Marlene Ronstedt


New Protocols for old Asset Classes

A conversation with Consensys’ founder and CEO Joe Lubin and the Consensys CSO Sam Cassatt

It seems like a no brainer that, eventually, financial assets will become fully digitalized. Automation will significantly speed up bureaucratic processes which are done today by office clerks. Blockchain protocols will step into their place to govern a financial system not too dissimlar from today’s. Joe Lubin and Sam Cassat talk about how such a new infrastructure could look like.

Marlene: Initial Coin Offerings (ICOs) have become a popular way for blockchain startups to pull off huge financing rounds with little effort compared to traditional VC funding. Companies issue their own utility token which investors buy for future services. In the eyes of the SEC, however, coins like this are securities. How are blockchain companies changing their strategy?

Sam: Today we see blockchain companies combining what has happened technologically and in funding. They are then trying to apply it to the regulatory regime in the US. The result of that has been a growth in the infrastructure for security tokens. For example, Goldman Sachs backed Circle which bought Poloniex. Part of the impetus for the sale was that they would take Poloniex, a crypto exchange and turn it into a regulated securities exchange, an ATS. There are a number of parties moving along that dimension which are trying to create ATSs to prepare technologically and infrastructurally for this coming regulatory regime. It remains to be seen how the regulatory regime and the technological infrastructure will interact.

Marlene: You just mentioned that Goldman Sachs backed Circle. And they are by far not the only institutional investors coming into the space. How are companies preparing for this new class of investors?

Sam: There’s a lot of core fintech that’s being built to prepare exactly for this. We are working on a product called Trustology which is a custody product. Coinbase launched their custody product a few weeks ago. We need serious institutional grade custodians in order for the market to function well and for institutional players to uphold their mandate, their customers and their regulators.

Joe: We are starting to see the advent of financial industry infrastructure. This new world of decentralized computers will have companies in it, the same kind of companies that are providing resources to the legacy economy. Those organizations will need the same financial instruments that enable the old organizations to operate financially and efficiently. For example, we will need derivatives, futures and options. And we are already seeing a lot of that being built.

Marlene: In the coming years we will see not only classic financial products being tokenized, but also all types of other assets. What else will become blockchainyfied?

Sam: In any case where there is an asset class, that is relatively illiquid, difficult and slow to administrate normally with pieces of paper, like real estate. The fluidity and the ease of use have enabled new pools of liquidity. Our platform Meridio is a real estate tokenization platform. You will start seeing a lot of things like that to become tokenized. For example, most people are not able to buy a 100 million dollar project -

Marlene: But through tokenization they can buy a fraction of it.

Sam: Exactly.

Marlene: What are some other benefits of tokenizing assets?

Joe: Through tokenization delays are getting squeezed out of economic activities. All elements of our society are currently realized in analogue form. For example, my driver’s license or my passport are tokens that reference into a government maintained ledger. Or consider laws, we have a subjective, non-guaranteed enforcement of those systems. Already today, companies are building those elements in a digital form. Beyond cryptocurrencies, we build identity, reputation, legally enforceable agreements and government certificates. All natively digital. With those tools in place clearing and settlement happens in the instance of seconds. Regulators could add some delays if they want to. Once you’ve done that, you can stack your value creation events much more closely in time. Additionally, a society would benefit from guaranteed automated trust and guaranteed execution of rule-based systems.

Sam: Financial and legal behavior of businesses at the highest levels move at the speed of boardrooms and court systems. The ability of a value generating mechanism is limited by human speed and paper. Through automation of those processes, we end up with entities which are able to articulate themselves at a much faster speed. For example, the reason why we have money is because it is a crude way to reduce friction in economic interactions. I don’t want to carry my ten cows around with me, so humans built an abstraction on top of it. It is a physically slow, human-sized, and human speed abstraction. What happens when we have digital speed?

Marlene: So what do regulators say about all this?

Joe: We’ve been lucky to get called in by regulators to share our understanding of what this new technology is. We helped to enable the different, very smart people in those agencies understand that blockchain may bring a fundamentally new construct and it may be possible to use existing rules to assess it, but it may need a new way of organizing collective action. Director Hinman of the SEC for corporate finance said that he felt Ether was no security. He shares an understanding that those new networks, business models, protocol-based platforms are not necessarily securities.

Sam: I think what was really encouraging about what director Hinman said, was not only that he recognized that there are different types of business models, or different types of decentralization that might influence the way they interpret securities. But, that Hinman simultaneously recognizes that there is a new class of business models emerging. and they don’t want to stifle that. The fact that they are deeply integrating that into the way they are viewing their stewardship of our economy and securities frameworks, that’s really encouraging.

Marlene: It seems like the key here is rather digitalization and automation than decentralization. Why do we need blockchain for these processes?

Joe: There are lots of different use cases in the world, many are best architected in a centralized fashion. Some will benefit from partial decentralization. If you have a consortium of corporations inside a mesh, it makes sense to build shared trustworthy infrastructure if everybody has a node on that network. That’s a viable architecture for a consortium.

Sam: I think you can analogize this to locally located servers versus the cloud. It took a long time for CIOs to become comfortable with the cloud. They had to understand why it is valuable to have their systems open to the internet, architected as a walled garden. In case of blockchain, the motivation has something to do with privacy and security.

We are now moving up the levels of abstraction on top of the Etheruem blockchain that has higher trust, higher security and is maybe a bit slower than some other architectures you can have. We are now moving to, what people call, layer two which has a higher level of abstraction.

Marlene: So it depends on the use case.

Sam: Yes, so what we see what is happening right now is an emergence of a bunch of things sitting at this layer two level of abstraction. Like plasma or the Lumen Networks which is aiming at social networks and games, that have different trust models, different consensus models, that achieve extremely high throughput.

Those tradeoffs of privacy and scalability will tilt less towards using an internalized consortium system, and more towards a public system. You can have network effects which proof quite often that. I think we are seeing a trend in this direction as well. The final part, the security part, is really when people become comfortable enough — in the 90ies credit card companies wouldn’t even let you do transactions online and now we have 100k transactions per second on Black Friday.

Joe: There are lots of good reasons to have partially decentralized implementations of systems. But as we do move towards a world where we are tokenizing everything, a huge number of deep illiquid assets will come online. Sophisticated traders have been attracted to those markets and they are going to be looking for ways to manipulate those markets. In such a case you don’t want a network of 21 nodes where everyone knows each other. The participants can be bribed or censored. But not in a radically decentralized trust architecture. Radical decentralization will, I think, subserve more use cases in time.

Marlene: But doesn’t this make the whole process more complicated? How will people spend, store and trade all those different tokens?

Joe: Currently, we have all those separate, siloed markets, to trade equities against money. We won’t be able to trade all those different assets against one another. In a world in which you are tokenizing everything from kilowatt hours to bonds, to beyonce tickets one natural thing to ask is: how do we deal effectively with those tokens? We could have a George Costanza wallet, in which you carry around your different tokens and coins.

Marlene: Which makes it complicated

Joe: Exactly. I think we are going to move to having wallets, and points of sale, that enable us to prioritize tokens, in the order we want to get rid of them. As a vendor, you can prioritize the order in which you want to accept tokens. And Sam can run his exchange service so that if I’m trying to buy something from you and my agent can’t get this transaction done via your agent, he can make a little cut and facilitate that exchange with the right tokens. So it becomes again, just a simple act of buying and selling.

Me: At the end of the day the average user is probably not even going to realize what they are doing there.

Joe: All through the day.

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