understand why we would go into that topic and there were arguments like “It’s about fraud and money laundering and so on.”
And the argumentation was not always very differentiated.
And this has changed over the last few years very significantly.
Ian:
I imagine now as more banks come online with offerings, you do become in a B2B setting you’re actually probably working with other other regulated entities more and more often among banks and maybe clients move from one bank to the other or they have two three banks at the same time.
So you are working then with more peers.
Stephan:
That’s true. We are basically very open to work together with other companies.
We proved that when we established the transaction bank, but we also have a corporation with a partners group in the area of private equity. cooperate with Redalpine when it comes to venture capital.
Most recently, we also established a corporation with Bitcoin Suisse, the pioneer among the Swiss crypto companies. So that’s something that is very natural for us to deal with others.
What’s interesting is that clients with larger amounts of money also want to diversify.
And what we observed is that an increasing number of banks and also very reputable banks would accept fiat money that has a crypto background when it came through our bank.
So it seems that the industry trusts that we would do that due diligence in a very good way.
We do that by analyzing four elements to put it simply. Now the first is KYC as in the traditional area. The second is the AML analysis. The third is it certainly needs to be properly taxed.
The money and the forces, it needs to go through a chain analysis.
So each coin, Bitcoin for example, that is brought to our bank is analyzed by partner companies. That level of security, knowing that it came from another bank, regulated at the same level, with the same tradition of professionalism, helps.
And more and more over time.
Yes, this drives adoption and that’s something that can be seen now very nicely.
I mean, you mentioned the 34 banks that are open also to accept that someone buys or sells or sometimes even brings coins. And that’s an important step.
And if you have a look at the PostFinance, that’s quite remarkable. They opened it in their e -banking for the clients, that’s two and a half million clients, if I remember correctly, in Switzerland.
And these are all steps that will further add to the adoption.
Ian:
Definitely. And now just thinking about how the offering has developed, I think you have added some other things, for instance, staking, which also brings other challenges, technically, regulatory -wise as well. How do you continue to evaluate new parts of the offering and who you work with and those further steps?
Stephan:
I think the market is highly dynamic and we expect a lot of further development. For us, cryptocurrencies are just the first representative of digital assets, but by the end everything will be digitalized. All kinds of assets will be digitalized.
be it real estate or non -traditional assets, but also traditional equity bonds and so on. And the reason for that conviction is that blockchain technology is just very powerful. It is much less costly to do transactions. It’s much more efficient. And you can also trade with fractions of certain assets. So I would expect that we are at the very beginning.
And digital assets will become more important.
Ian:
You have added also a staking offering, is that correct? And different things.
What else is coming up or can I ask you that question?
Stephan:
I mean, we most recently established this corporation with Bitcoin Suisse and there basically two arguments behind that.
On the one hand side, we are an asset manager that has proven skills in dealing with fiat money and also with clients from the crypto community.
So what we offer to Bitcoin Suisse is that they can send their clients to us.
They will go through the onboarding process. And on the other hand, we also profit from Bitcoin Suisse.
For example, currently this is from their investment know-how when it comes to crypto.
We established a joint advisory board where we share our views about crypto before we take the investment decisions.
And such a collaboration certainly also helps when you think about future trends, new developments and so on.
I think we as a traditional bank even with experience in the crypto space needs to work closely together with selected partners in order to be or remain at a good point.
Ian:
You’ve mentioned a couple of times the fiat topics – I know early on, and this was also part of the catalyst for your offering, crypto companies who needed access to fiat and then to trading.
Is that still a topic today? The crossover between the fiat and crypto world and how is that developing?
Stephan:
It still is a topic.
Actually, I’m a little bit surprised.
I would have expected a far quicker competition in that area. But I think there are good reasons for many banks to say we do not accept this kind of clients because you need to have the necessary knowledge to do KYC and AML analysis.
And what we observe now is more competition when it comes to plain vanilla corporates that deal with blockchain or crypto.
However, there are also many, actually many complex business models that, for example, involve US dollar clearing that is from a compliance perspective, complex that involves a higher number of transactions and so on.
And in that area, we still have very little competition.
Because by the end, even if you have a look at the market, it is still a niche.
If you have a look at capitalization of crypto in the world, it’s compared to traditional assets, it’s still a niche.
And also if you have a look at the corporates that deal with blockchain and crypto, it’s a number that is not huge.
Very small, in comparison to most other things.
Ian:
You talked about competition and mentioned custody.
That seems to be one area where banks have put a lot of effort into building out offerings. So maybe that is the area where there is most competition, would you say?
Stephan:
Yeah, I think that’s mainly for an asset manager as we are a very interesting spot because there is so many applications with tokens going forward and to have a trustworthy stable institution to store that value is something that I believe is very valuable.
Actually, the interesting thing is when I went for the first time to the Crypto Finance Conference in St. Moritz, people asked me what I was doing there. They were talking about the getting rid of institutions like ours.
And this has actually changed a little bit in the last few years.
And what I expect is kind of a convergence between the traditional financial system and the new technologies that the digital world brings.
These technologies basically put a lot of pressure on established companies to further improve their processes and their services.
On the other hand, they will not replace the traditional financial system.
Regulators and states will not allow for that after they have been building up the regulation in traditional financial systems over many decades.
Now, why are institutions still necessary?
I mean in the transactional business I can well imagine that a lot of institutions will disappear since peer-to-peer transactions might be more efficient.
However, in asset management there is always quite a lot of emotion and sensitivity behind it. And if you have a look at the clients currently, most of the clients that would hold the assets are digital adoptors.
And it will take quite a while until that transfer of wealth to the digital natives will take place. And if you have a look at digital adopters, and I’m also one, I think that in sensitive questions like wealth management, which is the basis for your family and for your existence, the trust in an institution and in a person will for a long time play an important role.
So I think there is also a time component that needs to be taken into account if you have a look at what’s going on in this financial system.
And therefore, institutions that are open to deal with these new technological opportunities will be in place for a long time.
Ian:
And the clients, talking about those who say are less digitally-affine of your clients, but who now understand that Maerki Baumann has quite a sophisticated crypto offering, are trying to understand that, and of course speaking to your client advisors about that, how well are they getting that knowledge and assimilating that knowledge in the portfolio context and so on?
Is that a big jump for them, or is it?
Stephan:
It’s very different, and I think it has more to do with mindset than with age.
We observe a lot of clients, also older clients that are very interested in the topic and they want to be educated and they ask for further information.
However, from having the knowledge about an asset class to take an investment decision, that’s quite a long way.
What’s interesting is we are focusing on not only one generation, but we are always trying to get in contact with the next and even next-next generation, irrespective of crypto.
And that’s currently a very interesting thing. So it can happen that we organize a day where the grandchildren of the clients would come to the bank and then they talk with the client advisor about crypto. And in many cases, they know much more about it.
And that’s something that can also be observed.
Certain generations don’t deal on their own with the new topic or take the investment decisions, but they often involve the next generation that are proficient and interested to discuss about that.
Ian:
Obviously, working with different partners for your offering has been quite key to where you are today. Just talk a little bit about how the Swiss ecosystem, you mentioned regulators, you mentioned other people, the legislatures, politicians.
We often are very happy to talk about the Swiss ecosystem and that is also developing and changing over time.
What has been your experience and how do you see that developing going forward? Also knowing that things in Europe and the US and different places are also changing.
Stephan:
I mean, Switzerland was extremely early by establishing the crypto value and this was actually a corporation between entrepreneurs but also politicians and institutions in Switzerland.
I had always asked myself, how do we bring the Swiss financial center into the next stage?
Because we have a lot of advantages that are related to Switzerland, stability of the political system, the financial market infrastructure and so on.
We have highly educated people, have very renowned universities and research institutions with the hochschule, for example. And the element that was missing was an entrepreneurial spirit when it comes to digitalization – to bring the services, the traditional services into the future.
And I think this was recognized by entrepreneurs but also by some politicians up to the Federal Council that such a fintech and the crypto blockchain hub in Switzerland might also help to bring the financial center into the future.
And it was very impressive to see the reactions from politicians when we announced to go into crypto as a bank in 2019. And it was also impressive to observe that in 2021, one of the most advanced digital ledger laws in the world went through the Swiss parliament with 100 % approval.
So I think we had an extremely good starting point.
And what we are now observing is other hubs that also emerge.
My impression is that mainly Middle East and in Asia, there is now a lot of dynamics. Often, you can read in the media that the US is very cautious when it comes to the topic.
I am very sure that by the end, the US will be one of the leading nations when it comes to digital assets.
They have the most important financial center in New York.
It’s a very important country and if such a new asset class and the new technology that fundamentally changes the financial industry emerges, they will also be involved.
And if you have a look at the major US banks that also applied for a Bitcoin ETF or Ether ETF, that is not a coincidence.
So I think competition, international competition has already significantly increased.
Ian:
And does Switzerland then stand a chance when all of the rest of the world really starts to develop?
Stephan:
Yes, I think so. I think it has a chance as a financial center for asset management in general since it has a very clear and trustworthy regulation.
It has a lot of competent people and education institutions and so on and it has a system that is very reliable and trustworthy.
Mainly when it comes to a custody of assets in combination with the necessary technological know-how, I think we are in a very good position.
However, it needs openness to deal with these opportunities.
And don’t take the foot off the gas.
Ian:
Yeah, that’s true.
Many, many institutions have often, you know, over the past five years, used this phrase, blockchain, not Bitcoin.
Obviously, Maerki Baumann took a bit the other side, right, going directly into crypto, but tokenization, and you mentioned fractionalization and different things digital assets coming forward.
How ready are you for that and even for things which, for instance, SDX may be doing with the development of digital bonds and so on?
How ready are banks like yours for those developments?
Stephan:
We are basically open to deal with these topics. We’re also in close contact with Incore, the transaction bank, about these topics.
We realize that the client is a bit cautious currently and I think it has to do with the fact that you need reliable secondary markets also to sell these to these assets. You need the necessary research competence.
You need to establish new models to value these assets, so I think it will happen, but slower than we maybe originally expected.
One step at a time.
Ian:
Obviously, you’ve taken steps quite quickly at Maerki Baumann and come quite a ways.
I’m sure you’re having conversations with other banking executives and with the people that you work with at the universities and in the institutions – associations, how do you talk to them about these things and what do you say to them?
What advice do you give them from your own experience?
Stephan:
The interesting thing is in the first two years when we went in that business, many people were laughing a bit about our strategy.
Then two years they were rather quiet and now they want to have an exchange of thought, even much bigger institutions as we are.
My suggestion is always to be open, to be open when it comes to new technologies, even disruptive technologies, not only see the risks and cannibalization potential but also the opportunities and also to show openness when it comes to corporations, because banks will not be the ones that are in technology, the leading institutions.
And what I would also tell them is one very nice episode from this March when we launched our new crypto brand ARCHIP.
ARCHIP consists of “Arch” that represents the ‘bridge function’ that we have as a bank and the “chip” that represents the technology orientation.
We decided to bring together all our services under that new crypto brand ARCHIP.
And we asked ourselves, how can we promote that?
How can we launch that without a big amount of money for promotions?
And we decided just to celebrate our 5th anniversary.
And we also invited the 25 most important Swiss crypto entrepreneurs. And people were telling me, don’t come and this will be difficult and so on.
By the end, we organized that event.
From the 25 crypto entrepreneurs, 23 showed up.
And in total, 700 people showed up for a party.
And it was announced as a crypto party.
There were 200 or 300 traditional clients. were 200 corporate clients.
There were business partners and so on. And that’s the story I would tell my colleagues and also my critical colleagues.
We took that decision five years ago and it was also involved with a lot of risks, I think.
But that event of that ARCHIP launch was for me the proof of that concept.
Ian:
Definitely a milestone.
Very, very good. With that, think we’ll wrap things up.
It’s been very interesting to speak about all of those experiences.
I know that this isn’t the end of the story.
More things are coming up and some things which I think you are developing now and perhaps in a few months or a year or so we’ll be able to talk about even more.
Digital capital market infrastructure lays a foundation for a new evolution in finance – one that combines proven parts of traditional structures and the potential of new technology like blockchain and DLT. This transition has has many layers – as well as challenges and opportunities.
But what efficiencies does digital capital market infrastructure actually bring? What links remain between the “old and new” worlds – with exchanges, central securities depositories (CSD) and other elements of the ecosystem? And how do changing regulations and technological innovations promise to alter the landscape overtime?
In Part 1 of this RULEMATCH Spot On episode, Ian Simpson speaks to David Newns, Head of SIX Digital Exchange (SDX) for an in-depth discussion of SDX’s development and operations, perspectives on the current state of digital assets and SDX’s place in the wider world of digital capital markets.
Episode show notes:
(1:31) – What is SDX exactly?
(2:50) – Equal regulation as the foundation of SDX
(6:30) – How Switzerland (and SDX) have benefited from crypto
(11:05) – The advantages of regulation
(12:35) – The why and how of dual asset listings
(17:44) – Why bonds and how successful they are on SDX
(20:05) – Digital bonds in financial products
(22:50) – (Digital) securities equivalence and why it’s useful
(25:38) – Digital central bank money – the missing component
(25:59) – Why capital markets need riskless digital money
(30:37) – The key considerations for building a blockchain-based capital market infrastructure
(36:17) – Moving forward towards “digital supremacy”
(36:50) – Intermediated (dematerialized) securities in the digital assets space – and why Switzerland is good at them
(39:45) – Central securities depositories (CSD) on the blockchain and collateral mobilization
(42:54) – “Borrowing” DeFi use cases for regulated financial services
(43:52) – Privacy, settlement finality and other considerations for use of a private blockchain
(50:44) – The use cases for instantaneous (precision) settlement and its potential downsides
(55:07) – Details on the trading and settlement processes of SDX
(58:29) – (No) needs for a Central Counterparty Clearing House (CCP)
We do expect that ultimately all assets will essentially be digital assets and will live on blockchain. So one of our primary roles is to enable the transformation of the Swiss financial center into that tokenized and blockchain-based future that I believe lies ahead of us.
START OF FULL EPISODE:
Ian Simpson:
Hello and welcome to another episode of RULEMATCH Spot On, the only podcast focused exclusively on the institutional crypto and digital assets industry.
I’m your host Ian Simpson. And if you want to know what banks hedge funds capital market infrastructure providers asset managers and others are doing in crypto and digital assets and how they’re doing it. This is the place for you.
My guest today is David Newns. He is Head of the SIX Digital Exchange SDX and Chairman at AsiaNext.
David spent quite a few years working for State Street where he was Global Head of Global Link Execution Services. And perhaps interesting to note that before that he worked for several years at MicroStrategy, a company which some people know from the crypto or should we say Bitcoin space.
David, welcome to RULEMATCH Spot On.
David:
Thank you, Ian. It’s a pleasure to be here.
Ian:
Just to start out, David, I think it would be interesting for our viewers and especially for who are outside of Switzerland and maybe aren’t familiar with the ecosystem to understand in particular what SDX, the SIX Digital Exchange, is and maybe also importantly what it is not.
Can you just give us some details on that?
David:
Absolutely Ian.
So what SIX Digital Exchange is, is a fully regulated financial market infrastructure provider and that is a CSD, which is the Central Securities Depository and an exchange.
Uniquely, that’s built on top of blockchain infrastructure – the first of its kind in the world.
So first we were granted a license to operate a CSD and an exchange on blockchain. And we’re part of SIX Group, which is the infrastructure provider for Switzerland.
SIX Group provides the stock market, the central securities depository, the traditional world, the repo facility for the Swiss National Bank, the Interbank Clearing Platform, so the RTGS platform that the market uses here.
And somewhat uniquely, it’s still member-owned.
So, SIX itself is owned by the 100-plus banks here in Switzerland.
Ian:
And looking at the ambition of SDX, and I actually remember being at one of the first events when it was announced several years ago, it seemed like the overall ambition, long -term ambition, of course, was to build something up to the same standard, the same level as the SIX Swiss exchange as it is now, run it in parallel and eventually transfer over.
Is this part of the overall vision of the digitalization of capital markets as we talk about them?
David:
Absolutely. I believe that we’re both a catalyst for that, that digitalization of capital markets and we’re a vehicle to enable that to happen.
And also, we are the future of capital markets here in Switzerland in that we do expect that ultimately all assets will essentially be digital assets and will live on blockchain.
So one of our primary roles is to enable the transformation of the Swiss financial center into that tokenized and blockchain-based future that I believe lies ahead of us.
Ian:
That’s very, very interesting.
You mentioned, of course, that SIX being member-owned and that applies also to SDX.
So that obviously implies a buy-in from those members to catalyze and move the space forward as capital markets become more digital and evolve, right?
David:
Yes, and it’s a very interesting setup as a result because you have this ability to essentially orchestrate that migration. The members themselves can leverage SIX and also have obviously a significant say in to what we do and what our prioritization is.
When it comes to their journey and how they wish to adopt digital assets and how they need to overcome the hurdles that exist out there.
The role that we play as well in terms of the relationship with the central bank as a provider of the repo facility and as a provider of the RTGS platform, the technology provider, they operate these systems – it’s also really critical because if you look at this, and I’m sure we’ll get onto this later when we talk about central bank digital currencies, not only is it the case that we can help further the ambitions of our members, the banks, and market participants, but we can also provide an environment in which a policymaker, central bank, such as the can actually explore what tokenization might mean for them and their role in both supporting that transition – as well as exploring technology, understanding the risks and the benefits associated with that.
But with a vehicle, again, that they can use that is in production, that’s always going to be there, where there are existing members who can then participate in the initiatives that they are using to bring themselves forth and to establish understanding and learning on their side as well and push the needle forwards when it comes to how they wish to interact with capital markets and support those into those capital markets in the future.
Ian:
Because of course it doesn’t make sense to just have something top-down if the people who are using it, you know, don’t want to or can’t or it doesn’t make sense for what they…
David:
I think that’s actually, that’s a very interesting point or a sort of a way to visualize it because you can’t do things top-down in capital markets.
You really have to think about how to do things completely from the bottom up. You need to have the “most firmest” of foundations.
If we look at, you were saying, what is…
You asked a question, I did not answer it. Which is is SIX Digital Exchange, what is it not?
So it’s not a crypto exchange. On the FMI side, at the moment, we do not do, we don’t offer a trading platform for cryptocurrencies.
If I look at the heritage of cryptocurrencies and the evolution of that particular space – what’s fascinating is that it’s from the perspective of the capital markets, we see that as being, and it’s not mine, this is not my metaphor, this is Rene from Standard Chartered saying, “It’s a big R&D shop.”
What we see sort of happening over there as it were, that we can take learnings from.
It’s been a massive development effort in terms of new and innovative technologies.
Some of the most substantial breakthroughs, you think, in terms of innovation and invention in the 21st century have occurred in that world.
But that world historically has not been regulated and has not been approaching the technology directly from the perspective of regulation, whereas in capital markets, specifically the financial market infrastructure everything that we do has always come from the regulated context out, as it were.
So we start with, at the very basis, and this is back to your “top-down versus bottom-up” metaphor, we need to think about building an architecture from the ground up.
And in fact, you might even go even further and say it’s from the substructure up, because we need to start with effective, clear, regulation in capital markets.
In Switzerland, we’ve had that for many years.
Switzerland has, I think one of its great benefits has been that we have an informed and effective regulator in FINMA who has significant capacity when it comes to their understanding of digital assets.
Also, the way that market participants can interact with FINMA, I think, is in a very constructive fashion.
And I think as a result of that, we’ve had innovation here in Switzerland that I would argue is the envy of the world when it comes to how far we’ve taken crypto.
If you look at the Crypto Valley, it is an unknown thing. If you talk to people in the crypto sphere, they are very aware of Crypto Valley.
We have a number of foundations here for blockchains. We have the Web3 Foundation.
The Crypto Valley Association itself is a great articulator and a supporter of the industry overall.
So, FIMMA enabled that to exist and thrive, which is a great start, and the capacity of knowledge, understanding, engineers, and so on.
It meant that the deployment of digital assets in the regulated space was much easier, as it were, because we had this developer community that was already there and this understanding.
But simultaneously, the regulations as they applied to capital markets and to digital securities could also be seen and effectively implemented by FINMA.
We could have informed conversations with them when we wish to take that forward, roll out a regulated piece of blockchain infrastructure, which was a great, which was an enormous and very significant component on top of that sort of foundational layer of regulation.
Now you need to have regulated blockchain and the license that we were granted, or licenses, in 2021 to operate a central securities depository and an exchange based on blockchain technology.
Those licenses are identical to the ones that are granted to the traditional FMI, the traditional CSD and exchange at Six Group.
But they are unique in that they’re being applied to blockchain.
And it was only because FIMMA had this depth of understanding of blockchain and awareness of both the opportunities, but also the risks associated with that, that we could have that conversation with them, get them comfortable that we had addressed the risks, and we could actually discharge our responsibilities when it came to an operator of a CSD and exchange, based on that new technology.
Ian:
So you mentioned that, right, the regulation at the same level as the SIX Exchange as it is now.
That’s both the trading and the CSD in one.
Obviously, it’s an advantage, it’s regulated.
Are there any disadvantages to being under that regulatory regime or do you think that is a good fit for how things will be going forward?
David:
So for what we need to do.
I think it needs…
We’re fortunate here in that I do not believe that’s any way a disadvantage for the specific role that we are and the specific product set that we are providing to the market.
You do not want to have a different set of regulations that cover digital securities and we’re talking about here fixed income and equity, for instance, versus their traditional counterparts because ultimately you don’t want to confuse an investor at the end of the day.
“Well, this is one thing, this particular kind of financial instrument, but because this other one is digital, it’s completely different.”
Because when it comes to holding those in your portfolio, it’s going to cause some confusion and a challenge to accommodate if – because the underlying technology varies – you have to perceive the financial instrument as being somehow fundamentally intrinsically different.
Ian:
And we’ll get to the products in just a second, but on that point, I’ve noticed some of the products listed on SDX are dual listed, right?
You are listing on the regular exchange and on SDX at the same time. Is that also the reasoning behind the same level of regulation?
David:
So if you couldn’t, if you didn’t have the same level of regulation, you couldn’t achieve that.
I think there’s a number of reasons why that’s really important.
One, as I mentioned before, you don’t want to have the underlying technology to dictate what the financial instrument actually is, how it behaves and how it can sit in a portfolio.
The digital securities that are issued on SDX are legally identical to traditional securities and therefore you can have this dual listing structure.
But why do you need to have them dual listed is a really important question, I think.
If you imagine we have this regulation at the foundation, almost like the underlying substructure.
You then can deploy a regulated blockchain.
And a regulated blockchain means that market participants can carry out regulated activities on that, knowing that they are compliant with the regulations.
That’s what they have to do.
They have no choice. They have to do that. That’s not a discretionary sort of option.
But what you also need is interoperability with the traditional infrastructure because you don’t want to have a situation where – when I’m issuing a digital bond, as I mentioned on the investor side – it can’t be worse than or different to a traditional bond in terms of the financial aspects of it.
As an issuer, you don’t want to be issuing a bond where the price you get for that bond is going to be different, higher, “worse than” the price that you’re going to get for a bond in the traditional world.
Because then why would you issue?
Because you’re specifically trying to, now it’s got a purpose which is to raise capital and you want to raise capital at the lowest possible price.
So if I can’t reach the largest amount of liquidity as an investor base when it comes to issuing that bond, I will not get the best price for that bond.
And since my primary concern is raising capital, that’s a big problem.
The first bond that SIX issued on the platform was a dual tranche bond.
We had a digital tranche and a traditional tranche.
So, we issued simultaneously on SDX and on SIS, the traditional infrastructure.
But the ability to move that bond backwards and forwards was really complicated.
It took days actually to detokenize and then create the bond on the other side. And it had two ISINs.
And for those of you who aware of what an ISIN is, that’s a pretty significant thing.
Basically means it’s a completely different something. It’s a completely different instrument. It’s not the same bond.
And that makes life very difficult for bank treasuries as well as for investors when it comes to actually holding that.
So that lack of fungibility, despite it being theoretically the same issuance, is a big problem.
And the lack of liquidity that the digital had meant that to go to the market again and go, “OK, who’s going to issue the next one?”
The idea that you would issue a bond to just the members and the underlying investors on SDX, not be able to reach the investors that exist on the traditional infrastructure was a big non-starter.
So in fact, our members came back to us and said, “Here’s a shopping list of requirements for scaling and for further issuances on the platform.”
And one of the top prerequisites was you need to build to actually list on SDX on the blockchain, but also somehow enable that to reach the investor base of those members who were not on the SDX platform because we only had Credit Suisse, ZKB and UBS at point in time.
The dual listing structure was the answer to that and a bridge between the two pieces of infrastructure.
So we have a bridge between SDX and SIS. You issue on SDX, but the bond can then be immobilized in SDX and made available on SIS as well – move backwards and forwards completely seamlessly.
So that process is one that happens in seconds rather than in days now.
And there’s one ISIN, regardless of whether it’s on SDX listed or SIS or SSX listed.
That’s the notion of dual listed, natively digital bonds, which is a standard way that we issue bonds on the platform today.
It was extremely novel at the time and is very much the way we expect that all bonds in this sort of, at this point in time where we’re migrating from digital to traditional to digital, that sort of structure enables that migration because it lowers the friction that would otherwise impede adoption.
Because as an issuer, you have an equivalent instrument to a non-native digital instrument.
Ian:
So we’ve talked about the bonds and how that works a little bit in detail.
We’ll go into some more topics for the infrastructure itself.
I mean, actually quite successful what you’ve done so far.
The news came out that there has been over one billion issued on SDX. And recently, let me get the numbers right if I can, a seven-year, 200 million Swiss franc bond from the World Bank was issued on SDX.
Just stepping back – why did you start with bonds and what was kind of the reasoning behind that?
David:
Absolutely. think we’re now up to 1.4, so it’s moving quickly.
Bonds are a relatively simple instrument to start with. There’s a constant supply. So unlike IPOs of equity, for instance, there is a regular issuance cadence associated with bonds.
So as a sort of ammunition to try things out and to move forwards in terms of adoption and understand what the requirements are from a technical perspective, legal perspective, regulatory perspective and so on, and for our members to sort of understand and get their hands used to it, this is technology, bonds are a great, sort of barrel of unending instruments that can be issued.
There is that.
They also lend themselves very well in the digital context to use cases down the line.
So there’s an expectation that we will be providing, and we can get onto this a little later, functionality that can enable collateral mobilization more effectively on blockchain and high quality collateral, high quality liquid assets, are typically bonds.
So not only are they really useful in terms of this supply of ammunition for trying things out, but also there’s very clear future use cases that we are intending to deploy which will leverage bonds.
Ian:
Okay, very, very interesting. Just one thing that comes to mind now, bond ETFs or bond products, even actively managed ones are somewhat popular.
I’ve seen some things in the news recently that those are becoming more and more popular.
How would a digitalized bond issued by SDX operate within a fund structure or something like that?
Is that possible at this point?
David:
It absolutely could be, and it may well be that that’s happening today. Because again, if we go back to this idea of the legal, similitude or whatever, the fact that it’s the same digitally versus traditionally, it means that these bonds can be used in the same context that traditional bonds can be used.
And if you look at, again, this sort of, progress that we’ve been making as we’ve gone along, we sort of checked all the boxes around, you know, is this genuinely the same as a traditional bond?
The second bond, I think, that was issued on the platform, by the City of Lugano, in 2022, one thing that was critical about that was that not only did Moody’s determine that its risk weighting, that its rating should be the same as its traditional equivalent should have been issued on the traditional infrastructure, which was a major process.
Ratings normally happen after issuance, but in this instance, it was a multi-week process, I think four weeks-worth of work with Moody’s, the City of Lugano and SDX to ensure that the underlying technology didn’t somehow impinge upon the risk rating and the answer was satisfactorily, “No it doesn’t.”
But that also meant that all subsequent issuances could follow the same – they didn’t need to go through the same process.
Very grateful to Paolo Bortolin, the deputy CFO of City of Lugano for his patience and his pioneering spirits when it came to getting that through the door – and repeat customer now actually, in the case of City of Lugano.
But that meant, not only was that a major step forward, but also the SNB deemed that bond to be eligible for inclusion in the SNB’s collateral basket.
So you could then use it for repo.
And it is used, and we know from conversations that we’ve had in the marketplace, that it does indeed, as do the other digital bonds, appear as collateral for repo.
That is obviously a critical component, again, of the capital market infrastructure in Switzerland or indeed in any economy.
So to answer, a long way to answer your question, yes, I would be.
I don’t see any reason why not, because these are identical to their traditional equivalents.
If we think again about that metaphor of building up foundations, where you have the regulatory foundation layer at the sub-layer, then you have this regulated blockchain infrastructure.
There is a interoperability component which is also critical. That interoperability both in terms of working with traditional infrastructure, so you have these bridges.
So whilst we’re migrating, these instruments can flow backwards and forwards, but also that the instruments themselves can do that because they are considered identical.
And we’re heading as we build that up and then add on more. And on that network of participants that we’ve now onboarded onto the blockchain infrastructure, you have a network by which these bonds can be issued, traded and settled and custodied amongst a large variety of members.
When that network reaches a certain size, you’ve kind of really achieved what we might call digital securities equivalence, in that you can do everything with a digital version of an instrument that you can do with a traditional world, with one exception – which I’m sure we’ll get onto – which is you need to have this magical central bank digital currency component.
But there’s all this building work that needs to go on just to get to the not very exciting sounding “equivalence.”
Because all you’ve done now is build…
Ian:
You’ve got back to zero.
David:
Back to zero.
This is back to the question around “top-down versus bottom up.”
You have no choice whatsoever but to start at the bottom and build up to that level.
Because only then, having done all that work on the foundational components, can you actually build a superstructure of blockchain which is enabling use cases that you previously could not access because the technology that exists in traditional infrastructure does not facilitate the broad array of use cases that we have available within blockchain technology.
Ian:
We touched on how the banks and the people are interacting with these and I also have another question about the bonds and the issuance but let’s go first to the next things coming up. You alluded to collateral and collateral mobilization and things like that.
People might be thinking also of tokenized equities or other products.
What is now the next step, assuming that things move forward from bonds from here?
David:
Absolutely. So we might want to touch a bit on this sort of missing component as well, is so the something that those who are not familiar with financial market infrastructure may be unaware of or not fully understand the significance of is central bank money.
In the principles of financial market infrastructure, which the BIS have published and which FMI’s follow, there is a principle which is, I think it’s principle seven – which I have tattooed on my forearm, which is that “Whenever possible, systemically important transactions should take place in central bank money.”
The reason for that is that central bank money is the only form of riskless settlement asset that there is in the world today.
So all other forms of money…money that isn’t issued by the central bank, have risk associated with that because those forms of money are issued by commercial banks.
Therefore, there is a counterparty risk associated with that.
When you are conducting transactions that are considered systemically important, so wholesale transactions, and those are transactions that occur between banks and typically for purposes of payments between banks or the settlement of securities transactions.
These should take place in central bank money so that you have the maximum surety of settlement finality.
So the transactions that underpin your entire financial services sector that goes all the way up to retail and in consumers transferring money to other consumers, ultimately those transactions between individual human beings “part and parcel,” go all the way down the stack until the banks of those individuals – assuming they’re not the same bank – that transaction will ultimately be settled.
That liability that’s now being generated between one bank and another bank is settled in central bank money because that transaction is not allowed to fail.
If that transaction fails, the whole edifice all the way up to consumers begins to sort of teeter and doesn’t have that sort of that confidence.
That’s one important factor, which is just for absolute surety that this whole edifice is built on the right foundations.
The other aspect of it is that if I hold tokens that represent a settlement asset on my balance sheet, to facilitate these transactions if those tokens are commercial bank money, that’s not considered riskless as an asset.
I have to hold cash on my balance sheet to offset against that risk…
Ian:
Capital requirements….
David:
Capital requirements.
The more tokens I need to hold, or the more amount of tokens I need to hold, the bigger the capital charge is for holding those.
So, if you imagine that I’m trying to get my members to transact on SDX, but I’m having them transact in a stablecoin, or some such digital currency, or digital form of cash, but they have to hold cash against that, then the more activity, the more capital is required.
So immediately you see this does not scale.
This is not something that’s going to be able to be adopted in that sort of wholesale environment because the actors, those involved are going to end up with a ballooning of capital requirement and a capital charge.
There’s that aspect of it as well.
So there’s both the sort of the structural aspect and then there’s the scaling aspect, which are both which are interrelated, obviously.
There’s also the fact that if the market moves through to become more and more orientated around blockchain and token-based money, or tokenized money, tokenized everything, then for the central bank to actually be able to conduct monetary policy effectively, it will need a form of token-based central bank money just to ensure that it can continue carry out monetary policy operations.
For the central bank’s perspective, it’s also important that both to support but also to participate in and to help maintain the integrity and the stability of financial markets and to able to execute monetary policy, it will need a form of tokenized central bank money should the world move in this direction.
So lots of reasons for there to be…there needs to be some form of tokenized central bank money on blockchain.
Ian:
So basically, in a nutshell, you’re saying that this piece of the central bank digital currency is the intermediate step that needs to happen before the wider use cases of other things beyond what’s come first with bond and so on and so forth can develop and be adopted by more and more members and bring everybody into the ecosystem.
David:
It’s hard to say what is, how and what it is actually, it’s a catalyst on the one hand because… security, I wouldn’t call it a security blanket, but a reassurance that there is now this instrument as
So it gives you, as a member joining SDX, say if you’re a large bank and you’re thinking “How will I leverage this technology…?”
Then you’ll quickly start thinking, “Well, I need to choose a platform that is going to be here to stay, that clearly has a future. And now which one is that going be?”
That’s one thing, because there are other ways that you could potentially leverage blockchain technology.
But you’ll start sort of going, “Well, it really needs to have, you know, be in a jurisdiction where the regulations support it. So I can’t be building out some exciting sort of blockchain-based trading platform in the US instance right now.
Ian:
Or the Bahamas.
David:
Or doing it in a jurisdiction where I could do it, but there isn’t a regulator who has quite a, not quite so much credibility, and is able to enforce regulation in the way that the SNB can.
So you need to have confidence about the regulator. The regulations need to be clear.
But also these, you start going, are those pieces in place?
Because before you know it, you’re actually just checking off the box of like, “Do you have the right regulation? Is there a regulated, licensed blockchain that exists so I can actually conduct my activities on that infrastructure in a way that again means that I trust the counterparty will deliver the service and that I will not, I will be able to be in compliance myself and also I trust the counterparty to deliver because I know it has the appropriate control environment, the license is dictated and so on and so on.”
So that gives you the confidence.
But then you’d also say, “Functionally, what I do on that, where’s the interoperability? Where’s the liquidity?”
Because if it’s going to depend entirely on instruments that have only been issued on that blockchain, then that might be too limited in terms of instruments.
But if it’s got interoperability with traditional infrastructure and can, for instance, tokenize as SDX can any instrument that’s available on the digital infrastructure and then hold that as a token on that blockchain or that’s another massive checkbox.
But also “When I’m transacting on that platform, do my activities scale?”
If transacting means that I’m having to hold a form of tokenized deposit or I’m having to hold some sort of stablecoin, then that will come with significant constraints because now I’ve got this potential capital charge that I’ve got to think about.
And then before I know it, my treasury is going to go, “It’s really expensive what you’re intending to do over there from a capital perspective.”
And capital is a scarce resource that we need to be very careful about.
But when you’re doing your stuff there and not doing it on traditional infrastructure, you have this massive issue. The question will be, “Well, what form of settlement asset exists on that blockchain that will prevent that particular circumstance, that scenario from occurring?”
And really, you’re quite limited in terms of what solutions you have.
So you have a CBDC.
There are alternatives to that that are limited in some pretty substantial way to a CBDC, but I do believe potentially can give you a stopgap.
A trigger mechanism is another one where transactions ultimately trigger the RTGS system to do the settlement.
You don’t keep the cash on a chain.
The problem with that is that we are trying to keep all the assets on the same chain so that we can carry out activities that leverage the blockchain infrastructure’s inherent innovative functionality such as being able to do composability to actually program activities on chain.
And that only really works if you have both the investment token and the settlement token on the same blockchain.
It might get you forwards a little bit having a trigger mechanism, but ultimately you’re still going to have to want cash on chain at some point.
And then there’s forms of synthetic CBDC, which I think are highly innovative and certainly again move the needle, but also have limitations.
And they’re typically a little bit less (maybe) substantial compared to sort of just massive counterparty risk or at least that being a massive issue.
Because in a synthetic CBDC, efforts are taken to ensure that there’s a notion of “bankruptcy remoteness,” but there typically other issues arise and they’re typically related to liquidity risk.
There are scenarios in which you may not be able to de-tokenize, go back to the token issuer and turn those tokens back into cash.
So that causes problems again.
If you’re choosing a blockchain or choosing where to actually innovate, then this last piece that comes into play, the CBDC, as you say, that gives you confidence because this whole infrastructure you have now, it’s like looking at a building site and seeing that they’ve done the foundations as opposed to looking at a building site going…
Ian:
There’s just a hole…
David:
There’s not even a hole.
There’s just a field. I’m not going to construct my skyscraper on that.
I know that will be an expensive and dangerous disaster.
So we have completed the foundation building and now are actually deploying the superstructure.
And the superstructure is where you get what I would call that “digital supremacy.”
So now the instruments you’re issuing digitally and the activity you’re conducting digitally will be superior in terms of what you can access in terms of functionality, in terms of use cases, than that which you can access in the traditional world.
We can get onto that if you want…
Ian:
Let’s get to that maybe in the next step, but first let’s dive down a little bit deep into the rabbit hole to understand some of the mechanics, so then maybe we can understand better how that will work.
So on SDX, a few topics that would be interesting probably for listeners to understand “under the hood.”
You mentioned operating the exchange and the CSD under one roof, under one regulation.
There is the concept from traditional finance of intermediated securities, and I understand that you carry that concept over into what you do at STX.
Can you just explain to us what that is, how it works and why maybe you keep that process in this setup as well?
David:
Absolutely. what we have in Switzerland on the traditional FMI are “dematerialized, intermediated securities,” which is a fancy way of saying there’s no bit of paper.
There’s no certificate.
We’ve dematerialized that certificate.
The record is only electronic, and it’s intermediated in that the end investor acquires the instrument through an intermediary through a broker, and then it’s held at their custodian.
That works really well when transposed onto digital.
The difference being that the record of that dematerialized intermittent security only ever exists on the blockchain.
So the instrument itself isn’t a tokenized certified security, so there isn’t something else, somewhere else that is the original certificate that’s been immobilized and then there’s a token issued.
The record on the ledger is the security.
That’s where the ownership actually is related to. That’s what we have.
We had that in Switzerland for a great number of years.
That was not by design. It just happens to be the most advanced form of traditional security. This was not the case in Germany until relatively recently.
So they couldn’t do the same things we could do in Switzerland with applying the regulations straight to blockchain because they didn’t have this concept of dematerialized over there.
That’s also, relatively recently, that also came into law in Germany and they can now have similar (sort of) things.
They can exploit the blockchain in similar ways, again, leveraging their traditional securities.
Yes, that’s the way that the vast majority of the securities market works here, where you don’t as an investor directly access the financial market infrastructure yourself, you do it via an intermediary.
And the CSD sits in the middle of that as well.
Ian:
Is that still needed actually in that sense?
David:
The interesting thing here is the CSD is now distributed.
It’s a distributed centralized securities depository – clearly an oxymoron.
Each of our members runs a node on our network, and that node, they can only see the records of the central securities depository that are related to their customer holdings and their transactions.
So they have a view of that, essentially, as a sort of virtual ledger which exists distributed across all the different nodes.
So what you can then do with that, essentially, you now have this distributed database that everyone has a copy of.
There is now…Instead of everyone having to reconcile their database that contains information about the holdings that are related to them as a member, that database is held, they have, they hold that database themselves.
So they don’t have to reconcile an internal database with that database, they hold that database themselves.
When it comes to use cases such as collateral mobilization, we all (all members) share the same version of the truth.
This is what underpins the concept of a distributed ledger and blockchain technology is that we all share the same truth.
It’s what’s called a state machine – as opposed to a stateless situation.
We all know the stateless system at any one time, which means that I can instantaneously go, “I have instruments that I wish to immobilize here so that you can lend me instantaneously tokens off the back of that.”
So collateral mobilization, so that means I will…
“So here are some bonds I want to, that I will immobilize as collateral for you lending me Swiss francs.”
And instead of that being, “I send you information about my holdings, you recognize that they’re there, you tell me to immobilize them, I then prove that I’ve immobilized them.”
And that process taking hours potentially in the most advanced systems, and just to be clear, Switzerland has probably the most advanced example of this in the world.
In other jurisdictions, this can take days. If you can immobilize that instantaneously, then you can achieve what is possible over periods of hours, instantaneously.
So if you want to get funding and you need it like in the next few minutes, then this facility can be achieved through this technology.
But it’s not…
And there are other ways you could potentially do that, but that’s one of the benefits.
This notion that we can all agree on the state of the system.
So, I can show you what I have, and you can instantly verify that because you also have the ability to view exactly the same information at exactly the same time.
Ian:
This would be, shall we say, analogous to what some people in the crypto space with the smart contract are doing for decentralized lending and things like that.
David:
Exactly, the same thing as that.
So we can…so back to Standard Chartered of Rene’s perspective that R&D happens in the crypto world and we kind “borrow” all their ideas or “steal” them and repurpose them for ourselves. is a bit absolutely.
So if you look at the use cases around the sort of instantaneous borrowing and lending facilities that exist in DeFi, yes, we can now achieve that.
As a result of that giant building effort, we can achieve that but in a completely regulated context with safe and trusted counterparties, where ultimately the underlying investor has protection because of that edifice of regulation etc. regulated counterparties and so on.
Ian:
Let’s talk about then the layer that we’re talking about here that’s enabling this, blockchain.
I think it’s a pretty well-known fact that you use a private blockchain to do this, Corda, and maybe you weren’t involved right at the beginning in the design of that and the choices of that, but what are the considerations?
For the actual DLT blockchain layer, Corda in this case, privacy being one, but are there some other considerations that make that particular flavor of blockchain useful for what you’re doing?
David:
Absolutely. So we have a highly effective partner in R3, which I believe has been a huge innovator in this space.
Really drove adoption forwards and specifically because there are requirements that the capital markets have that are relatively challenging to achieve on DLT and blockchain technology.
Privacy is one of the biggest ones is that… Yes, having a distributed ledger is great, but as per my example, you should only see the holdings that are yours.
You shouldn’t be able to see everyone else’s holdings in the context of capital markets.
I can give you an unfair advantage over your competitors in that instance. So being able to reveal information is important, but also just as important is being able to prevent individuals or parties from seeing information that they shouldn’t be able to.
So having confidentiality of transactions and privacy of holdings is really, really important in the capital market context.
Functionally, that’s really a key.
There are issues around concepts such as settlement finality.
Settlement finality, which means that all parties agree the transaction is complete. That is a critical idea or concept within capital markets.
We shouldn’t be in any disagreement as to whether something is done and transfer ownership can now either has also been completed or can commence depending on where we are in that transaction and settlement cycle.
So settlement finality is absolutely critical. What you have on public chains tends to be more probabilistic rather than deterministic when it comes to settlement finality, which is a massive “no -no.”
Can’t have any vagueness when it comes to “Is this done?”
From a risk perspective, an everything perspective, that’s one of again, one of the sort of cornerstones of capital markets is that: as an FMI, we own settlement finalities.
It’s up to us to know.
And the central securities depository is where that finality is recorded.
So that is the golden source of who owns what securities in a capital markets context.
A public chain has massive limitations about that due to the way the consensus mechanisms work.
In addition, we can go into…there’s a whole challenge around things like MEV.
So the way that validators can essentially reorder transactions at all and the scurrilous activity that that can potentially lead to, which has actually happened.
We know that has occurred, that does occur, has occurred in the public chain space.
There’s a whole…and it can go on.
There’s lots of reasons…
And there’s performance reasons with some chains and then there’s things…and there’s stability reasons.
There’s security issues.
Now all of this kind of is trumped by the fact that as a financial market infrastructure provider, the regulator requires that we own the risk parameter around technology that we’re using to discharge our obligation to actually deploy functionality that the license enables us to avail ourselves of.
And there is no legal entity that I could even outsource to in the case of a public chain where I can say, and I’m depending upon this organization and here is my SLA between myself and that organization which runs this public blockchain.
There is no such thing in a decentralized blockchain that you can actually do that, with that concept that exists very firmly within the regulated world.
Where risks within a capital market structure that have been recognized should have some ownership, especially when it comes to licensed activities being discharged so that the regulator can go…can actually give…to associate risk and responsibility and ensure that there is ownership of those risks.
So that’s all very difficult to do on a public chain.
And certainly, it’s a private permission ledger is far more digestible for a regulator when it comes to handing out a license.
That having been said, we are extremely excited about what we can use public chains for.
And I think there’s a tremendous amount of innovation that’s going on in the public chain space that is addressing some of these issues associated with…that prevent capital markets adopting this infrastructure.
So R3 themselves have innovation and functionality that enables connectivity to public chains.
So interoperability is…
One way of approaching this is that you take your private-permissioned ledger and have it interoperate with public chains so that you can potentially move assets or carry operations backwards and forwards between public and private-permissioned.
And then there are entire innovations, new chains such as Canton, which is designed from the ground up to address the needs of regulated capital markets.
It’s almost like it’s gone through a shopping list what it needs to do to achieve adoption by capital markets all the way up to the recently announced, the validator foundation that it has, whose name escapes me.
But the relationship with the Linux Foundation and so on to ensure that the governance of that chain is friendly to market participants and regulators.
So there’s another aspect…
Ian:
The DLT/blockchain as I understand it, you use it at SDX, not just for the CSD side, but also for the settlement in the trading side, correct? (Correct me if I’m wrong.)
So there’s a certain article from the Financial Times I found very interesting recently, talked about exactly what you just said, the problems with public blockchains, and was actually focusing on the problems of tokenization as well.
But then coming to the topic of atomic settlement or instantaneous settlement, which is enabled by DLT technology like this.
However, at the same time, it potentially cuts out some other advantages of the way the markets work today with T+1, T+2 settlement, netting and so on and so forth.
Obviously, the decision has been made at SDX to go with atomic settlement.
What do you think about those trade-offs between instantaneous versus capital efficiency?
David:
The atomic settlement structure, that is something that I don’t believe lends itself to high-frequency trading, active trading generally.
My background before I joined SDX, I was very heavily involved in trading platforms, MTFs and CEFs, independent trade sort of, and self-supervised unlicensed platforms. very much so.
And half of those were specifically geared around high frequency trading.
In that world, it simply doesn’t work without netting.
There’s not enough liquidity in the world to actually manage the settlement of the transactional flow that goes through HFT for foreign exchange, for instance.
So I don’t believe that atomic settlement is a universal sort of panacea for all settlement context.
What I tend to think of atomic settlement as not so much like is it T+0, T+1, T+2 or atomic, which one is best.
Atomic is more to a point-in-time settlement – is precision settlement.
So it’s saying, for example, for…around this notion again of borrowing and lending, being able to actually say that at that particular point in time, I need to be able to be sure of the transaction.
It will occur then, and ownership will be transferred then. So to be able to say that 11:05 tomorrow morning, the transaction will happen.
That’s what I think is more interesting for us, that sort of that confidence you get around that, than it is around, I am now moving from all my highly liquid equities now transacting HFT style but settling atomically.
No way.
The pre-funding requirements are insane.
Also when it comes to actually being able to do that, facilitate the transactions.
And then subsequently, there’s an enormous amount of efficiency that comes through netting that exists today that even T+0 enables significant amounts of efficiency around.
In the future, I have no doubt that we will have settlement windows that will be available.
That requires more infrastructure than we have today related to settlement and clearing, but something that we’re very much looking into as facility in the future.
The specific use cases and even the instruments that we’re focusing on here, they do not trade frequently.
So they don’t have this need for us to worry so much about that the settlement being inefficient because we don’t support netting.
I think it’ll also show that moving trading into this context, sort of high frequency trading of liquid instruments, probably quite a long way down the line, because the benefits around that when it comes to leveraging blockchain for trading are less obvious than they are for these less frequently traded instruments, but ones that are used in these contexts – the contexts of collateral mobility, because they’re considered to be high quality liquid assets.
Ian:
And when we talk about that process, we don’t have a graphic or a diagram for our viewers and listeners, but just walk us through the actual process of the trading.
So there’s a trade match, You use a central limit order book?
David:
Correct.
So we actually use the same infrastructure as.. So we say, provided…that you guys at RULEMATCH use, we use a Nasdaq engine for the matching process.
But the matching process also includes leveraging the blockchain to determine the availability of the assets so that we can…so that the trade, so the matching and trading is all one indivisible matching/trading/settlement, all one indivisible step.
Ian:
Right. And that blockchain bit at the beginning is part of the risk assessment?
David:
Exactly. So it’s all, it’s not, well, it’s part of the “Can this match occur?” sort of process.
So again, unlike trading in high frequency where you begin to measure latency matching in single digit microseconds, we’re talking about this will be, it’ll take a second to actually carry out this activity, which is two, three orders of magnitude slower than HFT is typically associated with or expects in any way, shape or form.
Again, does not lend itself to every use case.
And I think that’s also what people really need to understand when talking about where blockchain comes in.
It doesn’t sort of wipe away the existing world.
It fits in to areas where it can bring significant advantage and coexist alongside for the foreseeable future the traditional infrastructure, which again is why this interoperability is so critical between what we’re building on the blockchain side and traditional infrastructure, because there will be so much interaction and activities – that make no sense to migrate across anytime soon – will stay where they are in the traditional ecosystem.
It’s a completely different story when it comes to the active trading of cryptocurrencies, which actually, although it sounds like you’re doing something related, because it’s got a blockchain involved in there, as you are fully aware, it is totally different.
That’s just trading a pair – which then kicks off a whole process which is still the same, looks very very similar to the traditional sort of FX.
Ian:
The infrastructure is totally old fashioned.
David:
Exactly, and a bit old fashioned but also highly optimized.
I mean it’s…and we’ve seen both the matching speeds have become literally unbelievably fast because you don’t know what it means to match in single digit microseconds, nothing in your normal world happens at that speed that you’re aware of, can’t be consciously aware of things that happen at microsecond speeds.
And then all the optimization around settlement is something that’s taken us years in the market to actually arrive at.
On the FX side and transposing that onto crypto is a challenge, right?
It’s really actually taking the best of breed from the institutional space and somehow getting that to work in crypto is the challenge there, I think,
Rather where we’re coming in the other direction from security is going, “We can do all this transformative activity, leveraging technology in these areas, but they don’t look much like the challenges that we have over there.”
Ian:
So one term I have not heard you talk about in this entire discussion and also how you operated SDX is a CCP.
So is the idea of the setup at SDX really, I mean, there is no CCP?
David:
Not for this. This is what’s also interesting.
Is that, no, because there’s no kind of counterparty risk associated with the transactions that are occurring because the indivisible nature of that match/trade/settlement process – there is no need for a CCP to step in and actually facilitate the trade.
Nor is there any notion of bilateral counterparty risk that the CCP obviates or eliminates.
So for atomic you could absolutely see that a CCP would be a way to facilitate any T+0,T+2 and so on and again so down the line.
Would I expect there to be integration to some form of CCP?
Absolutely, because that certainly is one direction you could take.
The one direction of travel you could go in to facilitate that non-atomic settlement for those use cases where that will be required.
Ian:
David Newns, thank you very much for joining the podcast. Look forward to future conversations sometime soon.
The RULEMATCH interface is designed to serve the specific needs of banks, securities firms and their institutional clients.
Account management
Within the participant section of the RULEMATCH interface, users have a broad overview of their account structure, including organizations, accounts and user profiles, with their granular permissions. The sophisticated account structure enables prime brokerage through sponsored access to the RULEMATCH trading venue.
Trading operations
Participants may trade through the configurable trading interface of RULEMATCH with a range of order types and time-in-force/triggering conditions. They may also connect to the trading venue via industry-standard access protocols FIX 4.4/5.0SP2 as well as Nasdaq’s binary protocols ITCH/OUCH. The latter allow for ultra-low latency trading at speeds down to 30 microseconds.
Collateral, margining, clearing and settlement
Through the treasury dashboard of the RULEMATCH interface, participants track the current trading, clearing and settlement cycles together with the multilaterally netted obligations and entitlements for each cycle. Additional views also present an overview of the participant’s collateral portfolio and a comprehensive analysis of the margining calculations in real time.
Reporting
Participants can access a wide range of reports covering trading, collateral, clearing, settlement entitlements and obligations as well as assets in custody, pending withdrawals and more.
More information about trading, clearing and settlement operations on the RULEMATCH trading venue can be found here.
