CRYPTO: Re-making Traditional Banks with Custodian/Exchange Staking-as-a-Service

2019 has started off with a bang in capital markets blockchain -- (1) a $20 million investment by Nasdaq in enterprise blockchain FX player Symbiont, on the heels of Baakt and ErisX, (2) a Security Token Realized conference well attended by financial services execs from companies like State Street, of which 70%+ owned BTC, (3) and meaningful technical developments and financial products from folks like Tokeny, Securitize, Templum, Atomic Capital and others. But let us shift to another leg of the crypto stool this year, which is staking-as-a-service. We recommend reading the Coindesk op-ed from Michael Casey linked below, which outlines how a transition from proof-of-work to proof-of-stake in Ethereum (if it ever happens) could lead to the intermediation of crypto deposit holding on behalf of consumers. If investors get paid for outsourcing private key management to custodians, argues Casey, we re-create the fractional banking system with its pitfalls, like counterparty risk and incentive trends towards leverage. 

We agree, but aren't immediately put off by the comparison because credit is the lifeblood of inter-temporal economic decision making. Staking reminds us of two things from traditional finance -- capital requirements for banks, and interest-bearing deposits within those banks. As soon as users realize that they should be getting some interest return from their outsourced cryptocurrency accounts at exchanges or custodians, there should be broad competition around this product. If Coinbase offers 3% while Binance offers 4% of staking rewards (or vice versa), the consumer choice becomes more clear. This is exactly what banks compete on in terms of attracting deposits.

Users can already get an interest rate on their crypto for margin lending, up to 7% or so depending on the token. As an aside -- that margin lending may be a bad deal for the lender, since you are powering the short-selling of the capital asset you hold. You could also compare staking returns to dividends that corporations pay to their shareholders, as shareholders buy the equity and commit capital to an asset.  Given that these staking rewards are raw inflation (rather than cashflow earned by a corporation), the dividends become a value transfer between holders that stake and those that do not -- a tax on the unsophisticated user. Also, a dividend by law has to be passed on to the beneficial owner, which is a good thing. But that's not very anarchist of us.


Source: Forbes (Symbiont), Security Tokens Realised (agendavideo), Coindesk (Staking op-ed), Medium (On fractional banking), Token Daily (on staking as a service), Celcius Network (interest on ETH)

WEALTH MANAGEMENT: Fidelity launches Crypto custody, has won this game before

Everyone knows: Fidelity has made its move into crypto custody. The firm has been toying with an offering into the space since starting to mine Bitcoin since 2015. The product itself is exactly what institutional investors, i.e., fund manufacturers, have been complaining about over the last year: (1) a custody platform, akin to Coinbase / Xapo / Bitgo / Kingdom Trust, and (2) an order routing system that creates best execution across exchanges, independent versions of which also exist (e.g., XTRD). But to package it and make it accessible for the traditional financial services industry is a massive leap for the asset class.

Here's what many people don't know. Fidelity is one of the top 4 investment advisor custodians in the United States -- including BNY Mellon Pershing, Schwab, and TD Ameritrade. Together, these firms control about $2 trillion in advisor assets, with another $1 trillion in independent RIA assets sitting on smaller players or self-clearing firms like LPL. These custodians know (1) how to service a long tail of small independent money managers, (2) throw annual conferences attended by thousands of people to look at investment products, (3) enable hundreds of wealth tech companies to sit on top of their core services, and (4) deliver performance reporting and other tools helping regular people access their assets. That is not something any of the crypto players come close to doing or understanding.

To moderate our excitement, we highlight that serving a manufacturer (i.e, a crypto fund) is not the same as serving a distributor (i.e., a financial advisor). Still, we believe the software is transferable to some extent, and the entire world of digital wealth management awaits open APIs here. Second, we think best execution will be a real boon to the space, unbundling what an exchange should do from what a broker should do. If regulators like the NY Attorney General continue to find bundling and conflicts of interest offensive, some US firms will have to be broken up into component parts and spun off. Not Fidelity -- which will benefit from being impartial. And further, with enough volume and a good routing system, perhaps arbitrage bots and crypto market manipulation may start to fade out of the ecosystem. Fidelity's entry -- though long time in the making -- is a clear win for crypto.


Source: BloombergCNBC, Fidelity (RIAsCrypto)

CRYPTO: As ICOs wind down, Developers code and Financiers finance.

Hope you like bad news. We are in an Ethereum sentiment downward spiral. As prices fall both (1) quite naturally as design result from fundraising in ETH, and (2) from an increasing number of financial derivatives shorting token economies, i.e., BitMex, ETH as a currency is less attractive to hold for a newly formed company. Dissenters from the ETH thesis are becoming louder, with some claiming that all utility token values trend to zero, and others (see TechCrunch discussion source) suggesting that ETH will bleed out all of its value into those utility tokens. While we don't agree with either and it can't be both, the end result is that ICO funding has meaningfully slowed to a bit over $300 million. That's a 2017 May equivalent. 


Hope you like good news. Ethereum's use as a decentralized computing platform is growing. While many other Dapp stores (i.e., Dfinity, EOS, NEO, Cardano) are only now getting funded on future claims, Ethereum is churning away at building useful apps. ConsenSys backed Alethio put together a chart of operation codes, which we take to mean how much computing the system is doing. More is better, as is more diversity of operations. The chart has been going around the web, but we think it's useful to reiterate as a counter to the ICO fundraising data. First you raise, and then, you build. Actually, first you sell, then you hire, then you build.


Second, while non-equity token funding is failing, security token offerings (STOs) are starting to hit the market. Should we be counting this in our ICO numbers? Take for example Tokeny, which used to be primarily an ICO technology platform. Since the shift in the winds, it has pivoted to enabling STOs. The latest projects to use its system are a $250 million real estate tokenization and a $50 million equity tokenization in a fintech company. These two deals alone match the entire ICO market from last month and are just the tip of the iceberg. No wonder that Bank of America is rumored to join Nomura and Fidelity in the crypto custody race. Investment banking fees and exchange listing fees for all asset classes are in the cross-hairs, in a way that enterprise blockchain cannot solve (e.g., accepting crypto as payment). 

Unfortunately, by the time the incumbent custodians are in the game, there may not be much left of the crypto currency market caps. The snake will have eaten its own tail (thanks Cardano!). So instead of messing with digital assets backed by the techno hope of Millennials, they will turn their sights on the familiar glow of securitization.  

Source: Autonomous NEXT (ICOs), Tokeny (STO vs ICO), ICO Journal (Bank of America), Reddit (AlethioTechCrunch editorial

CRYPTO: Institutional Trading & Custody vs Binance

Source:  Coinhills

Source: Coinhills

Autonomous hosted 3 panel sessions with experts from the crypto world in London last week (Alex Baitlin of Trustology, Kevin Beardsley of B2C2, David Siegel of Pillar ProjectJohn Pfeffer, and Alexander Shelkovnikov of Semantic Ventures). We talked about the development of infrastructure surrounding crypto, the institutionalization of ICOs, and approaches to valuation. Two key developments are needed for traditional finance and the crypto economy to meet -- and get us out of a place where the only tradeable product is a derivative settled in cash.

First, custody of traditional financial instruments is not the same as the custody of crypto - controlling someone's key to access a digital asset is fundamentally different from keeping books and records of stock ownership. Hot wallets (online storage) expose your private key to hacking, and cold wallets (printed note) expose it to the elements (weather, xrays etc.) where the wallet is based. Multisig solutions, where 2 or more sets of keys are required to sign transactions -- one owned by you and one by the service which operates the custody -- are an effective means to ensure custody security but are hard to operationalize. A crypto-custody smart account may match private banks on bespoke features when built. But it could take the large custodians (BNY Mellon, State Street) several years to get through a budget cycle, get a product planned, and put software in place. While this happens, firms like BitGo and Xapo have an open field.

Source:  Coinhills ,  Xapo Custody

The second layer that's needed for capital markets is effective institutional exchanges. Today's exchanges are lightly regulated, have no best-execution requirement, have widely different liquidity, and offer different prices. OTC brokers like B2C2 and Genesis have been building out software and capital solutions in the space, but we are still early. Decentralized exchanges, like Republic Protocol raising $34MM, are a potential solution in the future, but that infrastructure is not here yet either. A good example of the current state of play is Binance, which is getting chased out of Japan by regulators, and is now headed to Malta.

Binance has grown incredibly quickly (rumored to be running at an MRR of $10-100 million) to be one of the top retail crypto exchanges world-wide for several reasons. First is the rush into altcoins out of the large cap cryptocurrencies -- with retail investors chasing 100x returns, while the beta of the crypto space drags everything else down. You can imagine regulators being least comfortable with these types of assets. Second, Binance has a referral program that rewards people in a percentage of commissions from anyone they refer into the exchange. By paying users commissions on referred trading, they are essentially turning all their clients into unlicensed brokers of potential securities

And last, the Binance Coin ICO tokenized a coupon token that discounts trading on the Binance platform, a token with a market cap all-time-high of $2 billion. The company also promised buy-backs (burning) in order to influence the price. Mature companies do plenty of financial engineering through share buy-backs, but it is a highly sensitive and regulated area of the capital markets to avoid market manipulation and insider trading. So it feels like we are still 6-18 months away from an institutional chassis. The question is -- does that matter, and for whom?

CRYPTO: We Need Real Crypto Custody

Source: Coinbase

Source: Coinbase

Sure, the crypto economy has valuable infrastructure innovation that will change the world. But "code is law" is just not enough, because code is full of bugs and humans don't know what they want. The finance people are right about at least one thing. And that thing is custody.

In today's world, owning Bitcoin or Ethereum means learning a mish-mash of technical information while risking accidentally losing all your money. And if you don't lose your money through technical error, or the endless ICO phishing scams, there's a good chance something else can go wrong. We know of the hack last year that pulled $150 million from the DAO project on Ethereum, which was reversed through the hard fork but to the creation of Ethereum Classic -- $1.7 billion value out of the ecosystem. Another $160 million just got flushed down the drain, with users locked out of their money permanently due to a mistake in the fix of a previous $30 million hack of the Parity wallet for the cryptocurrency.

We can keep saying that there's nothing wrong with the blockchain technology, and it is the infrastructure providers like the Parity wallet, or the Mt Gox exchange, or the smart contract writers for the DAO that made the mistake. But that is a cop out. Users shouldn't care about why they lost money, if it happens to them by no reasonable fault of their own. The answer is to build safe storage of these assets up to the standards of the traditional financial economy. Sure, we may lose some crypto anarchists in the process to Monero and Zcash, but we will gain the global economy. The good news is that this is indeed in progress. Coinbase plans to offer institutional custody to crypto funds starting at a $100k fee (ouch!). And see Alex Batlin leaving BNY Mellon to start Trustology at Consensys, delivering crypto custody as a service. This is what needs to be finished before we invent the rest.