How to make the digital asset markets grow – What can governments do to encourage the growth of digital asset markets?
- Future of Finance
- Mar 28, 2024
- 14 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
The time in which regulators observed rather than intervened in digital asset markets is now over, and regulators are starting to work with the private sector to design effective regulations that match the pace of technological development, but progress would be much faster if a single regulator was given responsibility for digital finance.
The reliance of traditional finance on national forms of regulation is ill-suited to the genuinely global and highly mobile digital asset markets, as the constant migration of cryptocurrency exchanges in search of accommodating jurisdictions proved, so a major jurisdiction needs to establish a minimum standard all jurisdictions can support.
The principal benefit of regulatory sandboxes is not to produce Unicorns or drive the reform of existing regulations but to prove that existing regulations are adequate to the task of regulating digital assets, which is of greater value to institutions that are regulated already than to new market entrants whose businesses test existing regulations.
Experience has shown that existing frameworks of law are adaptable to novel conceptions of property such as natively digital assets, but at this nascent stage in the development of the digital asset markets, the flexibility of the law is less important than a clear line between what is acceptable within the law already and what must await the further evolution of the law.
Governments can influence the rate of growth of the digital asset markets directly by encouraging equity investment in smaller companies and issuing government bonds in tokenised form, which would have knock-on effects in encouraging atomic settlement using tokenised central or commercial bank money as the cash leg of the transaction.
Transcript
00:14 Dominic Hobson: Hello, I’m Dominic Hobson, Co-founder of Future of Finance. My guest today is Gilbert Verdian, CEO of Quant, a business dedicated to making blockchains work for banks, for asset managers, for insurers, and for technology vendors by ensuring that blockchain protocols and traditional systems can interoperate successfully. Our topic today is how to accelerate our progress towards large and liquid digital asset markets. Gilbert, thank you very much for joining us.
00:44 Gilbert Verdian: Thank you, Dominic. It’s great to be here.
00:47 Dominic Hobson: I’d like to begin by asking what governments can do. And by that I mean regulation. I mean law. I may even mean direct measures that governments could take. And I would like to start, I suppose, with regulation, if we just focus on that narrow question. And the reason for doing that is that it’s the reason most often cited by digital asset issuers and by digital asset investors as to why they’re not doing more right now. They’re saying, `Well, the regulatory environment is very uncertain,’ and that seems to apply whether a regulator is very active, like Gary Gensler is with the Securities and Exchange Commission (SEC) in the United States, or whether they’re relatively laid back, like the Financial Conduct Authority (FCA) is in the United Kingdom. So you get varieties of uncertainty, but this is the main excuse, if you like, for not doing anything if you’re an issuer or an investor. What would you advise a regulator who is keen to encourage the growth of the digital asset markets actually to do?
01:55 Gilbert Verdian: I think we’re in an era of digital finance now, and it’s inevitable that the markets, the instruments, the infrastructure will need to change and evolve. And to do that, you need clear regulation, the right regulation, and not heavy-handed regulation. It feels like regulators have, for the past ten years, just taken a step back to view the evolution of the market, where it’s heading, what they need to understand and what they need to regulate and how. But it feels like that moment has passed. There’s no longer the ability to just sit back and let the market decide. It feels that regulators need to be even more involved than they were before, because the market has changed and the value in the market has changed. Instruments are changing, money is changing into digital money, and it feels the right time for them to, instead of having a reactive regulation, to have a very proactive, in the sense that they can co-design with private-public partnership, what good looks like. And they are doing bits around consultations and getting feedback from the market, but it feels still a bit too slow. And where we’re seeing the market heading is quite accelerated and quite rapid. So it does make sense for the regulation to adopt and to adapt to that speed. And what we need from regulators is clarity and a clear set of rules on what institutions, what digital assets, instruments, equities, et cetera, need and can do. And it also makes sense to also consider reviewing regulation and reviewing regulators. As I said, we’re in an era of digital finance. The responsibility in this is still unclear based on which regulator you’re talking to. There’s been discussions around reviewing the regulators from a parliamentary perspective, in the UK, for example. But maybe it makes sense to have a new regulator that’s solely responsible for digital finance and that allows a very clear, single source of truth, regulation, coming from one regulator, rather than a multitude of regulation coming from a multitude of regulators.
04:37 Dominic Hobson: Can’t think what market you have in mind there, Gilbert, but I’m sure most listeners will. One thought that occurred to me, you used the word there `adopt’ as well as the word `adapt.’ And we do see, to your point about regulation needing to catch up with the progress of the technology, we do see certain jurisdictions around the world starting to develop market-leading regulatory regimes for digital assets, if you like. I’m thinking here of the Middle East in particular. One of the worries that occurs to me is that when these jurisdictions are formulating their regulations, they tend to look at what’s been going on in the most advanced jurisdictions. They might look at Singapore or the European Union, or occasionally the United States or the United Kingdom. And this is a long running debate in regulation as to whether you want a single playing field all over the world, or whether you want jurisdictions to compete to attract business. And I guess that’s my question to you is: do you worry that this kind of copycat approach to digital asset regulation is leading to a sort of convergence on, to borrow your phrase, what looks good or what feels good? And is that convergence a good outcome compared to more intense competition to come up with regulations that succeed or fail on their own merits, as opposed to being copied from somebody else’s plans?
06:06 Gilbert Verdian: I think the very nature of digital finance is global by default, and that’s why it’s very different to our current financial instruments and our current financial systems, where they’re very segmented into jurisdictions and you have complete authority and sovereignty of that jurisdiction. The nature of new forms of assets, in terms of digital assets, digital instruments, financial digital finance, [is that] they are very easily able to be migrated and operate globally. And so what we’re seeing regulators do is trying very hard to attract their centres of excellence or their jurisdiction as the appropriate place for global finance. But I think what can happen is a constant rush of institutions just favouring what’s the best regulation, what’s the best jurisdiction at the time. And then that migration, if someone else comes up with a better model than the migration to another jurisdiction. And we saw that happen quite considerably during the focus of the crypto exchange era, where they just migrated to a jurisdiction based on whoever allowed them to operate in a particular place. We can’t have that uncertainty with institutions, and we need stability and we need resilience. And so what we need from a global perspective is harmonisation of regulation and acceptance of regulatory rules. So it makes sense to have a baseline regulation that is consistent between major jurisdictions, similar to what we have in Europe, in passporting, for example, where different regulators are able to set their own rules, but they’re respected and accepted in different jurisdictions. And so it’s very easy for firms to migrate regulation and regulators as they’re working in different jurisdictions. But it also makes sense for more, larger jurisdictions like the UK to really set the example and set the bar of what that looks like. We’ve always been a financial centre, and it makes the UK very attractive globally. And so if we get this right and we are seen as a modern, proactive regulator, and if we think about having a new form of regulation, or a new form of regulator managing digital finance, then we can set the bar on what that can look like globally, and harmonise a UK-led approach to other regulators and allow global firms to really operate globally, but based in the UK, and export that regulation to a harmonised system.
09:16 Dominic Hobson: I see what you’re saying. We need regulatory competition, but not regulatory arbitrage. It’s kind of not helpful for FTX to be able to move from Hong Kong to Bahamas. But it would be helpful if leading jurisdictions like the UK set out a basic foundation on which other markets could build. And on that point, I think I’m right to say the UK was the first jurisdiction to have a regulatory sandbox. And I’ve become a bit cynical about sandboxes. Every jurisdiction seems to have one now, but I’ve never seen a compelling set of data which indicates that these are actually successful. That they’ve grown. That lots of unicorns have emerged. You do see people emerge from them into the regulated area, but you don’t see a lot of unicorns as a result of that. And I also, perhaps more worryingly, haven’t seen regulations adapting as a result of the experience which regulators have had inside these sandboxes. Am I being too cynical about the ubiquity of the sandbox? Are they still useful devices? I’m amazed that United Kingdom, for example, is having, withdrawn from the European Union, is kind of copying Europe now. It’s copying its own invention back again, almost. Am I being too cynical?
10:36 Gilbert Verdian: I think sandboxes are a good tool to validate regulatory thinking in terms of what can work and what potentially might not work. I don’t think they’re a be-all-and-end-all, but they’re really designed to allow existing regulated entities, such as institutions, to venture into a new area, which is quite unknown and unclear for them. And the sandbox is a great way to test the waters and understand, well, does existing regulation apply or not, or do we need something different? And most times, what we’re seeing is the sandbox can be practically tested to understand the market reaction, the risk, the compliance, for example, without having enforcement, which is quite good. But then most of the time it shows existing regulated entities that we do have sufficient regulation today that can cover that new aspect, that new instrument, that new offering, or whatever it is. So it is a good practical validation. But being a sandbox, it’s probably more beneficial to existing regulated entities than to small start-ups or smaller entities getting into that space.
11:56 Dominic Hobson: Let’s talk a bit about the law now. And I’m bringing up the law not just because it’s often raised as a barrier alongside regulation, but because if you look back at, say, the industrial revolution, it wasn’t just about steam and coal and electricity, it was actually about changes in the law as well, laws of contract, laws of patent, laws of limited liability. So if we are progressing towards a digital asset revolution or a digitisation-digitalisation revolution, the law is actually going to be very important. And I’ve been taking part in several conversations in which a lot of hope seems to being invested in the greater flexibility of the common law jurisdictions. The sort of Anglo Saxon world of United Kingdom, United States, Singapore, which have this common law tradition, as opposed to the civil law tradition, which you see at work in, most obviously, the European Union, but also in Germany, France, Switzerland, and the work of the UK Law Commission looks very promising. I certainly find it very helpful to read. Whereas when you look at things like the Markets in Crypto Assets Regulation (MiCAR) out of the EU, it seems a bit backward-looking, out-of-date almost as soon as it’s passed, it kind of lacks that adaptability going forward. And then, on the other hand, I look at what’s happening in Germany, the eWpG [the Electronic Securities Act] – I daren’t try and pronounce the name of the law itself – it does seem to have encouraged activity, not just issuance but also the development of custodial services, registration services and so on. So I wonder what your view is of the law. Is it better to be inside an adaptable system which can evolve naturally in response to challenges, or do you need governments to sort of step in and say, `Well, actually we’re going to change the law, write a whole set of new laws so that you know exactly where you stand in relation to the courts in the development of this asset class.’ And maybe there’s a third option between these two where you kind of, and you touched on this in one of your earlier comments, where you kind of modify what you have already, you sort of change the law to accommodate this new asset rather than rewrite it completely. So what is it to be? Evolution, revolution, or some sort of compromise in the middle? What’s your view?
14:11 Gilbert Verdian: I think what we’re seeing is an evolution of existing laws to adapt to a digital age. The [UK] Law Commission’s report was a few hundred pages long and very detailed, and the output of that was to redefine property in terms of including digital assets. And that makes sense. You can fit under an existing structure and an existing framework and a legal framework. And what happens then is … It’s determined by case law, it happens case-by-case, and then you’ve got precedents. So it’s quite adaptable and it feels like the right approach. But what we need is not heavy-handed law. I think what we need is a structure that we can work within, but also underneath that you’ve got regulation which is allowing compliance to the law, but also providing very clear guidelines and clear rules on what is permitted, what is acceptable, and what is a grey area. And a grey area is what you can bring up into case law and determine what is right. Because it’s such a nascent area, I think there will be a lot of that. We’re still quite early. The maturity is still yet to come but having that certainty and having that framework in place makes sense. But we need to adapt and evolve the regulatory system, but also the legal system as we progress. So we are at the beginning of a digital finance transformation, and having the tools that underpin it right now is the right way, and we just have to see this through. So it could be quite different over the next five to ten years, but it’ll be quite clear in terms of the evolution of what is correct from a legal perspective and what is applicable from a regulatory perspective.
16:14 Dominic Hobson: Okay, let’s put regulation and law to one side and ask, as I indicated the outset, what governments could actually do directly. And here I have two concrete ideas to put to you. One is that governments … The UK government could say, we’re going to issue all gilt-edged securities now in purely digital native form only, and that would pretty much instantly create a large liquid benchmark token market. My second idea is, one of the obstacles to rapid growth in digital assets is this hugely inefficient and highly intermediated post trade infrastructure you have in the securities, and to a lesser extent, in the payments markets as well. What if, and my experience here is largely based on the securities markets, if mandatory buy-ins were imposed? So if you fail to settle a securities trade, actually you were mandatorily bought in, and the cost of that is potentially open-ended. So it’s a very serious cost, much more serious than the financial penalties currently being imposed on organisations that fail to settle. Would you support government looking to kick-start progress by taking steps like that, by setting an example, and by imposing penalties on the inefficient? Is that a way forward? Would you like to see governments acting directly in that sort of way?
17:39 Gilbert Verdian: I think there’s been, in technology specifically, there’s been many instances where government intervention and action has really fostered a whole generation of growth within that technology sector. I mean, we saw that in 1983 with the adoption of the Internet. There were many competing network protocols, local area and wider network protocols. It was only when the Department of Defense stepped in and said, `We’re all going to be using TCP/IP and the cut-off date is 1 January 1983,’ then everyone had to follow suit, because otherwise you cannot work with government if you’re not following the same protocol, if you’re not implementing the same protocol. So I think we’ve seen that work quite a few times. What the UK is quite good in doing already is we’ve been able to start changing legislation and rules. And if you look at the listing rules that are changing for the London Stock Exchange, making it easier to list, that’s quite positive. In the budget, two weeks ago, the Chancellor [of the Exchequer] announced that they’re allowing ISAs [Individual Savings Accounts] for UK plc shares. That’s another great way to foster and encourage liquidity and growth in that sector. It makes sense for, if we are transitioning to a digital finance economy, it makes sense for the government to enact that in some form of action. Gilts [gilt-edged securities or government bonds] have been very interesting. I think it’s a matter of time before Treasuries and gilts are tokenised and there’s tests that people have done in terms of experiments on if that’s possible. It very much is but if the original issuance is done in a tokenised form by government, that’s a great way to trickle down into the rest of the economy, because that’s how it’s stored, that’s how it’s traded, and that’s how it’s transacted from a settlement perspective. And then having that trickle-down effect will also allow us to consider T-Zero [T+0, or settlement on the same day as the trade takes place] settlement, because then you’ve got assets that are very liquid, that are on-chain from a custody and ownership perspective. It’s very clear. And then you marry that with tokenised commercial bank money for settlement, and then you’ve got a leapfrog from T+3 [trade date plus three days] to T-Zero, almost real-time, and all the processes can be embedded within that transaction. So it will be a catalyst into the system, starting from the top down. So it’s yet to be seen. I think there’s enormous opportunity to look at the capital markets in a new way. And if there’s a top-down action that can trickle into the rest of the market, it should be considered.