How to make the digital asset markets grow – What can be done now to overcome the absence of digital money on blockchain networks?
- Future of Finance
- Apr 3, 2024
- 9 min read
Updated: Jan 30
A Future of Finance interview with Gilbert Verdian, CEO of Quant.
Tokenised assets markets, though rich in the promise of cost savings and higher returns on investment, remain disappointingly small. However, the obstacles to the scaling of the digital asset markets are increasingly well-understood, and gradually being cleared. Legacy laws and regulations are proving more workable than expected, and being adapted where they are not. Experiments by regulators, central banks and private sector firms, sometimes in regulatory sandboxes and sometimes at BIS Innovation Centres, may not have bred a new caste of blockchain giants but they have proved that the technology works and legal and regulatory constraints are not fatal. Established intermediaries are losing their scepticism and fear of disintermediation and exploring the opportunities to profit. Whole new infrastructures, such a unified ledger or single programmable platform, are being conceived. Ways of putting central and commercial bank money on blockchain are being found. So it feels like the time is ripe for a business such as Quant, whose founders recognised at the beginning of the Initial Coin Offering (ICO) bubble in 2015-17 that the digital assets industry was creating potentially existential problems for itself in its lack of alignment with existing regulations, its failure to develop regulated forms of digital money on-chain to complete the cash leg of transactions and the determination of competing blockchain protocols to monopolise activity rather than capitalise on the network effects of making digital assets portable between blockchains. Since its foundation in 2015, Quant has focused on adapting blockchain technology to meet the needs of regulated banks, asset managers and insurers, and reassure the regulators and central banks that supervise them, by developing tools that enable blockchain protocols and traditional systems to interoperate successfully. Dominic Hobson, co-founder of Future of Finance, spoke to Gilbert Verdian, CEO of Quant.
Key Insights
Settlement of digital assets without fiat currency being available on blockchain networks is problematic, and central bank digital currencies (CBDCs) remain a distant prospect, but commercial banks are increasingly excited by the efficiency savings and service enhancements made possible by the programmability of digital money, including tokenised deposits.
Claims that money is already digital ignore the fact that payments require push-and-pull exchanges of data to complete transactions, whereas truly digital forms of money enable the sequence of actions that complete a transaction, such as financial crime checks and the availability of money in an account, to be programmed into the digital money itself.
Cryptocurrency will continue to exist as a speculative investment, though institutional investors will favour regulated cryptocurrencies and cryptocurrency investment vehicles such as the spot Bitcoin Exchange Traded Funds recently authorised in the United States, and the regulated variety of cryptocurrencies can be expected to drive out the unregulated varieties.
Transcript
20:42 Dominic Hobson: The second topic I’d like to raise with you in accelerating progress towards large and liquid digital asset markets is money. You’ve touched on this in your previous comments. I know it’s a specialist subject of yours. What I mean here is the obvious thing, that as long as we don’t have money, digital money, available on-chain, you’re always going to have to come off the chain to settle transactions. That makes it very difficult to achieve that T+0 settlement. It obviously raises costs. It maintains various forms of potentially unproductive intermediation, both domestically and across national borders. It ties up capital in large buffers of cash and collateral people have to keep in different markets. And it is a widely agreed constraint, for all those reasons, on the growth of digital asset markets. Yet the solutions which we’ve come up with so far, Stablecoins are one of them, and you and I have spoken about this before, but they’re clearly not a long-term answer because they’re not that stable and they’re about to be regulated in different ways and so on. Tokenised deposits seem an interesting proposition, seem to reproduce commercial bank money, but they remain at this point a purely an intra-bank solution. We’re not seeing a lot of issues of those come out. And yet central bank digital currencies (CBDCs), which are the obvious answer to this question – putting fiat currency directly on-chain in that fashion, whether it’s wholesale or retail – that seems still, particularly in a major reserve currency, quite a long way into the future. So what can we do now, to tackle that lack of a native digital currency on-chain?
22:40 Gilbert Verdian: With the clients we work with and talk to, we’re seeing a huge interest in tokenised bank deposits or bank liabilities for the benefit of having programmability. And that was proven with the work that we did in Project Rosalind [a joint experiment between the Bank for International Settlements (BIS) London Innovation Centre and the Bank of England to develop prototypes for an Application Programming Interface (API) for operating a CBDC between a central bank and commercial banks] with the Bank of England [and] BIS. Having the ability to programme workflows, logic triggers, et cetera, in money itself allows you to automate a whole bunch of complex processes – checks, authorisations, et cetera. So commercial banks are quite well-versed in banking and payments, but they’re seeing the benefits and the potential with a new form of money. And having digital money, in terms of digital dollars, digital pounds, digital euros, et cetera, allows them to serve a market that is emerging. And it is around tokenisation, it is around digital assets. And having the existing form of money serve a new form of instrument is just not fit for purpose. There’s challenges, there’s friction, there’s a lot of complex workflows that have to happen in the background just to do a settlement between something that’s modern and digital with the legacy. It’s very cumbersome. So they are actively exploring and looking at what they can do in the short-term, and what they can implement with programmability, with tokenised bank deposits, and how to serve the use-cases and the customer needs of today, which is not that far off for them. It’s imminent. I mean, you’ve seen the market expand and grow with ETFs [Exchange Traded Funds, a reference to US regulators permitting spot Bitcoin funds to be distributed], and now the FCA is allowing the same in the UK. And so there is a need to serve this market, this regulated market, and they’re not willing to wait for CBDCs. I mean, they are imminent as well. But imminent from a central bank perspective is ten years, and imminence from a commercial bank perspective is a couple of years. So we’re seeing them step up their efforts in understanding and implementing what programmable payments can look like, what programmable money looks like for their use cases, for their customers, and how they can do that with commercial bank money, with tokenised deposits and tokenised liabilities.
25:17 Dominic Hobson: I’d like to tease out, because I think you’ve said something very interesting there about programmability being the point at which digital money meets payments. And that you think, and I think you were saying this, that programmability is the feature or the benefit which is driving the interest of the commercial banks in finding their own solutions to the absence of on-chain digital money. Am I right to think that? Am I right to think of programmability and payments as being at a crucial interface in driving progress here?
25:53 Gilbert Verdian: That’s correct. I mean, what we’ve got today is electronic money, and that’s been the architecture and the design from 30 years ago, and it hasn’t changed that much. So it’s very binary, it’s a push and a pull, and all these things happen after the transaction is made. What programmability does is enable money to be digital. So you’re actually evolving that instrument to become a digital instrument and a new form of money. And the difference between a digital form of money and an electronic form of money is the ability to have programmability and logic built into the transaction itself, into the money itself. This has been demonstrated in numerous use-cases. We did it with [Project] Rosalind. We showed having programmability allows certain conditions to be met. Like an event occurs, a trigger happens, an authorisation or a release, or an event occurs within the transaction flow. And that could be done by the banks, by an authorised third party, and you could build upon that to allow different parts of the transaction to occur. And then money is released if those conditions are met. And it could be very simple. If a fraud check is done and AML [Anti Money Laundering] check is done, then release the funds. So it’s a very simple example. From an end-user perspective, it gives people like you and me, consumers and businesses, the ability to code logic into that. Very simply put, we can actually say, when my salary comes in, take the direct debits one hour after it comes in. So that’s the triggers that we implement ourselves. So then we prevent it from being overdrawn. We don’t have the friction of having all the text and messages from your bank that you’re overdrawn. And it’s just a simple example to show what programmability can look like for us. So having that within capital markets is even more powerful, because then you can automate settlement processes, counterparty checks, post-trade processes, for example, and put that into the money itself. When this happens from a delivery perspective, then release the payment and it could be almost real time and it could be on-chain. So you don’t have to go out of the existing systems to do it, you don’t have to go and do correspondent banking, you don’t have to wait three days for the money to arrive for settlements. All those things become automated and frictionless, which is one of the holy grails of everyone’s goals, to get to that.
28:37 Dominic Hobson: This might seem an odd question to ask, particularly after you’ve just outlined the benefits of programmable money in making payments more efficient. But I’m constantly surprised when I go around and talk to experienced people in large institutions who still struggle to distinguish between cryptocurrencies and digital forms of money. I wonder if you think that the reputational damage which cryptocurrencies have done to the whole idea of digital money … And the cryptocurrency industry, parts of it are perfectly respectable, I’m sure, but large parts of it have a rather inglorious recent past, and that lodges in people’s minds in a way that the successes don’t. Now, cryptocurrencies are being brought steadily within the regulatory perimeter in the major jurisdictions. But I wonder if you – and here I risk here going back to our regulatory discussion – I wonder if you think regulators are going far enough in their treatment of the cryptocurrency industry. Would you, for example, the thought that occurs to me is that maybe cryptocurrency should be regulated like dangerous drugs or alcohol or tobacco. Are regulators doing enough to create regulatory distance between cryptocurrencies and CBDCs and tokenised deposits, in your view?
30:01 Gilbert Verdian: Look, I think they [cryptocurrencies] will always be there. There is a market for that. People see that as an investment, and they can invest to make some returns from that. In the new asset class, the regulated side is bringing that into the ETF [Exchange Traded Fund] fold, and that was done by the SEC [Securities and Exchange Commission], followed by the FCA [Financial Conduct Authority] now. And that allows institutions to invest in that. And investing only for the returns is a form of value. Can we get more than 6 per cent return on this this year? Is it an asset class that can meet our investment … investors’ needs, for example? But I think what will happen is there’ll be regulatory alternatives where you have the protections, the consumer benefits, the legal and the financial protections of investing with regulated institutions, but investing in more regulated assets, that are digital assets. There could be a tokenised fund, there could be a security that’s tokenised, it could be tokenised money. And you get the FX [foreign exchange] in a digital asset form rather than interest in your bank account. And then you could trade the FX, for example, separately to the instrument itself. So there’s going to be a new alternative, which is more trusted, safer, backed by institutions and central banks. And there will be an alternative, and there’ll be a choice. So do you want to invest in something that is less risky and you have a certain amount of returns, or do you want to invest in something that’s more risky, which has a potential of certain amount of returns? And if something goes wrong, you don’t have recourse, whereas on the regulated side, you do. There’s protections and laws built in. So I think having the alternative will allow smart investors to understand that they can have better returns, but in a safer instrument. And eventually there will be that flight to safety, because then you’ll have tokenised money that you’re paying with, that’s protected digital assets, that are all instruments that are already regulated. And as an investor, you get that same experience. It’s a new asset class. The way you invest is different. You’ve got access to more funds, you’ve got access to better liquidity, and that will allow you to make a better choice, to pick the safer option or the riskier option, and it’ll be up to consumers. So there will be a market for both eventually.
32:47 Dominic Hobson: So you solve the problem of the disreputable instrument by providing a more reputable instrument, and that over time, people will … can be trusted to make the right choice.
32:59 Gilbert Verdian: Exactly. It’ll be consumer choice or investor choice. Yes