DeFi's Breathtaking Rise, Neobanks, and Zilliqa's Whiskey Tokens
Off The Blocks, Vol 127, Wednesday, February 3, 2021
My work focuses on creating ecosystems for tech adoption. At Proteum, we connect the dots on things that matter in an increasingly interconnected and decentralized world - physical, financial, and digital.
The Breathtaking Rise of DeFi
News cycles in the last 10 days have been awash with the rollercoaster trading activity in some publicly traded companies in the USA - Gamestop, AMC, Blackberry, Nokia, Bed Bath & Beyond etc. The frenzy briefly slipped into commodities such as silver, and it seemed that all things sold short in the markets would soar like a phoenix. The starting narrative was that a bunch of retail traders on Reddit saw an opportunity where $GME was subject to the tyranny of large hedge funds, who had large short positions in the stock. Changing the game on the ‘suits’ was an opportunity that the Redditors, armed with Robinhood accounts, could not resist and for good measure did not. This was not about fundamentals, but about going against the grain and showing that the old school bankers and hedge fund managers had much to learn from the wisdom of the crowds. Within 10 days, the price of $GME went from $35 to a peak of $483. Melvin Capital, the hedge fund that bet against $GME lost more than 50% in January and closed shop.
Robinhood, as a free trading platform heavily favored by the digital-first generation, has borne the brunt of the blame for its practices and role in the episode. As the price of $GME skyrocketed, the regulators at National Securities Clearing Corporation (NSCC) demanded a $3B increase in daily collateral - concerned that the clearinghouse could be left holding the bag in case the price of $GME and other securities cratered. In the US, it takes 2 days to settle stock trades. As a result, Robinhood had to throttle trading activity in these ‘volatile’ stocks, drawing the ire of traders, regulators, and politicians alike. As the dust starts to settle, it will be important to look at the model of the NSCC and its parent company Depository Trust and Clearing Corporation (DTCC). DTCC centralizes the settlement of all stocks and bonds and is an “approved monopoly with unmatched scale”.
Ironically, this collective power of the crowds has already fueled an alternative to Wall Street in the form of Decentralized Finance or DeFi. In many ways, DeFi is the Wall Street for an alternative financial system, that is global and powered by rapid innovation. The embers from the crypto market crash in 2018 are beginning to light up an even bigger fire than before. The crossover from traditional finance to DeFi is happening at a breathtaking pace. It is estimated that about $30B is locked up in smart contracts today - a 60x increase since March 2020.
This locked-up value highlights innovation at scale, powered by smaller ecosystems each focused on creating a specific product focused on privacy, payments, insurance, remittance, commodities, etc. Each one of these ecosystems is powered by its own asset and is independently turning the vertically integrated model of traditional finance upside down and decentralizing it. In turn, DeFi applications and platforms are permissionless, transparent, and accessible to anybody with the right blockchain wallet. The applications range from simple loans (Maker) to complex derivatives (Synthetix), and decentralized exchanges (Uniswap), dominated mostly by the Ethereum platform. Uniswap, a decentralized exchange that facilitates automated transactions between cryptocurrency tokens on the Ethereum blockchain through the use of smart contracts, facilitated $30B in trade volume just for January 2021 and over $50B since its launch earlier in 2020. Potentially, a Uniswap like trade settlement in real-time for the $GME shares could have averted the moment of crisis for applications like Robinhood.
If DeFi applications are to scale and go mainstream, it will likely require wholehearted participation from the DTCC and other financial institutions. Admittedly, the interoperability of these applications is low at the moment, and that can hinder scalability. While Ethereum is dominant, other platforms like Cardano, Tezos, and Hyperledger have their own benefits and remain entirely unbridged ecosystems. The financial world is intricately interconnected and it requires data to be shared at a massive scale. To move between different platforms requires data transparency and transferability across these chains. From a consumer perspective, on and off-ramps and consistency in transaction costs for the not so early adopters are key challenges to bring them into the fold of DeFi applications. Indeed, this morning Visa announced that it is partnering with banks to provide an on-ramp for banking customers to gain exposure to Bitcoin.
The silver lining is that these developments are not lost to the DTCC. Like all large institutions, they have displayed a lot of inertia and have been reluctant to lead the transformation. However, in summer 2020, DTCC did outline their thinking about digital assets and playing a role with DeFi. DTCC’s Project Whitney, was a prototype digital infrastructure on Ethereum for issuer services across primary and secondary private markets.
One of the objectives was to determine how the combination of off-chain compliance enforcement of eligible security tokens and an authoritative stock record would bring legitimacy to transactions on a public blockchain.
Regulatory compliance will play a big role in ushering in this transformation and may bring in additional challenges that may not be well determined or understood yet. For now, it does seem that DeFi will be an increasingly important component for traditional financial institutions. Tribalism, for both sides, is counterproductive to the goal of servicing the end-users and I fully expect them to embrace the innovation and market opportunities that can be tapped through mutual collaboration.
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Forbes has a great story on neobanks aka challenger banks - fintech startups that are giving traditional banks a run for their money. As estimated by Cornerstone Advisors and Strategy Corps about 12M US consumers are customers of Chime - an online bank. Across all US consumers, 11% consider a digital bank their primary institution. The digital banks have, in the aggregate, 17% share of secondary accounts and 30% of consumers’ third accounts. Traditional banks were the big losers in 2020. Most consumers are looking for a primary bank that can help them improve their financial health. Significantly, they don’t perceive that their banks have the impact on their financial health and performance to the extent that Chime customers do, a big reason for Chime’s success.
Ray Dalio, founder, Bridgewater Associates, recently penned an article: What I Think of Bitcoin. It is backed by tons of good research and makes for a good read. He says “Bitcoin may look especially attractive to some investors now for the same reasons that gold has been supported in the last few years. Neither gold nor Bitcoin pay a yield on an outright basis, but this matters little when yields on other assets have collapsed.” He is correct to point out that the asset is volatile and that it’s “future adoption by large institutional investors will hinge on regulation”. However, I think it is a bit naive to think that Bitcoin (particularly) is not supply constrained, or that other digital currencies can be “Bitcoin-like” to compete against it meaningfully. Nevertheless, read it here to interpret it yourself.
News From The World This Week
Japan to Have Blockchain-Based Stock Exchange in 2022: SBI Holdings has reportedly partnered with Sumitomo Mitsui Financial Group (SMFG) to launch a digital stock exchange slated for spring 2022. SBI and SMFG are expected to launch the platform in Osaka to compete against the Tokyo Stock Exchange (TSE). The news comes after the TSE was criticized for a major hardware glitch in September caused the worst outage ever for the world's third-largest equity market. The ODX is expected to start trading digital securities in 2023. More here.
IBM Blockchain Is a Shell of Its Former Self After Revenue Misses: IBM has cut its blockchain team down to almost nothing, according to four people familiar with the situation. This is not surprising. Back when we often met their teams at conferences, it was clear that they looked at blockchain as a ‘database’ and placed little emphasis on Bitcoin or the wider crypto economy. While they did launch an early version of a stablecoin, the efforts apparently went nowhere. The RedHat acquisition could have been a major boost to their efforts, but they always seemed to be in it for the wrong reasons. More here.
Zilliqa Brings Whiskey To the Blockchain: Zilliqa announces yet another use case. The sharding-based blockchain platform will help in the digital representation of exceptional single-malt Scotch whiskey known as “Casks of Distinction.” Firstly, Zilliqa will be tokenizing the “Casks of Distinction” as an asset-backed security. The blockchain platform will provide interested investors with these securities (the securities are backed by the whiskey). Once matured (that is, after bottling), the securities can then be easily traded on the HGX exchange. Investors have the option of trading the securities for cash or receiving a bottle of whiskey for every security owned. More here.
Proteum is a global investment and advisory firm that works with public, private, and start-up companies to help them create ecosystems for adoption. We help companies navigate tech, business, and regulatory challenges across markets.