Is the Future Digital?

We pulled together six leaders in the digital assets space to discuss the future of money at Profit & Loss Forex Network Chicago. During the ensuing hour, the panelists discussed whether or not we are at a turning point in the digital debate.

Analysing whether or not the future will be digital seems obvious – the world is increasingly, and quickly, turning to digital forms of money and new forms of technology to address a wide range of areas in traditional finance. But how far this transformation will go, and which types of firms will take us along the path, formed the basis of a lively discussion at Profit & Loss Forex Network Chicago.

Panellists included Ateet Ahluwalia, partner at CoVenture, a multi asset manager focused on crypto debt as well as venture capital; Peter Johnson, principal at Jump Capital, one of the largest and most active venture capital firms in the MidWest; Rumi Morales, partner and head of venture at Outlier Ventures, an investment advisory firm in the crypto asset, blockchain, AI and IOT space; Subhankar Sinha, head of Blockchain at BNY Mellon; Christine Sandler, head of sales and marketing at Fidelity Digital Assets; and James Radecki, founder and managing partner of 9th Decimal Strategies, a crypto and DLT alternative asset management portfolio construction provider, who moderated.

Starting off looking at monetary and payment systems, the panel addressed ‘the cash and the rails’.

“There’s a lot of debate about the future of money – how digital can it really be? The truth of the matter is that most people would believe that the payments technology is superior to anything that exists and it will ultimately take over,” Radecki opened. “The two big things that will drive the payment process have historically been – is it cheaper and more efficient to run from a cost perspective and is it more effective?”

Looking at what organisations are actually doing in terms of payments, BNY’s Sinha took the lead. “When we ask whether money is becoming digital, we have to clarify whether we are talking about representing money on a blockchain-based environment, or are we talking about using blockchain to reduce friction in the payment infrastructure. It’s a very important distinction,” he said. “Blockchain can be used to make the communication between different parts of the financial infrastructure more efficient. So when we talk about DVP or PVP, it’s actually messaging going back and forth between different parties, and the friction is generally that the information from A to B has to go through five different hops. If we have a blockchain environment, it can facilitate that communication without actually digitising and representing money on that particular rail – and that’s probably more easily achievable than actually representing dollar or sterling or euro, for example, on the blockchain.”

The panel then looked at how to create an infrastructure that reduces that messaging friction and at how fiat can be represented on the blockchain environment. “When we talk about the digitalisation of the finance rails and potentially even cash beyond that, where are we with all the other rails that go to support that infrastructure, like coin lending? Where are we in the evolution of what we’ll call the barriers to entry?” queried Radecki.

“You touched on a really key piece here,” said Fidelity’s Sandler. “When we talk about the infrastructure, we’re not just talking about the infrastructure to allow one-to-one payments. We’re also talking about the downstream effect. When we think about institutional adoption or using blockchain technologies or crypto to propel a business forward, there are any number of contingencies that have to fall into place, whether that’s the firms, the method of audit or the auditing firm that they use – anything that’s related to downstream processing. If they’re more on the traditional side, it really has to be built. So when you ask how far along the industry is, if this were a baseball game, we just pulled into the parking lot, which means we have a lot to build. But we also think that there is so much runway and so much potential when you think about the use cases.  We’re talking about one particular use case, which is money – but we’re also talking about anything of value that could be digitised and anything of value could be a concept as well, which is extraordinary.”

The discussion then turned to how to get traditional capital markets and crypto capital markets to work together to create the connectivity that’s needed. “What are the catalysts to get there?” asked Radecki.

“I think Bitcoin is digital gold and it is clearly going in that direction. I think stablecoins are going to become a new global money transfer rail,” said Jump’s Johnson. “When we look back five years from now and say, ‘Okay, what was the catalyst that drove those two things?’ I actually think we’re the catalyst. I think trading of digital assets is what’s propelling us forward to where we’re actually going. We’ll look back and trading is going to be a small portion of this market five, 10 years from now.”

Johnson added that the impact that stablecoins is going to have will be dramatic. “Digital assets are eating financial markets and the first bite that they’re taking is out of the foreign exchange markets. That is where stablecoin trading is going to take a big bite out of FX trading over the next few years. It’s going to be a 24/7, fully accessible, low cost, fast market powered by stablecoins.”

“I think the catalyst is regulation,” added CoVenture’s Ahluwalia. “In the absence of thoughtful regulation, you have a lot of institutional players that can’t get involved due to potential breach of fiduciary duty. How do you prove best execution? How do you actually access the market in a thoughtful way? Who’s your custodian? Who’s built that out? And now we have Fidelity in the game, which is obviously tremendously helpful from that perspective, but in terms of proving best execution and getting in the game in a way that doesn’t breach certain contracts you have with your clients, I think that’s the single biggest catalyst that can turn on the spigot of tremendous amounts of liquidity.”

Sandler added: “I agree that a catalyst is regulation, but I also think one of the tipping points could be valuation. The institutionalisation of valuation tools will be a catalyst also.”

Morales added another catalyst. “I think it will be around talent or lack thereof or demand for such, year-over-year. I think this past year has seen an over 500% increase in the demand for blockchain engineers. But most people in traditional institutions who are interested in blockchain engineering are not yet finding enough internal jobs. The flip side is amongst all tech developers in the world, only 10% are currently focused on blockchain. I want to see a better connection in the talent gap. We need to get developers more accustomed to the programming languages associated with crypto and distributed ledgers. And we need to get eager employees in institutions more opportunities to explore the tech.”

Returning to stablecoins, Johnson said he believes stablecoins (primarily those backed by fiat) are going to play a huge part in the future of money. “That is where this industry is going, where money is going, because when you think about what an ideal global payment system consists of, it’s a few things. It means you can transfer money anywhere in the world, any currency in the world, fast, free – or nearly free – and accessible to anyone,” he said. “So how can you build that? There’s a few ways you can fill that. Global central banks could coordinate and do it, though I don’t think that they will. Commercial banks could coordinate and do that, but I know how difficult it is to coordinate large commercial banks in doing these things, especially world-wide. A large tech company or tech companies could do this – that’s what Libra is trying to do.

“The most likely case is actually that you see in each individual country for each currency, you have a stablecoin that is issued in that country. Then that token representing that currency can be freely traded between anyone with a crypto wallet, and suddenly you have a system in which you can move any currency to anyone in the world fast, free, instant, 24/7. That’s where I think the future of money really is,” he added.

“What is it going to take for institutional investors to get up this curve,” asked Radecki. “How do we contend with liquidity under duress? Where are we at from the institutional liquidity perspective?”

“Institutions recognise that there is something to be had there,” said Ahluwalia. “That’s why you have a ‘who’s who’ of traditional finance getting involved. The real issue they face is that the entire ecosystem is $300 billion. So, in theory, Jeff Bezos can lever up another half a turn and he can take out the entire ecosystem. So that’s not actually feasible from a deployment standpoint. If you’re a traditional financial player, the way that they think about it is, ‘If the market’s this small, if I want to get a reasonable size position, I have to allocate an amount of money such that I’ll move the spot price a thousand basis points’. The slippage, the market movement, the front-running will just be ridiculous. So how do you work backwards from that? You want an options market. But there is no really hyper-developed options market, and actually, if you look at the counterparties involved in options, they’re not exactly creditworthy. So the counterparty credit risk is there and it’s in full force. So you work backwards from that.

“How do you price up an options market?,” he continued, “You have to have a thoughtful lending market. The fact that crypto is not really correlated to a heck of a lot of other macro markets, and it won’t be until it reaches critical mass. You don’t have an options market. If you work backwards, you don’t really have a lending market. So if you work backwards from there, the question is how do I get involved in an environment where the hype cycle and the tech cycle haven’t caught up to reality? The way you do that is you start with simple things like simple structured products and you have them get involved in custody, small loans. You have them get involved in structured products. Working backwards – that’s what institutions really need to see – and that will come as a function of the size of the market.”

Ahluwalia continued: “You’ve seen that grow orders of magnitude in the last three years alone. But what is going to be the real killer App is basic financial infrastructure. So the value creation has been extraordinary. I expect as this infrastructure is created by the likes of Fidelity or BNY Mellon or whoever, that it is going to take the ecosystem another order of magnitude or more in terms of growth.”

Giving an idea of the investability of the asset class, Ahluwalia pointed out that Bitcoin accounts for around 65-70% of the asset class, and adding Ethereum to that makes up 80% of the asset class. “So out of the $300 billion asset class, two assets make up the majority of the ecosystem. Until we have a thoughtful foundational layer of custody and of margin lending, which will then lead to options, etcetera, you really have to focus on the bread and butter basics and that is in fact what will lead institutions to get involved – and make no mistake – they are aggressively getting involved,” he said.

“Right now it’s not big enough for institutional players to really come in, in a meaningful way without moving the market,” said Johnson. “The players are there, which is a key part of what needs to be there, but the other part that we need in the market is capital efficiency – we need capital providers and we need product structures. It’s a very capital inefficient market right now. There’s pre-funding on almost every exchange. There’s no prime brokerage providing capital efficiency. The big banks need to get into this market and provide capital to make it more capital efficient. I think that is going to be – along with more capital-efficient products like options – what is going to help push this to institutional level size.”

Ahluwalia added: “The first thing we need is a custodian that can warehouse your assets on your behalf. That’s actually happening. The second piece is that you need a central counterparty. A lot of crypto native people want to beat the drum about how it’s decentralised and that is going to change the world, but you need a central counterparty to warehouse that counterparty credit risk function. That’s the whole game. The second you get that in the crypto space, people will be able to enter the market in size, especially on the institutional front, because it’ll eliminate a lot of that counterparty credit risk.

“We’re already gearing towards that part on the back of custody with thoughtful players that have a massive balance sheet that can make you whole,” he continued. “If something were to happen to the ecosystem, you’ll get that centralisation of liquidity and that liquidity will allow you to take bigger positions. It allows you to build structured product on the back of it and take serious views in the space. So I think that centralising of liquidity is going to be a big deal. You already have the who’s who of liquidity provision and high frequency involved. They’ve actually been involved since 2013, so the guys that need to be there on the ground are in; the big banks that need to put capital behind it to innovate in the space are in; the custody provision is there. Now it’s about building up that central counterparty to remove counterparty credit risk.”

Where does that come from? “It’ll come from a big traditional name. No crypto native name has the currency. No crypto native name has the reputation or the balance sheet to make you whole if something happens in the space,” Ahluwalia concluded.

Julie Ros
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Julie Ros

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