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Focus on the Basics of Crypto – Not the Cryptocurrency Casino

By Whit Knapp

The global financial system staggered from one major crisis to another in 2022. Starting in May with the collapse of the Terra “Stablecoin,” 2022 saw over $1 trillion of value extinguished with the collapse of Three Arrows Capital (3AC), Babel, BlockFi, Voyager Digital, and Celsius Network, culminating in the $8 billion collapse of FTX in December. The year 2023 started off with the collapse of Genesis Global Capital owned by the respected Digital Currency Group. The chaos in the cryptocurrency world then spilled over into the US banking system, beginning with bank runs on Silvergate Bank and Signature Bank, both gateway banks for the cryptocurrency world into the fiat world. Silicon Valley Bank (SVB), the principal crypto banker in the US, collapsed shortly thereafter. Both Signature Bank and SVB were put to bankruptcy when a combination of social media and internet banking facilitated bank runs draining a major volume of their deposits in just hours. The final chapter of this chaos came with the collapse and JPMorgan’s takeover of First Republic Bank. In addition to the instability injected into the financial system from the cryptocurrency world, the collapse of these banks was the result of failures by multiple parties: greed and gross mismanagement by the SVB executives, dereliction of fiduciary oversight duties by the SVB board of directors, the lack of timely and appropriate action by the responsible regulators (despite known prudential issues at the banks involved), and failure of auditors and rating agencies. In short, it was a perfect storm of market forces and key players’ failure to fulfill well-established responsibilities.

Now, mid-year 2023, another seismic disruption has hit the financial world with the SEC bringing charges against Binance and Coinbase, the two major pillars of the cryptocurrency world. Perhaps the most damaging result of these serial disasters from the cryptocurrency world has been the dark cloud it has cast over real-world assets, DLT (Digital Ledger Technology), and the associated digital assets which comprise real value use cases for the emerging digital age.

Under the best of circumstances, there has always been a lack of understanding of the fundamentals surrounding the financial system, and the operations of its foundational payment system. As stated in The Economist, “Payment is one of the most fundamental economic activities.” The lack of understanding of payment fundamentals has gone into overdrive by conflation with the cryptocurrency world. The cryptocurrency world made its first major entrance onto the world’s stage with the publication of Satoshi Nakamoto’s white paper in December of 2008. To understand the real intent of Satoshi’s work, one needs to read carefully the Title, the first sentence of the Abstract, and the Introduction to the white paper which introduces Bitcoin.

Title: Bitcoin: A Peer-to-Peer Electronic Cash System.

Abstract: A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another, without going through a financial institution.
Introduction: Commerce on the Internet has come to rely almost exclusively on financial institutions, serving as third parties to process electronic payments.

What Satoshi set out to accomplish was to move payments into the digital age by creating the ability to move value/money on the internet as easily as moving information. The objective was to create the new infrastructure/rails for payments, i.e. movement of money, which would update the centuries-old legacy systems which had become complex, costly, slow, insecure, and open to rent seekers taking advantage of the role of “trusted” intermediaries, a role which was necessary in the legacy system to solve the critical double spend issue, which had remained unresolved before the publication of the white paper.

At its base, secured by cryptography, Satoshi’s Bitcoin system provided the basics for a new payment system in the emerging digital internet-based world. In a careful reading of Satoshi’s entire whitepaper there is no suggestion of using bitcoin to hide transactions. Section 10 speaks of privacy, not secrecy, and refers to anonymous information as the same as that in existing stock exchange transactions.

Nowhere is there any suggestion of replacing existing global fiat currencies with bitcoin.
The global explosion of cryptocurrencies (there are 22,932 at the current count according to CoinMarketCap) is the result of “smart money” traders hijacking Satoshi’s basic concept to create a casino of cryptocurrency speculation where cryptocurrencies are bought and sold with an exchange rate based on “greater fool” pricing. As in all casinos, the house wins, and J.Q Public loses. When an onslaught of fraud ambushed the market, FTX being the ultimate and most notable example, the house finally lost. The authors of this debacle are now under criminal indictment for fraud and an array of financial crimes; if convicted, they face significant jail time.

Real-word finance and real-world assets are now having to bear the burden of the catastrophes created by “smart money,” which not only divert attention from the underlying basic value of the blockchain and digital assets but casts a miasma over the entire DLT and digital asset world. The moment the term blockchain or crypto enters a discussion, the majority of the participants lapse into thinking of the 22,000 plus cryptocurrencies, which are simply speculative vehicles with no basic value other than that established by the “greater fool” theory of pricing. Lost in the conversation is the real-world role and value of DLT, where the blockchain is its centerpiece and bitcoin its enabling native token. A distributed ledger with transactions immutably inscribed and cryptographically secured by the operation of a native token or currency provides a secure transmission of value from one party to another and facilitates the safe movement of value/money on the internet–the financial rails of the new digital age.
The presence of bad actors, hacks, rug pulls, fraud and nefarious illegal uses of cryptocurrencies make them unfit for enterprise use. Responsible executives do not want to waste time and resources exploring this space, even for promising real-world operational and real-world asset solutions. Opportunities for value-added innovation are all but drowned out.

It is critical to shift the dialogue from gloom and doom around the prospects for blockchain and digital assets to look at real-world use cases of significant value driven by new legal and regulatory based crypto technology. For simplicity, we will look at just three cases. It is, however, important to recognize that these examples have been drawn from an extensive list of candidates and historic leaders in this space. In this fine tuning, it would be remiss not to acknowledge perhaps the most notable contributor to the advance of digital financial services, R3, whose innovative technology has been directed by Richard Gendal Brown, one of the earliest pioneers of real-world use cases.

The candidates below have been chosen to represent three different pillars of the new technology; first, the foundation or underpinning for new products, the blockchain; second, products which can be developed on the blockchain; and third, an institution providing services for the different products emerging from the new technology.

Distributed ledger technology – DLT – has transported into the digital age the foundational base of finance, the double ledger, first introduced by the Medici bankers in Italy in the 15th century. Across distributed ledgers, supported by cryptography, digital assets, often in tokenized form, can be moved from one party to another without the need for a third-party or “trusted” intermediary, i.e., the core of Satoshi Nakamoto ‘s original work. The blockchain, the most frequently used expression of DLT, is used to secure the movement of value by cryptographically secured coins, the original coin being Satoshi’s bitcoin. As previously highlighted, Satoshi ‘s bitcoin has been hijacked for a tsunami of speculative purposes. With its swings in value, increasingly high fees and, with the advent of the BRC 120 token on top of the BTC, slowing transaction speeds, bitcoin is not fit for enterprise use.

Understanding the need for a blockchain dedicated to enterprise use, Figure Technologies and the Provenance Blockchain Foundation created a blockchain dedicated to the regulated financial services industry, a digital factory for finance. Provenance Blockchain moves value across its ledgers secured by its native coin, Hash. Provenance Blockchain Foundation is led by Morgan McKenney, a skilled transaction banker with years of experience with real world use cases. The Foundation’s role and purpose is to catalyze the growth and adoption of the chain and to support its development and security.

Combining real world asset experience with innovative regulations-based technology, Provenance Blockchain is configured not only for today’s needs but positioned to meet the evolving future needs. Provenance Blockchain is a decentralized, permissionless blockchain leveraging Cosmos SDKs and IBC for interoperability. Where needed to preserve confidentiality of specific transactional business information, Provenance Blockchain provides Zones. Zones, a key part of Provenance Blockchain, are private permissioned environments within the Provenance Blockchain Network, spokes off its Mainnet, which is public and decentralized. Together, Zones and the Mainnet make up the Network. With this configuration Zones allow a user to preserve confidentiality by navigating between permissioned and permissionless Provenance Blockchains. The merging of permissionless and permissioned blockchains is inevitable at some point in the future. Provenance Blockchain has future-proofed its offering in anticipation of this inevitability. Providence Blockchain is an excellent example of providing products for today, while planning for products of the future.

The success of the Provenance Blockchain is seen in its growing role as a leading public blockchain for financial services with an ecosystem of nearly $8bn in real-world financial asset value locked on-chain, making it the second largest blockchain after Ethereum. Further, the Provenance Blockchain global ecosystem consists of over 60 financial institutions, and more than $12bn in supported transactions. Financial assets currently live include mortgages, home equity lines of credit (HELOCs), private equity securities, private market funds, and payments.

A deep dive into both Figure and Provenance Blockchain is instructive and provides excellent examples of successful real world use cases which are too often overlooked in the cacophony of voices spouting misinformation and misunderstanding of the genuine meaning and value of crypto.
For an example of real-world paper-based products transformed into digitally native financial assets built on a blockchain, we look at Obligate, a Zürich-based, award-winning fintech (in the interest of full disclosure, I serve as an advisor to Obligate). Obligate has used its legal and regulatory-based tech to create in digital format two classic capital market instruments, bonds, and commercial paper. These digitalized instruments enable efficiency, security and cost-effective issuance which historically has been complex, time-consuming, and costly, previously making these instruments available only to large size issuers and institutional investors.

Both borrowers and investors benefit from the new technology. With the Obligate decentralized finance platform, companies can issue on-chain bonds and commercial paper obtaining funding from a diverse range of investors. This comes at a significant reduction in cost and time of traditional offerings but with the same regulatory certainty, as the instruments are globally enforceable, regulated debt securities.
At the same time, investors obtain access to a wide range of regulated digital debt assets which can be secured with collateral such as receivables. Utilizing smart contracts and tokenization in place of intermediaries such as paying and issuer agents, Obligate is able to reduce the costs associated with a bond issuance by 80% and reduce the time needed for an issuance from weeks to hours. A recently completed transaction is a real-world example of the innovative power of Obligate’s regulations based technology.

Despite all the noise from the crypto bros about the impending demise of banks, leading banks, particularly JPMorgan through its Onyx group, are taking first steps to position themselves for the digital world. Additionally, a new bank, Anchorage Digital based in San Francisco has become an important player fully dedicated to the emerging digital asset world. In January 2021 Anchorage Trust Company, a South Dakota chartered trust company, become Anchorage Digital Bank the first crypto-native service provider to be fully OCC regulated. As a regulated national bank, Anchorage Digital offers a crypto platform providing institutions with regulated and integrated digital asset financial services and infrastructure solutions.

As traditional banks and financial providers begin offering digital products and services, they need legally established and regulated entities to provide emerging digital services. Custody is perhaps the best example of a traditional service offered to meet crypto product needs. Segregated, secure, safe, and integrated custody is an optimal foundation requirement for crypto participation. To meet these needs, Anchorage Digital has focused on partnering with both crypto-native and traditional financial services market participants to provide custody as a core part of its regulated digital asset services and infrastructure. A mark of acceptance was seen when Anchorage Digital was contracted by the U.S. Department of Justice to be the custodian for all digital assets seized or forfeited in criminal cases.
It is important that we appreciate the fundamental misconception that the new crypto financial system is replacing traditional financial products and services. The reality is that basic financial operations continue as they have for hundreds of years. It is only how these products and services are provided which is changing with the advent of the digital financial age.

While the adoption of DLT/digital asset technology by traditional banks and financial intermediaries is slow and still in its early years, the technology continues to develop at warp speed. Hundreds of companies such as those identified above are dedicating significant resources and intellectual property to support real-world products and real-world assets. It is instructive that the “problems” of privacy, interoperability and scalability ascribed to the introduction of the CBDC, one of the most promising solutions to the historically low, inefficient, and costly cross border payments system, are being identified and solutions developed by the new tech community. At a time when technology and innovation are transforming the financial services industry at an exponential rate, it is crucial that the financial press and blogosphere shift attention away from the speculative cryptocurrency casino to focus on real-world crypto and the contributions that it is making to real-world products and services. To this end, it is also critical that the nomenclature around the new technology be better defined. As mentioned earlier, the words blockchain and crypto set off a flurry of disconnected dialog. At this moment, it should be clear that crypto is a separate and poorly defined category. It is not just cryptocurrency.

In closing, it is imperative that the U.S. regulatory community and other government supervisory entities, understand exactly what the new technology is, and to distinguish it from the speculative cryptocurrency casino, home to activities which one day may have value, but today is only serving to cast a negative light and distract attention from real-world value-added products and services. The regulatory and supervisory world must support the multiple real-world business cases which are made possible by the new crypto technology. It is critical to allow DLT/digital assets, the heart of crypto, to design the infrastructure for the modern rails of the legacy operations of transaction banking underpinned by payments.

 
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