21X is keeping the faith in a tokenised future for finance

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Just two years ago the founders of 21X were selling digital asset issuance and distribution on a Software as a Service (SaaS) basis. It was the decision by European regulators to launch a three-year Distributed Ledge Technology (DLT) Pilot Regime for financial market infrastructures to test whether blockchain technology is compatible with investor protection, financial stability and market integrity that persuaded the leadership of 21X that there is an opportunity in operating a digital asset exchange. Once applications opened in March 2023, they applied to the European Securities and Markets Authority (ESMA) for a licence to operate one within the framework set by the DLT Pilot Regime. The company is now embarked on a journey to build a public and permissionless but regulated token exchange that is protected by robust security measures and a full set of customer due diligence checks. 21X will serve initially institutional issuers and investors only, but its founders have the long-term ambition of democratising investment by making a wide range of asset classes available to retail investors faster and at lower cost. Future of Finance Co-founder Dominic Hobson spoke to Max Heinzle, CEO of 21X, about the types of business the company is seeking and the types of services it will provide. (1)

Hobson: Who owns your organisation, what are their expectations and how do they support your strategy?

Heinzle: 21X AG is owned 100 per cent by its parent company, 21.finance AG. The company has been supported through seed funding rounds - with investors that include family and friends, family offices, financial institutions and technology firms. The expectations of the owners are aligned with advancing the adoption of digital asset trading and leveraging blockchain technology to create a more efficient, transparent, and secure market infrastructure. They support 21X’s strategy through capital investment, strategic partnerships, and providing industry expertise.

Hobson: Is it accurate to describe your organisation as an “exchange” where buyers meet sellers on your platform, as opposed to, say, investors meeting issuers as principal?

Heinzle: Yes, it is accurate to describe 21X as an “exchange.” However, it’s much more than that. It’s a market infrastructure for tokenised financial instruments which, unlike a traditional exchange, offers additional services such as, in our case, settlement. 

Hobson: You have explained that your focus is on both primary market capital-raising and secondary market trading. What synergies do you see between the primary and the secondary markets?

Heinzle: The synergies between primary and secondary markets at 21X include enhanced liquidity and price discovery. Primary market capital-raising benefits from the presence of a vibrant secondary market where assets can be traded post-issuance. This liquidity attracts more issuers to the platform, knowing that their assets will have a market post-issuance.

Hobson: You have described your operating licences as “capital markets” and “financial market infrastructure.” Exactly what do these licences entitle you to do in terms of both instruments and activities and accredited investors?

Heinzle: Our “capital markets” and “financial market infrastructure” licences actually allow us to offer a wide range of financial instruments - specifically, equities, bonds, and funds.  These will be tokenised versions, meaning they represent ownership of traditional assets on a blockchain. Structured products are currently not confirmed for 21X, nor are listing requirements for them, initially. We can serve any regulatorily compliant accredited investors – even retail investors.         

Hobson: Are you seeking additional operating licences?

Heinzle: We believe our market infrastructure model for the trading of digital assets and other service offerings is not just applicable to our European Union (EU) platform. Therefore, we are looking to expanding our footprint by considering additional licences.  This includes licences that would allow us to operate in new jurisdictions and offer additional financial products. However, we don’t want to run before we can walk – and the go-live for our EU exchange remains our main focus for 2024.

Hobson: Your blockchain network is “public” rather than “private” or “public permissioned.” What explains your choice?

Heinzle: We chose a public blockchain network as we feel it will enhance transparency, security, and accessibility. This choice reflects our commitment to open and verifiable transaction records, fostering trust among participants – and is seen as the direction of travel by many major market players. The sense that the evolution of capital markets won’t happen in private has been gaining momentum of late in the financial technology (FinTech) world – and is very much proving to be the case.

Hobson: Which blockchain protocol do you use?

Heinzle: From go-live, 21X will operate on the Polygon Proof-of-Stake (PoS) network, an interoperability and scaling framework for building Ethereum-compatible blockchains. We chose the Polygon network, running on the Ethereum blockchain protocol due to its robust smart contract capabilities and wide adoption within the digital asset community.

Hobson: Do you work with a particular technology vendor?

Heinzle: We actually work with several technology vendors – from development companies to smart contract auditors - to ensure our platform is secure, scalable, and efficient. These partnerships help us integrate best-in-class technology solutions.

Hobson: In terms of the services, 21X provides issuance, trading and settlement – but not custody - on the public blockchain.  Registration is not on-chain. Could you explain this division of labour between systems?

Heinzle: Issuance, trading and settlement and custody will occur on the public blockchain to leverage its security and transparency. While 21X establishes itself as a reliable trading platform before expanding into custody - which requires a different set of expertise and infrastructure – it will work with existing, licensed custodians for safekeeping of user assets. Registration of the financial instrument remains off-chain to comply with regulatory requirements and ensure efficient record-keeping and data privacy, and centralised control over user identities. We will also be licensed under the eWpG (Gesetz zur Einführung elektronischer Wertpapiere – eWpG)  as a registrar. 21X will operate a registry for primary market issuances as well as on a secondary market for trading existing tokenised securities. And our eWpG licence will allow us to operate a crypto[-asset] security registry for issuing new security tokens on a blockchain.

Hobson: How do transactions settle? Is it “atomically”? And how do you deal with the cash leg of settlement? Is it off-chain via the conventional banking system, cash on-chain in tokenised form, or by direct or indirect connections to central bank Real Time Gross Settlement systems (RTGSs)?

Heinzle: Yes, transactions settle atomically, ensuring that both legs of a transaction (asset and cash) occur simultaneously. The cash leg is handled on-chain with our E-Money Token partner - and in the future through Markets in Crypto-Assets Regulation (MiCAR)-regulated parties or even Central Bank Digital Currencies (CBDCs). The consideration of CBDCs can happen due to our participation in the European Central Bank (ECB) Trials Wave 2, allowing us to gather valuable data and insights on real-world use cases of these currencies.

Hobson: Do your issuance services include offering or writing smart contracts?

Heinzle: Yes, our issuance services include offering and writing smart contracts tailored to the specific needs of issuers, ensuring seamless integration with the blockchain. When it comes to tokenisation, we will work with others to fulfil the tokenisation transformation process. In the future we will be able to tokenise assets ourselves - but under our conditions, and not create assets for others, such as issuers.

Hobson: Do you provide financial advisory services to issuers?

Heinzle: 21X will be able to collaborate with existing financial advisors who are familiar with the regulatory landscape in order to offer expertise to issuers. While we are presently focused on rolling out our market infrastructure, if 21X considers offering financial advice in future, a separate licence for financial advice might be required under regulations for investment or financial portfolio management as financial advisory services related to digital assets evolve.

Hobson: You have described the type of issuers you seek as “global.” How are you reaching a global audience?

Heinzle: We reach a global audience through strategic partnerships, targeted marketing campaigns, and participation in international financial and technology conferences. There is significant interest in the EU DLT Pilot Regime run by the European Securities and Markets Authority (ESMA) and we are seeing increased awareness in 21X following our licence application and this, combined with the extensive network of contacts of our senior management, is helping develop issuing business opportunities.

Hobson: The types of issuers you seek includes public companies, private companies, mutual funds, private equity funds and exchange-traded funds (ETFs). What explains your choice of targets?

Heinzle: We are targeting public companies, private companies, mutual funds, private equity funds, and ETFs due to their diverse capital needs and the potential for significant secondary market activity. Significantly, these are the products currently permitted under the EU DLT Pilot Regime. This will change in future, which will, in turn, lead to changes in our product offerings and targets. 

Hobson: You have described liquidity as “crucial.” How will secondary market liquidity help your primary market activities?

Heinzle: Secondary market liquidity is crucial as it provides confidence to primary market participants that their assets will have a ready market, thereby attracting more issuers. 

Hobson: Your target clients include market-makers and liquidity providers. Do you view these as the principal sources of liquidity or are automated market-makers (AMMs) part of your strategy?

Heinzle: We view both market-makers and liquidity providers as essential sources of liquidity. However, automated market-makers (AMMs) can also be part of our strategy as they ensure continuous liquidity and efficient price discovery. Nevertheless, we are talking about completely new financial instruments in a developing financial sector so we may need the experience of specialised market makers for this special product category.

Hobson: The types of investors you are seeking include asset owners such as pension funds and sovereign wealth funds, insurers, wealth managers and private banks, brokers, family offices, and accredited retail investors. Which type of investors are finding your services most attractive at the moment?

Heinzle: Currently, asset owners like pension funds, sovereign wealth funds, and accredited retail investors find our services most attractive due to the security and transparency offered by our platform and due to the fact that we will likely be the first and only exchange fully regulated by ESMA. Additionally, the exchange we hope to operate specifically allows retail investors to directly access markets without the need for intermediaries. This will be an important target market for us.

Hobson: Your choice of target asset classes (equities, bonds, funds, structured products such as ETPs) is relatively narrow. What explains your focus on these asset classes?

Heinzle: Our focus will be on equities, bonds, funds, and structured products. Our choice of these target asset classes has been driven by two imperatives – regulation and demand. Most importantly, we have to work within rules stipulated under the EU DLT Pilot Regime for what can and cannot be made available for trade on our exchange. And, secondly, it is driven by market demand and suitability for tokenisation and trading on a digital platform. 

Hobson: You mentioned custody earlier that you are providing custody services via third party custodians. Will you choose these or will the customers choose them? 

Heinzle: We intend to provide custody services via third-party custodians, giving our clients flexibility and ensuring the highest standards of asset security.  We do not hold a custody licence ourselves.

Hobson: You have explained that customer cash will be held by third-party banks. Do you choose the banks or can customers choose the bank they prefer?

Heinzle: Customer cash is converted into e-money tokens – and therefore held and exchanged from cash into e-money with a regulated e-money institution, to ensure security and compliance. 

Hobson: Are the additional services you provide – such as fractionalisation of assets, peer-to-peer trading, and direct market access (DMA) - designed to appeal to a particular type of investor, such as accredited retail investors?

Heinzle: Services like fractionalisation of assets, peer-to-peer trading, and direct market access (DMA) are designed to appeal to all accredited investors, including retail investors, offering them greater flexibility and investment opportunities. However, our focus at present is directed towards institutional investors – retail investors will be targeted in future.

Hobson: What industry accreditations - such as International Standard on Assurance Engagements (ISAE) certificates- has your organisation secured?

Heinzle: We have secured several industry accreditations, including ISAE 3402 and Service Organization Control (SOC) Type 2 certifications, ensuring our operations meet the highest standards of security and compliance.

Hobson: Your timetable to success (3-5 years) is not long but not short either. Are you fully funded for that timescale?

Heinzle: We are presently undergoing a Series A funding round, which should complete later this summer. Once this is closed, we will be fully funded to undertake the launch and scale-up of 21X before the end of 2024 and for our 18-24-month timetable to success, with strategic plans in place to achieve our growth and operational milestones within this period.

Hobson: Is there anything else we have not discussed that you would like to add?

Heinzle: Often when you’re working at the coalface, you lose sight of the bigger picture. This can be the case as we transform our industry from traditional finance to a world of trading and settlement of tokenised assets on the blockchain. The changes will be immense, but on a day-to-day basis it is easy to forget how immense. We believe that the go-live of 21X’s fully regulated Distributed Ledger Technology (DLT) exchange for digital assets – which should be before the close of 2024 – does truly represent a transformative leap in the financial sector, promising enhanced accessibility, efficiency, and transparency. And in a wider context, this move not only legitimises the digital asset trading market but will also catalyse wider innovation and growth in technology, products, markets and customers, marking a profound shift in the global financial landscape.

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(1) See also the earlier interview with Max Heinzle at https://futureoffinance.biz/21x-the-european-token-exchange-with-a-reassuringly-german-personality/