21X: The European token exchange with a reassuringly German personality
- Future of Finance
- Jan 24, 2024
- 40 min read
Updated: Mar 23
A Future of Finance interview with Max Heinzle, CEO of 21X
21X is a Frankfurt-headquartered token issuance, trading and settlement platform built on blockchain technology, and underpinned by a group of long-term investors, that expects to be the first to receive a licence to operate under the EU DLT Pilot Regime that allows operators of market infrastructures to test blockchain technology in the issuance, trading and settlement of tokenised financial instruments. The boldness of the company strategy is evident in its preference for a public, non-permissioned blockchain network, and the fullness of its commitment to automating as many functions as possible by the use of smart contracts. That said, the founders of 21X are astute enough to recognise that it will be easier to attract issuers and investors by working with rather than against the incumbent institutions that currently own those relationships, and within the regulatory frameworks that institutions prefer. They are confident that the shareholders of 21X support their long-term strategy and that the regulators would like to see the business succeed and thrive within the parameters set by investor protection and financial stability. Interestingly, 21X has also chosen Germany, the surprising market leader in digital asset market innovation in Europe, as its initial base of operations. Dominic Hobson, co-founder of Future of Finance, spoke to Max Heinzle, CEO of 21x, about where the company came from, where it is now, and where it intends to be in five years’ time.
Key Insights
21X is a blockchain-based trading and settlement system for tokenised equities, stocks, bonds and funds created by the founders of the 21 Finance digital asset issuance and distribution platform offered to regulated financial institutions on a white label basis.
21X is securing a trading and settlement system licence from the European Securities and Markets Authority (ESMA) under the Pilot Regime, which must also be agreed by the German federal financial markets regulator, the BaFin.
21X will provide its trading and settlement services via a public, permissionless blockchain network built on Polygon because it is best suited to the institutional business the exchange wishes to attract and maximises the benefits of atomic settlement and smart contracts.
Although the Pilot Regime will allow users of 21X to connect directly to the platform, 21X has decided to operate a B2B2X model, in which it will access underlying issuers and investors by forming partnerships with existing intermediaries.
A decentralised, peer-to-peer trading model on one protocol constrains the products 21X can support, necessitating an initial focus on securing the greatest efficiency gains (such as privately managed assets) rather than the highest volumes (such as high frequency trading).
21X expects the increased costs of atomic settlement, through increased pre-funding costs and loss of pre-settlement netting, to be offset by the lower trade and post-trade transaction costs associated with direct connections to token markets and self-custody.
21X will not provide issue structuring or listing requirement compliance services, or registration, custody and asset-servicing, at least initially, but it will offer token and smart contract manufacturing and distribution services to issuers and trading, matching and settlement services to investors.
Although 21X is supplying both primary and secondary market services, the value of each will vary by product, with bonds requiring both primary and secondary market support, while certificates and structured products need primary market support only.
21 X will source revenue from one-off and recurrent listing fees, volume-based issuance fees on some products, volume-based trading fees and API servicing fees chargeable to the service partners, though all these fees will be set at levels that reflect the efficiency gains.
The EU Pilot Regime imposes constraints – on product types, the market value of admissible product types, overall market values, and what must happen if those values are exceeded – but, as a pioneer of the Pilot Regime, 21X also experienced both a higher degree of uncertainty overall and a greater latitude to shape not only the outcome of its licence application but the future architecture of the Pilot Regime as a whole.
Although the point of entry for a licence application under the EU Pilot Regime is a national regulators (BaFin and the Bundesbank, in the case of 21X), supranational regulators – not just ESMA but also the European Commission and the European Central Bank (ECB), which is responsible for the tokenised cash 21X will use – have taken an interest in the process, because they want it to succeed.
The earliest issuers on 21X will probably be bond market issuers, private companies looking for equity and debt capital and asset managers looking to take advantage of the opportunity to fractionalise holdings in exchange-traded, private equity and real estate funds.
Investor activity on 21X is likely to be driven by a mixture of retail and institutional investors, listing agents and liquidity providers that have entered into partnerships with 21X, custodian banks and fund administrators, neo-banks and brokers, and cryptocurrency exchanges looking to expand their offerings.
The digital transformation of a capital market is by its nature a long-term project but 21X says both its new and its longstanding shareholders are less susceptible to short-term pressures and believe that the financial markets are now embarked on an irreversible process of far-reaching digitalisation.
The main obstacles to rapid adoption of tokenisation by incumbent financial institutions are its reliance on a new technology that must be connected to traditional systems, the novel nature of the risks posed by digital assets, the slow pace of regulatory reform and the lack of inter-operability between blockchain protocols and between blockchain protocols and traditional networks.
Fear of disintermediation on the part of incumbents is not proving a major obstacle to adoption of tokenisation, because there is a growing comprehension of the benefits and opportunities that tokenisation offers established firms.
The immediate priorities for 21X are a licence to proceed, a platform that is live with issuers and investors and compliant with regulations, but the long-term ambition of the company is to grow the range and value of the products issued, traded and settled on 21X in lockstep with regulatory authorities increasingly confident of the capacity, integrity and resilience of the business.
Transcript
00:14 Dominic Hobson: Hello, I’m Dominic Hobson, co-founder of Future of Finance. My guest today is Max Heinzle, CEO of 21 X, a fintech that’s developing a blockchain powered trading and settlement system for tokenised equities, stocks, bonds and funds. 21 X will be licensed as well. The company submitted an application to the European Securities and Markets Authority (ESMA) to be licensed as a European token exchange under the [European Union] EU pilot regime, and that licence is expected to be granted this Spring. Max, thanks very much for joining us.
00:48 Max Heinzle: Thank you, Dominic, for having me. It’s a pleasure to be here.
00:52 Dominic Hobson: Could we start perhaps with a little bit of history? Back in the spring of 2017, you could see that traditional banks were struggling to embrace digital transformation. So you established 21 Finance – that was a regulated marketplace-as-a-service platform to bridge that gap between where the banks were, the traditional banks were, and the digital in finance. I know you’ve also had some involvement in the past in crowdfunding. So tell us about your journey from where you were back in 2017 to where you are now, nearly seven years later. How have you evolved your business from selling this digital asset platform to banks as a service on this white label basis to actually now building and eventually operating a [Distributed Ledger Technology] DLT exchange? Is 21X the child, the progeny, of 21 Finance, or are they now separate businesses? Tell us the story.
01:47 Max Heinzle: Yeah, thank you, Dominic. Like you already said, and rightly so, we started off as a platform operator to then pivot into becoming a [Software as a Service] SaaS solution provider for specifically digital asset issuances and distributions through our white-labelled distribution platform. In the next step, what we came to understand was that the likes of financial institutions, or also intermediaries, were looking to enable secondary market functionality. And with then the regulatory developments in the EU following those closely, with the announcement mid-2022, we came to the strategic decision that we would actually apply for the licence under the EU DLT pilot regime and actually stopped operating as a SaaS provider to solely focus on that regulated market infrastructure. So when I talk about the infrastructure, the market infrastructure, it really derives from the nature of the regulatory framework, which is basically encompassing three different licences.One of them is the DLT-based multilateral trading facility (MTF). The second one is the DLT-based settlement system, and the third one is basically the combination out of both the MTF – so the multilateral trading facility – and the settlement system, which is the so called DLTTSS [DLT Trading and Settlement Systems]. And that then in the next step, with the application process starting last year in March in the EU, we basically handed in with the beginning of that regulatory regime in the EU to, in the next step, obtain the licence to operate both a primary and secondary market, which has a clear B2B2X [Business to Business to any end-user] focus. So with the likes of the clients that we have already gathered, but also with the likes of obviously new partners that we will be announcing shortly, we are now in the preparations of preparing the Go Live of 21X, which in essence is then again also a company which we founded last year. Given that we applied for the licence, it’s actually a 100 per cent subsidiary of 21 Finance. 21 Finance is a Liechtenstein based entity which is the original start-up, if you so wanted, that we founded back in 2017. And now with the addition and the fact that we have applied through a German subsidiary of ours, 21 X, we are actually going through that licence and approval process with both BaFin [Bundesanstalt für Finanzdienstleistungsaufsicht, the German federal supervisory authority] and ESMA.
04:40 Dominic Hobson: You mentioned Liechtenstein, but it’s interesting that the heart of your operation now will be Germany. And Germany has been surprisingly progressive in the field of digital assets. It’s got a very supportive legal structure, it’s had quite a lot of actual issuance activity as well, several dozen crypto securities been issued there, and about 7,000 or more digital twins of existing debt securities, albeit using a fairly traditional market infrastructure. But if you look at the markets in Europe, Germany is pretty far ahead. I was also interested to see that some of your Board members have links to Börse Stuttgart, which has built a cryptocurrency trading and custody business and had it for some years now. So tell us a bit about why Germany has been, beyond the obvious, why Germany has been attractive to you, and what the value of the German experience, and particularly of your Board members, has been to what you’re doing at 21x.
05:42 Max Heinzle: So we just recently announced that at 21x, our Board members, Alexander Höptner, and also Peter Grosskopf have joined us. I mean, looking at both their experiences in the field of fintech and also regulated capital markets, like you rightly so mentioned, Börse Stuttgart, or also Deutsche Börse. Actually, also, to name another player in the field of banking and fintech, which is Solaris Bank in particular, both Peter and Alex have extensive experience in that field. So for us, that is certainly something that is very important also in the light of us being a regulated financial institution that will be operating an on-chain market infrastructure to ensure that we have people on our board and also within the team, the operational team, that have both a combination out of tech expertise, but also in particular, obviously on subjects such as risk compliance and obviously also exchange experience. With that being said, I think, nevertheless, it’s pretty clear that with this innovative regulatory framework, we are entering basically a new playing field. It is an entirely new way of combining in a single entity both an MTF and a settlement system. And so there are some interesting comparisons, obviously, delving into traditional requirements from so called regulated TradFi [Traditional Finance] markets to the intersection of blockchain-based capital markets. That being said, we hope to be able to add also in the future further expertise from the likes of experts that have gathered an extensive amount of experience and know-how and add that basically to what our mission is: to basically drive the future of capital markets.
07:59 Dominic Hobson: Can we talk a little bit about the technology you’ve chosen, and I have two questions about this. One is you’ve opted for Polygon, and what’s interesting about that decision is that it’s a public, permissionless blockchain. So my questions are, what governed your selection of Polygon? But how contentious was it to choose a public, permissionless blockchain as opposed to going for a private one? What was your reasoning for both of those choices – Polygon and having a public chain?
08:35 Max Heinzle: So making use of Polygon was a decision that we made already back in 2022. At the time one of the – I mean, besides the technical, say, KPIs [Key Performance Indicators] and also metrics of the blockchain itself – [considerations was that] it was obviously also a key decision point or argument. It was to say, okay, we need to make sure that projects and actually pilots are being conducted of the likes of also capital market participants that are proving like institutional adoption. And Polygon was surely one of the blockchains where a lot of those projects were already happening back then. And I think we’ve been proven, to a degree, it has been proven that we’ve made a good choice given that a lot of the newer projects and products that have been launched on public blockchains were on Polygon. So there are some very large asset managers and some public projects such as, for example, Franklin Templeton money market funds and other products. The idea of matching, trading and settling on a public blockchain for us, it was pretty obvious that we wanted to try and automate as much of the, say, market infrastructure and really leverage smart contract functionality. And for the sake of, if one takes a closer look at the regulatory framework, in order to leverage the new possibilities that actually derive from such a framework for us, it was clear that we would go down that route, even though there are some, say, limitations or also challenges that come with that, right? Obviously with the target, one of the main objectives, being fast to realise T+0 [Trade Date plus Zero Days] transactions to trade and settle atomically.
10:53 Dominic Hobson: I’ll come back to those limitations you’ve just mentioned. But just one final technical question before I do. How are the users going to connect the 21X platform? Is this going to be API [Application Programme Interface] based interfaces?
11:08 Max Heinzle: So I briefly mentioned earlier that we have a B2B2X model, and keeping in mind that the regulatory framework actually allows for direct access also to this market infrastructure. It’s also one of the big, I would say, differentiators, really, between what we see in today’s TradFi markets. If you and me, as individuals or even non-regulated, say legal entities, wanted to onboard directly with an exchange, whether it is the London Stock Exchange or also Deutsche Börse, that doesn’t work in today’s world just yet. We all have to go through, say, respective market participants that are connected to the trading systems. And so for us, even though the regulatory framework allows for direct access, and that’s a game changer in itself, we decided that we would try and connect our to-be-regulated market infrastructure to the likes of players that are already operating in capital markets and enable them to this new form of actually matching and trading and settling security tokens. So, with that being said, we have already, and will be announcing shortly some of these partners that we are planning to launch 21X with in the next couple of months, obviously requiring for the licence to be approved. Happy also to share more on the status there. But really the reality is that we provide them in the next step, access to the likes of their clients, which are buyers and sellers of security tokens, in the next step. And obviously also tap into the side of the, if you so want, agents that are working out in the market that can assist with also product issuance, tokenisation services, custody services, given that we have a very open market approach. So really that’s the way we’re tackling it. And it might be the case that in the future we see that it makes sense to also open, if you so want, our services, directly to clients. But for the first steps that we’re looking to take, that’s not part of our strategy.
13:32 Dominic Hobson: You’re looking to build a fairly open ecosystem, if you like. But I promised to come back to that point you made about the limitations of blockchain technology. And you mentioned, I think, that you’re planning to match the trades on Polygon. But if I’ve understood your model correctly, you’re also going to be operating a central limit order book (CLOB) of the type that traditional exchanges operate. Now, in our conversations with digital asset exchanges, we’ve found that’s not unusual because blockchain is not always well adapted in terms of the speed and capacity which people need for trading activity. But could you tell us a little bit more about your actual matching and trading operating model here? You’re presumably looking to do, in the long run, peer-to-peer trading of these digital assets. How is this going to work in practice? Where does this CLOB meet matching meet trading on Polygon?
14:34 Max Heinzle: Yeah. So maybe just to clarify also here, because sometimes people get confused by the fact that it is a CLOB and that in itself doesn’t mean that it’s centralised. I mean, given that matching, trading and settlement is smart contract-enabled and running on Polygon, we have obviously smart contracts that are making all this possible, right? And it is, after all, peer-to-peer. So one of the key aspects of the EU DLT Pilot Regime are that clearing in that case is no longer a necessity. You don’t really have a central counterparty sitting in between the buy- and the sell-side. So that really differentiates us strongly also from the likes of AMM [Automated Market Maker] models – so AMM standing for automated market makers with a more centralised point of failure, if you so want. And we know that these are still at an early development stage and also bring certain weaknesses along. You mentioned a very important point, and that is efficiency, right? So we are still, if you so want, at the beginning of a journey of infrastructural layers, whether it is a Layer 1, a Layer 2, that comes with certain technical limitations and that in essence also plays back into the types of products that we can actually admit to trading. So when we consider, for instance, high frequency trading, that in the first step will not be possible to happen on a systematic set-up as we are going for it in the first step. But, with that being said, maybe it’s also important for the viewers to understand that when we are launching 21X on Polygon, then nevertheless we still have a multi-chain strategy that we’re looking to execute. We see that real world assets are one of the mega-trends now, in particular in the Web 3.0 space. Talking to the largest infrastructure providers globally, there is hardly any of them that don’t have it on their agenda at the moment. And so when we come to understand that security tokens are already being issued in a regulatorily compliant form and manner by various players globally in the market, fintechs that are specialised on that part of the security token value chain, that in the next step, what they are all looking for is liquidity, right? So the fact that we can then, in the next step, under the restrictions of the EU DLT Pilot Regime because it says and states very clearly, you can do equity, you can do debt and you can do fund structures. And there are some other thresholds and limitations that come with the EU DLT Pilot Regime, as you know, Dominic. But I think that then comes to make sense nevertheless, because we know there are certain types of products that have still a very, say, cumbersome processing and back office operations and procedures where there are huge efficiency gains already, even though they are not being able to provide it in the first step for high frequency trading and for us, as a to-be-regulated financial institution, but still being a fintech if you so want, we clearly see advantages in focusing, in obtaining the licence in the first step, sticking to that strategy of doing it on a public blockchain and then adding potentially also other EVM [Ethereum Virtual Machine ] compatible chains that have different, say, efficiencies or advantages as opposed to, for example, Polygon.
18:32 Dominic Hobson: We’ll come back to the Pilot Regime. Let’s stick with the operating model for now. When it comes to post-trade blockchain technology, Polygon will be fine. You’ve said you’re going to be settling these trades atomically. Now we have this conversation all the time at Future of Finance. People say, `Oh yes, settling atomically seems great in theory, but you have all the costs of pre-funding and more importantly, you potentially lose the benefits of netting – that ability of people to do more business with less money, if you like.’ What is your reaction to those very familiar criticisms of atomic settlement?
19:15 Max Heinzle: Yeah, so I think that’s a very interesting topic in general because obviously there are certain, if you so want, models that have been made use of in terms of the systems that TradFi markets are running on. I would even like to call them maybe systematic weaknesses of systems that allow for also, or that actually provide for the possibility for this to actually happen in the traditional capital markets. If we look at the new way that we at least see that markets will be moving towards and where they will be developing, then I believe that that will be compensated also through fee structures that in essence make use of the benefits of the new market infrastructure and that these benefits that are still existent if you so want in TradFi can be counted to some extent also through the efficiency gains that can be realised. I think that’s really such an attention field there. But for sure there will be an impact and certain mechanics as we see them in TradFi today will no longer actually have a role in the future. It’s kind of also, maybe to give another example, right, because we were talking about what made us decide to go for public blockchain. And in essence, we saw already a few years ago a clear trend from financial institutions to push more for private blockchains. We see, and that’s also the clear feedback from the market, financial institutions not being really that much focused on self-custody set-ups, but more making use of custody service providers or integrating custody services themselves. And nevertheless, I think if we think further and longer down the line, if we consider where the market is likely to move towards in the long term, I think there’s also a space for self-custody. And also here the European regulator considered this, right? They do allow the investors, buyers and holders of the assets to actually make use of self-custody on a market infrastructure such as ours. And I think that just goes to show how decentralised the future of capital markets will be able to be, right? Maybe to make it even more so specific for the listeners and viewers, is that it could mean in the future, Dominic, that you and me, that we just connect our wallet and that we place a buy or sell order because we have connected directly as the UBOs [Ultimate Beneficial Owners] of the settlement currency or the digital asset, or if you so want to call it, the security token. I mean, the EU regulator calls them DLT financial instruments, maybe to clarify also there.
22:49 Dominic Hobson: Well, could we be clear on this point about what services you’re planning to provide both now and in the future? You talked very early in this conversation about building up in effect an ecosystem of service providers to users of the 21X platform. You’ve just been talking now about integrating custody and a vision of the future in which self-custody is the norm, and it’s a very decentralised network which you are part of. But can I just ask you very narrowly the question: What are the functions that the 21X platform is going to offer from the outset? And I’m talking here of issuance services, of the trade matching, of the settlement, of how assets get serviced and indeed the custody. Are you, for example, going to, at the outset, provide a custody service of your own? Are you going to provide services to potential issuers, advising them on how to structure their issues, what documents they need and so on? In short, my question is: What are the services you’re going to be providing at the outset?
23:52 Max Heinzle: Yeah, so we will not be providing structuring services because in essence, the market is not waiting for further advisors to help, really, with structuring. I think it’s more the case that when I talked about an open market infrastructure that along the value chain of security tokens and starting with deal origination and structuring, we will be working with the likes of partners that are already providing these services. And we also have what we like to call listing agents that actually help to ensure, on the market side, dealing with the likes of clients such asset managers that are looking to launch tokenised products to basically ensure that the listing requirements are met, that the criteria are met for admission to issuance and distribution – so traditionally primary market or also then (optionally) admission to trading on 21X. But before that actually happens, we still have that important part of the tokenisation and the smart contract creation, right? And so the configuration of these smart contracts and also the implementation of product-specific corporate actions that being based on the underlying structure that is being taken care of by both partners of ours that are leading in the space of tokenisation services, but also by ourselves. So clients can choose if they just want to make use of our tokenisation capabilities. And in the next step, it is important to understand also technically that the requirements are met for these tokens then to be admitted, like I said earlier, to enable subscription and distribution and then also depending on whether it is a public or private offering to investors with everything that comes with that. So it really encompasses the process of token minting for primary issuance of these likes of tokenised financial instruments. And obviously to then also enable cross-border and cross-platform distribution through the API platform that we have. In the next step, admission to trading for the secondary market functionality, order placement by buyers and sellers, the order matching and execution by the order book, smart contract and obviously also the atomic matching and settlement of the buy and the sell orders. Before I move on to the custody side of things, and maybe also share some insights there, again it’s important, I think to understand that in addition to that, there’s something like the asset registrar, or call them the registrar services for an on-chain digital asset registry of non-custodial and also custodial wallets. So we are allowed to provide with the DLT TSS licence, we would be allowed to provide them also for custody services, but we won’t be doing that in the first step. Within our strategy, and also our plan, is to embed that as well as part of our offering, but it won’t be in the beginning stages. The case is actually that we are in the process of integrating like a global custodial partner that can provide for these services for the likes of our clients, whether it is on the sell- or on the buy-side. And then, like you rightly mentioned, also all the post trade servicing. So corporate actions such as dividend and coupon distributions and the facilitation of the NAV [Net Asset Value] calculation, for example, regulatory reporting, ongoing position and risk management. Some of these services are actually conducted by the likes of some of the largest players or financial institutions in capital markets, obviously supporting there through the role of, say for example, an administrator. That would be like a summary of what it is that we are offering alongside the value chain, either ourselves or through third party providers. And yeah, hope that gives a clear idea.
29:02 Dominic Hobson: This registration function you referred to is a specifically German service, is it not? Or do you see this as being a kind of pan-European, even global, function that’s going to develop as digital assets take off?
29:18 Max Heinzle: Yeah, so you’re right, it really is. It is the case that under the Electronic Securities Act, as they call it in Germany, the registrar function is actually a requirement. And nevertheless we are not only just because 21X is operating out of Germany, facing products that will be issued and approved also from a regulatory standpoint by the German regulator. So, after all, it’s called the EU DLT pilot regime. And so we actually are excited to be also working in projects that are being originated out of Luxembourg or also other countries. And here again, the registrar function, maybe also to put that in the context for the viewers, is really in essence just capturing who are the ultimate beneficial owners of each respective financial instrument. When it comes to other jurisdictions within the EU that is not, like you said, rightly so, not an obligation to have that specific. And it’s also, by the way, in Germany, a specific licence that you normally need for this registrar function. But that’s then not the case for other jurisdictions.
30:57 Dominic Hobson: As you look at the services you’re going to be providing across issuance, matching, trading, settlement, even what you were talking about with custody there, as you look at the range of things that are going to have to be done to make this market scale, where do you strike the balance now, at the outset, between the primary market and the secondary market? Which is more important as you get going?
31:25 Max Heinzle: Well, it really comes down to the types of products that we’re looking at, Dominic. Some of the products, if you so want, more alongside the product category of bonds, there will be a necessity for both the primary market functionality and the secondary market functionality. Some of these products, as we know, have already been in the primary market, issued and distributed, but are still lacking the critically needed infrastructure in order for secondary market functionality to be enabled, right? I think that when we are looking at other products such as certificates, which could be in the future, maybe also a possibility to trade some form of structured products also on a market infrastructure such as 21X, then the primary market is less relevant, right? So for us, our core focus at the moment is really in driving liquidity, but it comes hand in hand, and it is also for us, if you so want, also with our history of 21 Finance and the SaaS solution that we already in the past offered, actually in line of what we have in terms of capabilities in-house to enable also initial subscription before admitting the product actually to trading.
33:06 Dominic Hobson: What’s your revenue model? Are we talking of issuance fees, transaction fees, subscription fees? How are you going to get paid for all this work you’ve been doing and are going to be doing in future?
33:19 Max Heinzle: We traditionally have a set of different types of fees that we charge and it really comes down to what side of the market infrastructure we’re looking at. But maybe to sum it up in the most simplified form and manner, we have, like, for, example listing fees, which are on- time fees. We have listing servicing fees which are recurring fees depending on how long the products are actually listed and services required to be provided. We can in some instances for the primary market also charge issuance fees that are volume-based. That depends really on the nature of the underlying product. There are quite substantial differences there. Some products are a lot more price-sensitive, others are less price-sensitive. And then there are obviously also trading fees, right, for buyers and sellers each that are volume-based. And what I can say is that these are going to be extraordinarily competitive just on the basis of the efficiency gains that we are realising through our highly automated set-up. So then, rounding and summing it up, given that we have a strong focus on our API landscape, we do charge an API service fee also there to the respective partners.
34:55 Dominic Hobson: I promised to come back to the regulatory position and perhaps we could start with the EU Pilot Regime. Obviously, you filed this application, you’re expecting it to come through. I wonder if you could tell us what it’s like to try and build a business like this within the Pilot Regime, because it obviously allows you to experiment, but it only allows you to experiment within certain constraints. And I wonder how difficult you’ve found those constraints or how light you’ve found those constraints in terms of what you’re looking to do. What are the pros and the cons of the EU Pilot Regime as you’ve experienced it?
35:39 Max Heinzle: So, to maybe start off with maybe going back to the point where we came to understand that this new regulatory framework would be coming into effect about mid of 2022, as I mentioned before. We put together a team of both legal and technical experts. And we also got help from top advisory firms, both on the legal and also on the business and operational side. Because really what we did was we put together a concept. So we came up with a way, what we believed also with our background in regulated capital markets, to be a form that should be in line with the to-be-announced regulatory framework, right? And also the requirements. There was not really much guidance at that time. It was all very fresh and very new. And when we actually went and presented this to the likes of regulatory bodies within the EU, there was quite a big interest in understanding how we are going about addressing and solving certain matters and also mitigating risks and so on and so forth. So for us, in essence, the constraints were more from a point of view where you could say, as a first mover, there’s a lot of regulatory uncertainty and there’s not so much clarity, there’s not so much guidance. And still what helped was that dialogue also with the regulator. So actually, also the dialogue of our experts that are advising us, and existing relationships there, to really have a dialogue and find out what the perspective and the view of the regulator is on certain matters. But it goes without saying, when you’re doing this as one of the first players in Europe, then you don’t have much that you can take on as a benchmark and say, okay, that’s a proven model. So I think that is besides the fact that there are some thresholds. And, now talking more or less about the challenges that come with the first mover advantage, obviously there are some limitations, right? So let’s take that example with product limitations, right? We come to understand that certain products are tokenisable and also can be admitted to issuance, distribution and trading on a market infrastructure such as 21X. But other products cannot. And where is that line of what can actually be done and what cannot be done? So those are also questions that we addressed with the regulator very clearly, where we actually went into specific examples. And in order to ensure that what we are doing, again, is in accordance with what the regulator allows to happen. We have some other constraints, right? We have constraints as to what is the market cap of these products? They’ve put on certain thresholds. We have also, when it comes to the total market cap that is admitted to trading and listed on 21X. And we have also part of the application process and also the licence documentation is to embed strategies about what to do if we breach or exceed those thresholds. So you must actually outline a plan and have clarity as to what actions you’re going to take there. And that is in our view not so much of an issue to begin with because, I always like to say, we need to start to walk before we can actually run, before we hopefully are capable also of trialling to fly. So hand in hand with the regulators, and obviously having to obey to market surveillance and reporting standards, I think for a new financial institution there is good reason to, also from a regulatory standpoint, say, okay, let’s see that everything is actually running smoothly, that all the measures are in place. So I can say that there is a price that comes with being the first mover. But as with almost everything in life, Dominic, there is pros and cons. And I think most of us will be aware of what the advantages are of also being the first mover.
40:33 Dominic Hobson: And I guess when you start to bump up against those market cap and other constraints, that will be a problem of success. But it’s one you’ve had to think about already because the ESMA wants you to have an exit plan for once your business is so successful that you can no longer exist within the Pilot Regime constraints.
40:57 Max Heinzle: Sorry, maybe just to jump in here and maybe add one last thing Dominic, and that is, I think one thing is pretty obvious from the dialogue that we’ve had with various regulators now and also the feedback that has been provided. So also for people to understand. When we file for this licence application, we go in iterations. There are in the next step feedback loops where we actually get a chance to make additions to the licence application. And I think it is pretty obvious and clear that the regulator does not only want to see that this new framework that they’ve put into place actually comes to life, that it actually starts running, but that it is also market relevant because otherwise that’s not going to be the case. And so, looking into the future, I’m actually very optimistic that with the feedback that will be provided by the likes of market participants such as ourselves, the regulator will come to also make significant findings and will there be learnings in order to make amendments and also additions to this regulatory framework. I think it’s a great start and a fantastic starting point. I just want to make that very clear. In my personal opinion, I think what we have in the EU now is nothing less than one of the, if not the most, regulatory or revolutionary regulatory frameworks for capital market infrastructure. And it for sure it’s not done with a single release of a new pilot, but the idea surely will be to actually make this become an effective legal framework, right? So I think that’s also why this Pilot [Regime] has been launched in the first place.
42:58 Dominic Hobson: Just before we leave regulation. One possibly stupid question. In Europe, we obviously have the supranational level of supervision and regulation. We’ve talked a lot about ESMA and the Pilot Regime. What are your obligations at the national level? What do you have to do with the BaFin or the Bundesbank, or indeed with the regulator in Liechtenstein? Do you have national regulatory obligations as well?
43:21 Max Heinzle: So maybe to start off with the one that doesn’t have any relevance in that sense in the first place is the Liechtenstein regulator, right? So just because our holding company, 21 Finance, is based in Liechtenstein, there are no touching points in that sense when it comes to the DLTTSS licence and in particular also the application process. No, we decided to do it out of Germany. Maybe also there to provide a bit of colour. Why? Because Germany, by nature of being the largest country in the EU, has a very strong regulatory history. The German regulator, and also the reputation of being a regulated financial institution out of Germany, that, in our view, has a lot of benefits to it. And when we look at the fact that 21X, for that reason, was founded in Frankfurt, Germany, we have to go through the national regulator. So BaFin is our point of contact. Nevertheless, we enjoyed the pleasure of having the possibility to also present and discuss with representatives of ESMA and the EU commission. And I believe there were also participants from the European Central Bank in specific meetings and specific calls to basically elaborate on specific subjects and matters. And what has been the case is that besides BaFin and ESMA, there have been others that also reviewed our application, right? So when it comes to the cash leg, when it comes to the fact that we are talking about the settlement currency of 21X, which is if you so want tokenised fiat, then we also have touch points, obviously, with the likes of the Bundesbank or also the European Central Bank. And so we are actually, from the feedback that we received in December of last year, having been in exchange also with BaFin, again, we are hoping to receive now formal feedback in the next couple of days and that will then also, to my current understanding, include again various opinions also from other authorities, as I outlined earlier. So that’s kind of how it works.
46:02 Dominic Hobson: Okay, let’s assume the licence comes through in the Spring, as you expect. Let’s talk now about how you’re going to grow the business from that point. And I’d like to talk about it in four senses, I suppose. One is you need issuers, you’re going to need investors, you’re going to have to make choices about the type of instruments within the constraints of the Pilot Regime, the type of instruments you’re going to list and trade, but also about the partnerships you’re looking to build with third parties. Could we look at those four axes of growth in turn? Maybe start with issuers? What type of issuers are you looking to do you expect and aim to attract?
46:41 Max Heinzle: Yeah, so in the first place, issuers that are predominantly asset managers that already have products, that want to start trialling and take advantage of this new technology. So launching alternative investment funds or also the likes of issuers for bonds. I think these are a variety of different types of companies. We also know that there are some limitations again in the DLT Pilot Regime as to how big those companies can be, in particular when looking at equity offerings, for example. But we’re going to see products being launched that are rather also traditional products as we know them. Like for example, electronically traded- sorry, exchange traded – notes or exchange traded funds that in the next step will be made available in tokenised form or to fractionalise. Also the likes of private equity, private debt instruments, that normally would have a much higher threshold or minimum investment or subscription amount. These are certainly products that are in the pipeline. And that we will also see real estate, tokenised real estate, as part of financial instruments being wrapped into baskets. These are some of the examples.
48:27 Dominic Hobson: Right, you’ve talked about issuers and by extension you’ve talked about the asset classes you’ll be focusing on as well. What about the investors? Are the investors going to be mainly institutional, mainly retail, or a mixture of both?
48:40 Max Heinzle: So we’re going to have both institutional and retail investors connected through the likes of brokers, financial institutions that are connecting to our regulated market. So the nature is really going to be both retail and professional, respectively institutional investors. Getting back to the question that you asked earlier: Who else is going to be a participant on that market infrastructure? Very traditionally we also have liquidity providers that we have entered into partnerships and projects with, that we are connecting either through API or even smart contract based. And then already, like I mentioned before, we have a set of listing agents that we will be working with that facilitate driving products also to 21X. On the buy side, more along the lines of, the likes of, brokers, neo brokers, banks, neo banks, and maybe also one or the other crypto exchange that wants to expand their product and service offering.
49:52 Dominic Hobson: And if you’re focusing on the funds business, what about fund administrators and custodians?
49:57 Max Heinzle: Yeah, so obviously custodians, like I did mention before, are an integral part of our market infrastructure. Moving forward some of the, and just given the market stage and development where we are, development stage that we are at, some of the partners that we are looking to integrate already have their own custody set-up implemented. Others will make use of our integrated global custodial services. So that’s certainly another important part that you need in such a market infrastructure. And then rightly so, as you said, also fund administrators. So we are very pleased to be also working together with, for example, Apex Group. They are taking on, for example, also specific services in that field.
50:57 Dominic Hobson: So am I right to think that you’re going to be sharing your technology, as it were, with these partners? You say somewhere that the company is going to leverage its world-leading DLT technology to build this infrastructure and it’ll allow customers to incorporate the 21X platform into their own systems, whether it’s an exchange or something else. So you build the ecosystem by allowing multiple parties to trade and settle tokenised securities. But you don’t mean by that this is a technology play? This is really about creating an ecosystem. You’re not in the business of selling technology, token technology. You’re in the business of building an ecosystem. Is that right?
51:36 Max Heinzle: Yeah, I think that is right. I mean, the ecosystem that we’re trying to build will be critical for the success of a working, newly functioning market infrastructure layer where we need for certain roles to be taken care of. That in essence takes quite a lot, as we all know, and it depends on bringing various parties also to the table. I think that will be critical for our success. The fact of the matter is that things are running on blockchain, but I think we all know that most of us, we are using the Internet, but not many of us really know what is happening in the back and how the Internet functions. I think the kind of same thing goes also for blockchain technology. In the end it will be the low hanging fruits; it will be the efficiency and cost cutting; the efficiency gains and also the potentials for cutting costs that will supersede there and actually drive adoption. And for that purpose, we need to start with the underlying required infrastructure for that to happen. And does it need to be regulatorily compliant? I think, that being said, we see that many financial institutions or also intermediaries are delving into this subject. Some of them have been already early to adopt, others are still in the process of making decisions or are in the process already of implementation. So it’s going to take some time. I’m positive to say that we see that what this trend that has been kicked off now and that development. As also Larry Fink said a few days ago, this is surely one of the new trends for this to actually come to life.
53:49 Dominic Hobson: Now, the vision you’ve outlined is a compelling one, but it’s an awful lot of work and it’s not going to be cheap to do it all. And I know you’ve raised, I think, €10 million over the last year or so from a variety of shareholders. Can you tell me – and this really will bring our discussion almost to a close as we talk about what you’ve just been describing. You build this infrastructure. Will people come and use it? How do we drive adoption? You and I might think the opportunity is very obvious. My question is this: You’re well-funded for now. What are these shareholders thinking about this opportunity? What’s their view of how quickly you can turn what you’ve built into revenue, how you can scale it up and start actually to change the capital markets of Europe? What sort of timescale are they thinking? How do they think you’re going to do it? What’s the opportunity that they see for themselves?
54:46 Max Heinzle: So lately, and just given that we already started our journey, like a good six and a half years ago, or almost, you could say seven years ago, our shareholders were always convinced and have a strong background also in blockchain technology. They were early adopters themselves as well. The conviction that the technology is here to stay and that it is going to have a big impact on capital markets as we know them today, referring to TradFi, I think that is an integral part, to actually have the means and the backing and also the conviction to enter such an innovative project and go down a route that obviously will lag in showing returns. But after all, it’s highly scalable and I think the potential that derives from it is enormous. So with the likes of some of the newly engaging strategic, more strategic, partners, I think there is a much more long-term perception of what it is that we are doing here. Actually, I catch myself sometimes, Dominic, being overly optimistic and wanting to see that things happen much faster. I’m a very impatient guy. I hear that from my employees and colleagues all the time. But, after all, anybody that has worked in capital markets and has dealt with change in banking and finance, knows that things do take time, and we’re, after all, talking about also systematic change. So I’m pleased and I’m happy to, on the one hand side, see that we have this backing. I mean, some of the shareholders of 21 Finance are family offices that have not only trusted us and followed our journey over the last couple of years very closely, but are obviously tremendously excited that we are in a position to become one of the first, if not the first, company in Europe to provide such an infrastructure. And what reconfirms it is that we see through the various conversations that have now started to really significantly increase, that there is a strong shift in sentiment and conviction. I mean, one thing that just goes to show is that most of the world leading banks have implemented and set up departments specifically addressing digital assets and have also launched or are engaging in such projects. And so it will take time. But nevertheless, we see that to get the ball rolling, we are getting all the ducks in a row, if you so want, with the respective partners. And the team and myself are very excited to finally start operating this new market infrastructure.
58:11 Dominic Hobson: You said a minute ago that you occasionally get ahead of yourself and succumb to what might be called an error of optimism. I don’t know whether you ever succumb to errors of pessimism, but as you go around the marketplace, talking to your potential partners, to potential investors, to potential issuers, and you’ve said it’ll take time, but why does it take time? What are the reasons people are giving you? Is it, ` Oh, well, we’re quite happy with the MiFID system. We’ve got all these technology platforms which may be 20 years old, but we’re quite happy with it. It all works. We don’t really have a financial incentive to change.’ What are the arguments against moving rapidly in this space that you come across and which you think are probably fallacious?
58:59 Max Heinzle: Yeah, for sure the fact that it has a new underlying technological stack. So we’re talking about a new system, if you so want, and it needs to be connected, often, to old systems still, because a lot of those systems are just the underlying running systems. So there’s basically that part which is slowing things down. I think it’s also a question of education, understanding, regulation. It does take some time. After all, it is a new material and it does just take time for things to be reaching a point of understanding. And also, obviously, risks that derive from this new field of operating with digital securities, right? I mean, there’s a variety of liability and other risks that come alongside this subject that slows things down, right? We all know that, for example, receiving licences and receiving approval, just take us as an example, is a process that itself will take about a year’s time to be done. And if one considers all the preparation that went into it before you could even say it’s more along the lines of one and a half years to almost two years. So that, in itself, I think are a couple of good reasons why it will just take time. But nevertheless, for me personally, there is no question about whether it will happen or not. So that’s also the reason why we are thinking a bit more long-term.We want to really try and now shift and be a driving force for projects to not so much be any more pilots, but actually really be real world use-cases, real world asset tokenisation, like they say, and then scale up our operation. And also the amount of products that we are issuing alongside with our partners.
01:01:25 Dominic Hobson: On that new technology paradigm risk you referred to, do people bring up the question of interoperability? By which I mean they say, well, if we buy on Polygon, we can’t sell on Avalanche, or indeed we can’t sell on the Deutsche Börse. Is that lack of interoperability between not just blockchain protocols, but between the protocols and the traditional systems ever an objection you come up against? And if it could be fixed, would it encourage people to be more positive and act more quickly?
01:01:58 Max Heinzle: I think that it is another reason why maybe things are moving [slowly]. I mean, if we had more standardisation already, that would certainly accelerate also the development of this new market. But it is, after all, still a race that is to be won. And I think that there are some aspects and also some clear benefits of certain infrastructure layers, which is also why certain market participants are going to probably have to come to a consensus on what underlying technology is being used. And nevertheless, at the same time, interoperability is making advances. There are big advancements that we are seeing also in the space of interoperability. But yeah, I would agree. I think that interoperability as a topic for itself is another reason why things are not developing as fast as they could. If we had, say, an underlying standardised infrastructure layer.
01:03:14 Dominic Hobson: Now, I can see why issuers and investors are going to get excited about this once they get comfortable with the technology and the risks and see it scaling up. But what about these partners when you’re approaching them, these intermediaries who are already active in the capital markets, do you detect that they feel threatened? I mean, your website is pretty clear that the long-term success of this model depends to some extent on disintermediation of existing sources of cost. Are you running into resistance from people who think, well, you’re going to put me out of a job if you go down this path?
01:03:51 Max Heinzle: Funnily enough, not so much, Dominic. I think that there is still a lot of confidence in traditional capital markets and I think that, at the same time, it’s more the case that most of those large financial institutional players that we are dealing with, they see tremendous potential for themselves also moving forward: the cost cutting potentials for their current operations, being able to tap also into a new client base, reaching out to new customer segment. I think that’s definitely overweighing the sentiment and the feedback that we are getting. And I must say I think that it’s also pretty obvious that some of the traditional financial institutional players are also making moves themselves. I mean, they see this themselves also as an opportunity for them to maybe make shifts or amendments to the way they are set up in the future and also to the services and products they can provide in the future to their clients. But I think that, like I said earlier, Dominic, it will become very important for us to actually build an ecosystem and get market participants convinced that enabling tradability and trading and settlement and driving liquidity into tokenised securities is not a one-man job.
01:05:32 Dominic Hobson: A final question for you, Max, before I let you go. What will success look like? If we look five years ahead, would success be you’re bumping up against the market cap constraints of the EU Pilot Regime, you have to activate your exit plan from the Pilot Regime? Or is it something short of that, or something beyond that? Do you have a clear idea – you and your shareholders – do you have a clear idea of what success is going to look like? What will make you feel good about all the work that you’ve done, all the investment that you’ve made?
01:06:04 Max Heinzle: So first and foremost, maybe to take first the short-term perspective, I think for this year in particular. For us, the big milestones and our core objectives surely are that we obtain the licence, that we take 21Xx live, that we see the listings of the first products, and that actually the magic starts happening so that we actually see that operations are running and that this is also being done in accordance with regulatory requirements. I think that in itself is surely [enough] for this year on our plate. And then if we look ahead and you mentioned like a five-year time span, and probably you’re talking about five years, because the DLT Pilot Regime is supposed to run now for three years, and then they’ve already talked about a possible extension of another three years. So that would make it, given that the DLT regime started last year in March, pretty much that five years. Moving forward, and what I think is going to happen, and also maybe to address specifically your question on the threshold. I hope not to get into any troubles for saying this but let me take an optimistic standpoint here. And that is, I think that what’s likely to happen is that the EU DLT Pilot Regime will become effective, hopefully already before the five years’ time have passed. But possibly then, right, because it is supposed to, like I said, run for three years and then extend it possibly for another three years. So that’s my one hope. And the other hope is that the regulator comes to understand that the thresholds, if we put them into perspective and if we see that institutional adoption is actually happening from the likes of regulated financial institutions and that we can prove to the regulator that things are running the way they are supposed to, that we can then also hope for the release of certain thresholds. I remain very optimistic there because, after all, when we are looking at market relevancy, that’s surely the direction that it will have to go towards. By the way, having said that, that would also be my hope for the product restrictions that we still have, right? Excluding structured products as an example. I think I’m very optimistic there. I think that what we will be seeing is that the regulator will start to walk and run together also with the market providers and this market will actually become a much less … There will be much less restrictions than there are still today.
01:09:07 Dominic Hobson: Max Heinzle of 21 X, thank you very much for taking the time to share what you’re doing with the members of Future of Finance.
01:09:15 Max Heinzle: Yeah, thank you, Dominic. It was a great pleasure. Thank you for giving me the possibility to talk about what we are doing today.
