Mind the gap: Bridging the divide between DeFi and CeFi to grow yield

Transcript

Angie Lau: We often talk about value, but does it make sense that to achieve it, you pay for it by giving away double-digit yields to consumers? There are a lot of questions after the implosion of Terra and its governance token, LUNA, that led to fortunes being lost and plenty of name-calling for the crypto industry. But the world of digital currencies holds on strong as market participants try to make sense of the next steps.

Welcome to Word on the Block, the series that takes a deeper dive into blockchain and the emerging technologies that shape our world at the intersection of business, politics and economy. It’s what we cover right here on Forkast. I’m Editor-in-Chief Angie Lau. Well, today we’re in conversation with Phillip Gillespie, CEO of B2C2. This is a platform that’s looking to bridge the gap between cryptocurrencies and traditional finance by providing crypto liquidity to institutions and more. Phil, it’s great to have you.

Phillip Gillespie: Happy to be here, Angie. Thank you very much. 

Lau: We talk about this space quite often in the context of the technology, the innovation, but now I think we’ve gotten to a place where it’s maturing, and now institutional traditional finance players are looking in the space (in a) much more detailed (way) … more clearly. They want some action. How are you seeing the maturity of the space, and how are you positioning at B2C2?

Gillespie: Sure. So maybe it’s good to start with how B2C2 evolved, because I think it really tells how the industry itself evolved. When I joined B2C2 in 2017, I remember the founder of B2C2, Max Boonen — he was also a Goldman Sachs alumni, and I was working in Goldman Sachs in London … had been doing kind of overseeing systematic trading in FX — and he came to me and he said, ‘Would you like to join crypto?’ And this was again, 2017. Bitcoin was, I think, trading at US$3,000 to US$4,000 a coin. And I told him, ‘I don’t know about this market, this looks pretty crazy.’

And this is really interesting. So 2017, after I spoke to Max, I had to go to Japan to have a conference with all these Asian institutional clients representing Goldman Sachs to talk about FX. And at that conference, all the clients came up to me after the conference and said, ‘Hey, we’ve heard enough about dollar-yen. We’ve heard enough about euro. Can we please talk about Bitcoin?’ Twenty-seventeen. And that’s when I realized, ‘Wow, there’s a real demand out there.’ And there I was thinking, ‘Ok, this could just be a bubble. This could be a bit of a hype.’ But I realized that all of these institutions are already looking at it.

So I went back to London, told Max, ‘Hey, this is a great opportunity. And B2C2 should really build this industry out, and really bridge the gap for all these institutions on the sidelines who are looking to come in.’ And that was the start. So, since then, really, the market when we started in 2018 was still very, very young. Even the know-your-customer, anti-money laundering, everything was just so kind of patchy. But the regulations started coming in, the product started becoming more and more sophisticated.

And we’re at a turning point now where I think the institutions are really coming in, and they’re starting out with the products that they’re familiar with, like derivatives. They’re familiar with a lot of derivatives products. You don’t have to touch the spot underlying products, so it’s easier for them to come in, in order to access the yield, in order to access synthetic positions. And that’s kind of where we’ve evolved in the last three or four years. But I have to say, it’s been really fast and also very exciting. I mean, every month it seems like it’s new innovations. We’re making another step forward and we’re really happy to be part of that whole evolution.

Lau: Yeah, and let’s be candid, because right now we’re seemingly at the cusp of the next crypto winter. The market looks very different, good and bad. But let’s talk about that part … Do you still see that demand, and do you still see that appetite from institutionals coming into the space despite what we’re seeing right now?

Gillespie: So, in 2018, the whole ecosystem was driven by retail kind of speculation. You had a lot of people who were buying and selling on crypto exchanges. And once the market came down, people were burned and just said, ‘Ok, I’ve had enough of this crypto stuff.’ That was 2018. What’s different now?

So, obviously you still have retail speculation. That still exists, but it’s a lower share of the pie. But what’s more important is that now you have a lot of the regulatory framework. So, for example, in Japan right now we’re pushing this new product called DDAI. This is a yield enhancement product which is safe, regulated, and it’s completely different from DeFi. And three or four years ago, the regulatory landscape wasn’t clear. The institutions then didn’t really know, ‘Can we offer this product? Can we not?’ Now, especially in Japan with the Financial Services Agency, they’re warming up to the idea and they’ve approved with some of the counterparties to go ahead and start trading these products.

It’s a big difference. So, now I can go up to an institution like a proper, proper financial institution and say, ‘Hey, we have this product that’s approved by a regulator, that we’re offering to certain large institutional clients. Would you like to trade this product in order to enhance your yield on your underlying crypto?’

Lau: How big is that yield? We heard from Anchor it was 20% APR, and that was the Terra and LUNA debacle. How sustainable are these yields? So, first of all, what is the yield that you’re offering to institutions? And how sustainable is that?

Gillespie: Right. So we don’t trade DeFi, so we have nothing to do with DeFi. We’re constantly in the centralized finance world. And the way these products work is completely different from a DeFi protocol. What you’re essentially doing is it’s a covered call, like imagine you own a stock. This can be any instrument, not necessarily a crypto. Now, if you sell a call option on top, it’s a covered call position. So you set your strike and you gain a little bit of premium and you basically enhance your yield, while you might limit your upside. But at the same time, if you don’t think the market’s really going anywhere at the moment, like it is in crypto right now because the speculative volumes are down, it’s a great strategy to enhance your yield.

I think, for traditional financial institutions, it clicks immediately. They’re like, ‘Oh, great. So now you’re able to finally offer a dual-currency deposit, a covered call. All of these things now are approved and ready to go.’ The pure retail guys have a little bit of trouble understanding the crypto world because they’re like, ‘Hey, is this DeFi? What’s the protocol?’ And it’s like, ‘No, no, no. All we’re doing is we’re selling options.’ And it’s fully collateralized because you own the underlying, as well.

Lau: I think the difference is you’re doing it for institutionals, but for retail investors, DeFi is really a basic way in which they can function like their own banks. But yield is absolutely, to your point, a real tailwind for a lot of retail investors wanting to get into DeFi. But I think we’re starting to see the bloom off the rose a little bit. That play’s wilting, obviously, in current market conditions. But curious … What is the yield that you’re offering institutionals.

Gillespie: Well, I don’t know if we can go specifically into the numbers, but it’s a lot higher than say, 20%, 30%. I mean, it depends on where the implied volatility is trading. And, as you can imagine, the implied vol in the crypto space is very high. So you’re basically gaining the premium in response to that. So as long as the volatility is high and the premium itself is extremely high, and it’s much higher than, yeah.

Lau: So that’s, I mean, above 40s, very high already. So I can only imagine you’re close to the halfway mark. But for institutionals, is that attractive enough against current market conditions? Do they get the product? Do they want in? Because if they want in, they’ve got to buy Bitcoin or they’ve got to buy the underlying cryptocurrency. Do you see that appetite, still?

Gillespie: So, if we look at the last 10 years, a lot of the crypto activity was driven by crypto exchanges. Ten years ago, five years ago. And what we think is going to happen in the next 10 years is that a lot of the activity is going to be driven by OTC. What I mean here is, imagine crypto goes all over the place — everybody’s trading it, it’s on your phone, everyone’s accessing it all the time. Wouldn’t you rather be able to transact in crypto seamlessly through your local brokerage, which also transacts in equity, FX, everything else? Why does only crypto have to be on a crypto exchange? Well, it doesn’t. And that’s one of the things that we’re doing at B2C2. We’re creating the product accessibility, bridging the gap between the ecosystem and institutions.

So, a lot of these institutions, for example, in Japan, a lot of our clients are listed companies. They’re the chat application LINE — Naver LINE. You have GMO (Payment Gateway), Rakuten, our parent company, SBI. These are really large parent companies that are listed on the Tokyo Stock Exchange, and when they want to provide a yield enhancement product, they can’t just say, ‘Hey, here’s DeFi.’ Because they’re listed companies, they have a lot of reporting obligations.

Now, they have millions and millions of users that they want to provide the service to, so they come to B2C2 and say, ‘Hey, it’s great with all the stuff that’s happening in DeFi. We can’t access it. Can you come up with a way where we can provide yield enhancement products in a safe and reliable way which is approved by a local regulator and doesn’t cause any issue for a publicly traded company?’ And we say, ‘Yeah, sure, of course.’ You can do a dual-currency deposit-type product. We call it DDAI on our side. And we can actually trade with options combined and create this enhanced yield.

Lau: So, I hear what you’re saying that the products are expanding. And that’s really the signal that you’re seeing, that we’re watching. It’s starting to move about and be integrated in larger, more mature portfolio thinking. Having said that, are institutionals still wanting these products?

Gillespie: So, from when I joined in 2017 to now, the institutional participation is definitely increasing. But let’s take a second to define who these institutions are. So, you have these financial institutions that are like SBI, that are looking to provide different financial services to their end users. And ultimately you could say, ‘Oh, well, that’s retail. Or it’s a limited kind of user base.’ And maybe that’s true. But then you start having more and more of these hedge fund types, the family offices and everybody else who are now coming into this market, and we’re still seeing that side expand.

The big mystery, still, is the corporate side — corporate treasury, the companies saying, ‘Ok, why don’t we actually have some exposure to crypto?’ Now on that side, the biggest blocker is how these assets are treated from an accounting perspective, from a tax perspective. There’s so much unclarity. But the interest is picking up year on year, and I think having these extra products, like yield enhancement products, just helps even further for a lot of these companies to come into the space.

Lau: You just launched DDAI, and you shared what you’re doing. But you’re based in Japan. And why are you based in Japan, looking to the world here? What’s different about Japan that allows you to really grow the business there?

Gillespie: I think there’s two big reasons, for myself. One is that in terms of regulation and having the rules in place, because we service institutions. Institutions can’t just jump in when there’s no clarity around tax or rules of engagement and everything else, so Japan was one of the first movers in terms of setting up the rules and regulations so that people could interact with crypto. I have to say they went pretty hard, and they put some stringent rules around it, which made it hard to do business. But since we service institutions, we wanted to first establish our kind of business in a country that had clarity around the rules.

The second reason I’m in Japan is I’m half-Japanese and I’m raising my kids here, so that’s more of a personal reason. But it worked out really well because just as we suspected, Japan laid out its rules, and then the wind of regulation went from east to west, then Singapore, Hong Kong and so on. And then it started to move towards Europe and now we’re moving to the U.S. And that’s kind of how we grew the business, as well — rather quickly from 2018 to 2019 from Asia all the way to the U.S. But the lessons that we learned by first tackling one of the trickiest markets really worked out well when we started tackling Europe, the U.S. and everywhere else.

Lau: I think what we’re seeing coming out of Japan is really remarkable in setting potentially global standards here. And Japan had really been leading that in the early days, even amongst the G7. But recently, the upper house of Japan’s parliament has just posted a landmark law that really clarifies the status of stablecoins. How else is Japan leading the way, in your view, for crypto, for cryptocurrencies, for crypto businesses and for adoption?

Gillespie: There’s two things that have happened in the last three years that are driving countries like Japan and a lot of other countries to look at building stablecoins. One is Covid. So, each country responded differently, but this is what Japan did. The Japanese government ultimately said, ‘Ok, Covid is an economic disaster. Just like a lot of countries, let’s hand cash out. Let’s give everybody however many thousands of dollars each so that restaurant owners and everybody else doesn’t take too much of a hit due to — we didn’t have a full shutdown here — but due to reduced economic activity.’ That handout was a disaster. I think there’s conversations within the parliament to say, ‘Ok, everybody has a social security number. Why can’t we link a digital address? Why can’t the distribution of this cash be a little bit more seamless?’

The second thing that happened was that after the cash was received, the Japanese government said, ‘Hey, you know what, we need to specifically help the restaurant owners, we need to help the tourist industry.’ But what they realized is that once you hand somebody some cash, well, you can’t restrict them in terms of usage. So the Japanese government then had a campaign to say, ‘Ok, local travel, you get discounts, and if you eat at a local restaurant, you get discounts.’ Now, I’m pretty sure that the government officials realized, ‘Hey, wait a minute, there’s a lot of talk about the CBDC. In a perfect role, how would this work?’ Well, the way it would work is that everybody would have a wallet — a digital wallet — where, kind of, subsidized cash just goes directly in there. You’d be able to monitor the usage and say, ‘Ok, well, where is this cash going?’ And finally, you can whitelist the usage to say, ‘Ok, we were handing this cash out, not so that you can go buy cigarettes or go gamble on horses. We want you to help the local economy. This is what the cash handout is for.’

The other thing I have to say happened earlier this year — and I don’t think we need to go into it too much — but when you had the Ukraine-Russian conflict, we did something — and when I say ‘we,’ the United States of America and a lot of the Western countries — we did something that’s quite historic. We restricted the transaction of capital through the SWIFT network. For a lot of countries, it’s detrimental. You’re unable to transact and you’re unable to have trade activity with other countries. So I think there’s a movement — maybe not in the front — for a lot of countries, they’re thinking about it, but they don’t want to necessarily be too open about it. But I think a lot of countries are now thinking, ‘Ok, what do we do? Is there an alternative?’ And I think that 10, 20, 30, 40 years from now, people are going to look at this year and say, ‘Wow, that was the year. That was the first year where you had this major challenge, where countries started to say, “Ok, are we comfortable with doing everything on SWIFT, where you can potentially just be kicked out of the international financial system? Do we need an alternative? Do we need to think of another way to protect our own citizens and the country, and so on?’” I think these are two huge drivers.

Lau: Do you think stablecoins are pre-step before a CBDC?

Gillespie: I think it’s the same thing. I think when Japan said stablecoins are approved — and if you look at the way they define stablecoins, it’s pretty much a CBDC — I think they prefer the stablecoin to be developed from a trusted private sector company, one of the megabanks. And this is going to be, again, different. China is going to do it in a very different way from Japan, from European countries. I think the Japanese government probably realized that it’s probably better for a private company to develop these stablecoins that is fully trusted by the government and rubber-stamp so that they can serve the purpose of the government. To me, that’s what the law kind of signified, so it’s very specific to service local needs.

Lau: So many innovations coming out of Japan … and really a reference point for the rest of the world. Japan is so interesting right now. You’re there. The legacy banks are reacting, interacting with crypto in a really integrated way, along with government. It’s what we’re experiencing and what we’re observing and covering. How is that translating, in your view, to the rest of the world? How is it also a strategic launchpad for what you’re doing to the rest of the globe?

Gillespie: I think, at the end of the day, every country is looking at what other countries are doing and nobody really wants to be the first mover, so maybe I’ll talk about why Japan is actually the first mover, because it’s actually quite a conservative country. Why did they set the regulations first? The reason is actually Hong Kong and Singapore. So, in 2015, Tokyo actually slipped as the fourth-largest financial center behind Singapore. And that was exactly when the government also started looking at crypto and started embracing digital assets. This is a really interesting phenomenon, because I think you’re about to see similar stuff with, post-Brexit, the United Kingdom, other countries, because you have these macro drivers. Each country has these mandates to establish itself as a financial hub, as a financial innovator. So what we have is, since Japan is the first mover, whether it’s the UK, whether it’s Europe, whether it’s the U.S. or other countries, they’re looking at the kind of roles that Japan plays. It trickles all the way down to the rest of the community. I think some of the stuff that Japan did was great in terms of putting the rules and regulations in place.

There’s still a lot of work to be done around tax codes. In Japan, all crypto transactions are taxed as normal kind of income. It’s not treated as part of capital gains. So you have this massive discrepancy. All of these things are limiting the adoption and usage. And this isn’t exactly what they wanted to do. But now they’re kind of a test center where a lot of these rules come in place. In other countries, they’re observing how it works out. So they tweak their own kind of rules so that they don’t make the same mistakes as Japan.

In terms of what’s coming. I think right now the bureaucrats here are quite smart in their central planning. I think what they’re doing is they’re going to first lay out the groundwork for CBDCs, stablecoins … and then they’re going to start looking at reviewing the tax codes, reviewing everything else. But I think the Japanese government’s first priority was to start defining what stablecoin is, opening up the gates so that these banks can now come in and use stablecoins. And then they’re going to start looking at adjusting leverage, adjusting the tax code and adjusting everything else so that it then trickles down to retail and everyone else.

Lau: And everyone else is the rest of the world, isn’t it? Last thoughts on where you think we’re going to end up in five, 10 years from now?

Gillespie: Sure. So for one, in terms of a micro-structure, as crypto becomes mainstream, it’s going to be less exchange traded. It’s going to be more OTC traded. That’s just the definition of mainstream to me. You can’t have this ecosystem that says, ‘Hey, crypto is a siloed community, it’s in an exchange, it’s in DeFi.’ It’s going to have to be a larger community, which means there’s going to be a lot of exchange consolidation. There are over 450 exchanges in the world right now. Do I think there are going to be 500, 600 exchanges, or do I think there’s going to be more like 10 exchanges in five years? I think it’s the latter, because consolidation always happens, and where the world is going is that your local brokerage, your local even maybe banks, can transact in crypto. I think that’s just the nature of how the market evolves.

The second thing I think is we’ve talked a lot about securitizing token offerings. That, I think, is going to pick up. As soon as the rules are laid out for banks to participate and for other institutions to participate, one of the first things they’re going to look at is how do you securitize the assets that they have in a digital asset format. And that’s going to be a massive thing that’s going to be developing in the next few years as well.

Lau: I agree with a lot of that sentiment. I also think that there’ll be a further migration, potentially, of corporates once the regulatory rails are put in. It’s a very exciting world to be observing, covering and obviously having great conversations. Phil, it was a pleasure. Thanks for joining us on Word on the Block.

Gillespie: Thank you very much.

Lau: And thank you, everyone, for joining us on this latest episode of Word on the Block. I’m Angie Lau, Forkast Editor-in-Chief. Until the next time.