Late digitization is Asia’s edge in crypto, says Fireblocks CEO

Transcript

Angie Lau: You can be a student or an institutional investor, but anyone can lose their keys to their crypto. Today, we dive into the sensitive nature of custody solutions for enterprise, for individuals. Are we there yet? Is trust still an issue? And what happens when you lose access to your crypto? Whose responsibility is it? These are all questions more and more institutions and investors are searching answers to, in Asia and beyond.

Welcome to Word on the Block, the series that takes a deeper dive into blockchain and all the emerging technologies that shape our world at the intersection of business, politics and economy. It’s what we cover right here on Forkast.News. I’m Editor-in-Chief Angie Lau.

Just like a safe has a combination lock, crypto is secured with keys of its own. And just like a safe, you can sometimes lose or forget your password, and therein lies the issue. 

Today, we are joined by Israeli-based institutional custodian Fireblocks, who works with more than 100 financial institutions and, according to the firm, secures more than US$150 billion in digital assets every month. 

Now, Fireblocks was recently sued by one of its clients — staking platform StakeHound — who claims that it lost access to more than 38,000 Ether and that Fireblocks bears responsibility.

The bigger picture here is what does this say about the wider industry? It’s a growing industry, custody solutions. It’s also one where chain of custody can be murky. And then who’s held responsible?

Well, joining me today is the CEO of Fireblocks himself, Michael Shaulov. Michael, welcome to the show.

This is a growing industry. This is a growing part of the industry. In this case, it got a little bit messy. Thank you so much for joining us from your headquarters in New York.

Micahel Shaulov: Thanks for having me.

Lau: All right, let’s dive right into it. We caught wind of this lawsuit from one of your clients that said that Fireblocks was in part responsible for it losing access to 38,000 ETH. That’s a lot of money. It’s now suing Fireblocks in a Tel Aviv court. Can you get us up to speed here? What happened?

Shaulov: There are a couple of things that were caught up in the media, which are a bit incorrect, and also there are several reasons why they were basically brought up like this in the lawsuit. But one of the things that are actually very important to make clear is that neither that client nor any other of our clients actually ever lost keys to their wallets. Even that client, all of their keys to their wallets are basically backed up. The way that our system works is that all those keys are being backed up every 10 minutes across multiple cloud providers, across multiple availability zones. And there are additional procedures in which it’s also backed up by third parties. Honestly, it’s also the case with this particular client. The situation is that with all their production environments, they’re still using us and they’re still using the platform.

So there was a bit of a confusion there in terms of how it was presented through the lawsuit and in terms of how it was interpreted by the media, which I think it’s important for me not only to stress it on behalf of Fireblocks, but also, generally speaking, on behalf of the entire industry, that in terms of where we are today from basically providing the base infrastructure for custody technology and the ability to safe keep keys. The industry is at a very immature stage. I don’t think that any one of the big providers or anyone else has had any incident in terms of taking out the custody itself.

Now, specifically, as it relates to that incident, part of what Fireblocks is really famous for is enabling the cutting edge or the bleeding edge of this industry. So there are the basic things that most people are interested in in terms of storing their Bitcoin, trading Bitcoin and things like that. But one of the things that Fireblocks really enables is some of the cutting-edge use cases, such as staking, such as DeFi, interaction with smart contracts. And honestly, in the case of this particular client, where they were essentially stretching it into is something that is called liquid stacking, which is a combination of staking and DeFi together. Specifically, they were basically engaging in something that is in the preparation of the Ethereum 2 network that is not even live yet. 

So just to explain to the audience, this particular case is sort of abnormal because what that specific client was operating is basically on the far edge of what currently this industry is doing. And clearly, when you look historically into almost every innovation in this space or in any other space, autonomous driving or anything else, clearly there are risks. Usually, when people operate in this far edge of the innovation, it’s part of their responsibility to understand really well what they are doing, how they are engaging, and how they are building their products because they are operating in a sort of borderline area where it requires a lot of responsibility not to make mistakes because some of the things that are being done there are being done the first time.

This is the first thing that I want to make clear because of the ways that that was interpreted by people was that this is common and this is something that is just generally risky if a super reputable provider like Fireblocks that currently powers about 400 institutions, and we’ve secured today almost US$1 trillion of transactions, that can happen to us, then what does it mean to the rest of the industry? Nothing can be farther from the truth because essentially everything was functioning properly in terms of the core offering services and so on. This is something that is very important to put out there.

Lau: But let me just pause right there, because a lot of the audience aren’t so deep into crypto and blockchain to understand the nuance. We want to keep catching them up because you’re totally right. The headline is really scary. You’ve got 38,000 ETH. It’s today worth US$90 million, one company says, `Hey, I lost my keys and I’m going to sue Fireblocks, who I’ve been working with, because they were supposed to help me with our keys.’ That’s really just what the top headline is. 

The nuance is so much more important. You’re totally right. It’s not, `Here’s a 38,000 ETH. I’m going to stick it somewhere.’ For most people, they have it in a hard wallet, cold wallet, or if it’s a hot wallet, if you’re holding it with a custody provider, a custody solution, and or you have your own wallet that’s a USB, and you stick it in your pocket with some passwords. We’re not talking about that here. In this case, what you’re saying is that this is cutting-edge stuff. There was staking involved.

This is a staking firm. They are looking to leverage. They are looking to play within the margins of 38,000 ETH. Whose ETH is it? Are you leveraging your clients, et cetera, et cetera. This is part of their business innovation that they were working with you on. So to be enormously clear, we’re talking about the gray space right now.

Shaulov: Yeah, we’re talking about something that was in the space — this is probably the sub-zero-one percent of the activity that is being done that is so far out from [waht] most institutions, most people are actually engaged in. It’s not that it’s not important that we are not talking here about real crypto real money. But it’s important to stress to people that the infrastructure and the ability of providers like ourselves to really secure a large amount of funds, with insurance and all the procedures in place, is actually a pretty safe capability today.

Now, specifically, how innovation needs to proceed in this space — the space is continuously disrupting itself. So this sort of 0.1% of the experiments that are being done are important. Historically, of course, we’ve seen quite a few incidents. Then during those experiments, things were lost or stolen. But again, it’s not like the common situation for most investors that are operating in the space.

Lau: Got it, but let’s dive into that a little bit deeper. If the keys were not lost. Where is this access to 38,000 ETH? Is that lost forever?

Shaulov: That’s a good question as well. Maybe I’ll explain the overall procedure in terms of what’s going on with Ethereum 2. Specifically with Ethereum 2 staking — which is very different from regular staking — is that it’s less of a stake and it’s a bit more like a wormhole. The Ethereum Foundation is basically the Ethereum community that is building now Ethereum 2, which is sort of a new network that will be hopefully available somewhere between the next 10 to 12 months from now or 10 or 15 months from now. We all hope that they will be able to pull this. 

Essentially, the way that this activity is being done is that you sort of send your assets into an escrow that in due date, this escrow is on the blockchain in the smart contract. It’s basically an autonomous vehicle on the smart contract, that hopefully — if the Ethereum Foundation will be able to pull off the Ethereum 2 network —your funds will be released with an interest into this new network. Now, in order to release those funds into that new network in a year or a year and a half from now, you’ll need a specific password for that for a certain period of time. The way that Ethereum engineered it, it actually required a specific new algorithm that was not off the shelf available in the community that is called BLS (Boneh-Lynn-Shacham). But it’s not the algorithm that is being used to secure the standard Ethereum wallets or Bitcoin wallets. It’s basically a new algorithm that they wanted to use. Interestingly enough, about a month after this incident, back in March, they actually withdrew the requirement of using it because it was so new and people actually had issues with it unrelated to this specific incident. There were broader issues around it.

So what happened in that particular case is that there was some form of deviation from the protocol that was agreed between the parties. I don’t really want to get into the specifics over there because there is a court case. But there was a significant deviation that basically the protocols and the procedures that were socialized were not followed in a strict way. And eventually, a part of that password is basically lost.

Now, what will happen eventually is actually still unclear because, first of all, the Ethereum 2 network is still being built. It’s unclear if they will actually modify. They already modified the way that it works once, maybe they will modify it again. It’s also unclear what will happen if they eventually won’t be able to pull off the Ethereum 2 network where those funds will be returned to the original sender. That’s just to basically explain how innovative what we are talking about here is and how potentially uncommon it is compared to all the other things that are being done here.

Now, needless to say, that when you do something that is so nonstandard, there needs to be a lot of procedures in place on how to operate with innovation. There are a lot of lessons learned here. For example, one of them is: “If you’re really operating at the edge of the innovation, is it actually responsible to throw that amount of money into a single key? Should you basically break down your risk of it?” So I think a lot of lessons were learned over there in terms of how to operate at the edge. But I think most of our customers or all of our customers are actually not operating on that very edge.

Lau: It’s the edge that makes it exciting, no doubt. But to be clear then, we’ve got about US$90 million worth of ETH right now. Eventually, will it show up?

Shaulov: Eventually, if it will show up? Eventually, it’s still unclear what will happen there, but there is a probability that it won’t.

Lau: That’s essentially what we’re talking about, and that will obviously be determined in court. And the other thing is, will the Tel Aviv judge — and I don’t know if there are jury cases in civil cases in Tel Aviv — or even your attorneys be able to really explain this clearly? We’re talking about such innovative space and most people are still catching up to what blockchain actually is. Do you think that in a court of law you’re going to be heard?

Shaulov: It applies to both parties. It’s not that there is a lack of challenges overall around this. Clearly, there will be a lot of education that would need to be put in place in order to for both parties to introduce what happened and what we think are the liabilities. It is probably a fairly innovative case, given the fact that it’s a nonstarter. Having said that, in other jurisdictions, there are other players. It’s not the first lawsuit that exists in this space.

Lau: This is true, this is very true. You’ve been playing in the innovative space for a very long time, as a cybersecurity veteran in your previous incarnation at a Checkpoint where actually your introduction to the space led you to founding Fireblocks. This happened back in 2017. Hackers stole from South Korean exchanges to the tune of US$200 million worth of Bitcoin. That’s where you saw the opportunity. Tell us more about just how important cybersecurity and custody solutions were for you and your co-founders.

Shaulov: It’s foundational for this space. Just to reflect on what we discussed so far, the aspect around the control over the private key and the ability to basically secure this password can have significant implications not only around the particular position of an individual investor, or the individual institution that is in the possession of those funds, but I think that basically all those hacks, eventually, when they undermine basically the ability of the ecosystem to propagate into the mass market. The mass market, the retail market, the consumers, they don’t really understand cybersecurity. We don’t need to basically go into the extremes of crypto to realize that a lot of money is being stolen and lost because consumers — just generally speaking — don’t understand cybersecurity. The losses in the traditional financial systems are much greater than anything we are actually seeing right now in crypto — just to reflect on that.

Our mission is really to make it much simpler and safer for institutions to operate in crypto, because we do believe that there is a transformational capability around blockchain on financial institutions, on financial systems, on inclusion, on removing counterparty risk — which is extremely important. In that mission, a very critical part is really establishing trust, establishing access to the technology that makes it all secure. And I do think that eventually, while the end consumer and the retail on the long run is probably the most important possessor of the asset, I think that for a long period of time, actually the institutions will be the gateway. 

In order to really bring it to the masses, we need the banks. We need the neobanks. We need the exchanges. We need all those entities to be able to operate efficiently. They also need to be able to operate across some of the more interesting use cases that blockchain brings.

How to secure a long position on Bitcoin? That’s fairly simple. You can basically print a paper wallet and bury it under the tree in your backyard, and that will be reasonably secure. But how to bring this into a very transactional market where we’re talking about real-time payments, we’re talking about the replacement of FX, we’re talking about central bank digital currency and clearing of digital securities. That’s actually more challenging because here we actually need to merge speed, and convenience with cybersecurity. Anyone whose antivirus was sort of crunching his CPU when he had to do something that is important, knows that usually, cybersecurity or security and convenience and speed are fairly contradictory. What Fireblocks was able to do really well is to bring those things together and merge them.

Lau: And you’re doing that right now for institutional clients, including BNY Mellon and I said in the intro more than a hundred, you’re actually correcting me and saying it’s 400, now close to a trillion dollars in digital assets. Tell me about those clients like the BNY Mellon, like institutional names that we all know. What are they doing in the space? What are they asking you to do for them, for not only potentially their assets, but also their clients’ assets? What is the demand right now from institutions?

Shaulov: So interestingly enough, I think that all the major banks, they have now initiatives to basically establish the base of the technology to operate with digital assets. When we started the company at the end of 2017, 2018, there was a lot of interest, but as the market sort of collapsed after the ICO boom, most of those initiatives were basically clear and prioritized.

What we’re actually seeing right now is true movements that are being led by the senior leaders in all those banks, and I’m talking about traditional financial institutions to establish capability because of — I would say — three main reasons.

The first one is that they’re actually feeling the heat from the newcomers. When you look at companies like BlockFi, Celsius, and Coinbase and are actually looking at all these sorts of more regulated entities, that it’s very clear what they’re doing and it’s clear that you cannot dismiss them because, “Oh, they are operating on the edge. The regulator will come after them.”

Coinbase — maybe the regulator is overseeing Coinbase but I think it’s fairly clear that they’re here to last. They’re basically feeling the heat and they understand that they need to act and they need to establish the capability to first and foremost protect their business and to protect the capital that they currently have. 

Because if people are buying Bitcoin or stablecoin, there are capital outflows from those entities. Not only is there a capital outflow, you’re actually seeing a lot of those entities coming into the old business. So for example, BlockFi is launching a credit card program. It already becomes fairly gray in terms of, `are those crypto institutions or actually real financial players?’ That’s the first thing that they see and they also see a very big client demand, at least from the high net worth individual client base and from their institutional client base to provide these kinds of services.

The second thing that they see over there is really the business opportunity. A first-mover advantage in this market can actually mean quite a lot. Because first and foremost, the margins and the profits in this market are very high compared to what they’re seeing in their core business. Maybe the market is not as big as their core business, but the margins are very high. The second thing is that being the first mover allows you to interact with the regulators and interact with the definitions and the specifications for the broader mission here. We talk about central bank digital currencies, we talk about digital securities, we talk about payments — being a first-mover over here really allows you to define the rules of engagement and potentially place yourself in a position where not only can you preserve your place as a dominant financial player, but actually sort of front-run your traditional competitors.

Lau: I would argue that that theoretically is spot on. Realistically, it really depends on the jurisdiction that you’re in. People’s experience in Asia is very different than people’s experience in the United States, for example. First mover advantage is not necessarily your friend in specific regulatory jurisdictions. So I would just say that. But but you’re totally right. 

To your point that a lot of the institutions, the banking names that you know, they are being challenged by the aptly named challenger banks and the challenger crypto players who are also now in this regulatory space. And in fact, we’re seeing a lot of veterans from traditional banking get into crypto. In terms of first-mover advantage, I think it’s actually the leadership that the brain drain almost from traditional finance into crypto using the experience that they have in regulatory and compliance and AML, KYC and all of those things, knowing who the regulators are, having worked with compliance officers for decades, knowing all of that landscape and bringing it to the crypto world and creating a discipline there.

Shaulov: Yeah, I agree. We are seeing a lot of people moving into the space from the banks and hedge funds. People understand the opportunity. People also understand the advantage of an infrastructure that is being set up from the ground up to support it. Definitely, one of the biggest challenges that we see — more on the technology side — is around how we integrate our technology is the more traditional systems with the core platforms. Those are pretty complicated products and projects because, generally speaking, most of those banks have a fairly substantial technology depth. When you look at Coinbase, Binance, and all those providers, they are fully cloud, continuous delivery, continuous integration, they are set up with modern infrastructure for the 21st century or for the second decade of the 21st century. Whereas one would argue that you have a pretty decent amount of banks whose infrastructure is currently set up for the 90s. They need to basically leap. They need to make several leaps in order to to be able to consume and integrate this technology.

Lau: Who do you think is doing that better geography-wise? I note that you’re expanding in the Asia-Pacific. As you expand globally. You were there in New York, obviously with big, the center of the universe when it comes to the top financial firms in the world. But increasingly, there’s significant money here, there’s significant innovation here. Who does it better in your view or who has the potential to eventually do it better?

Shaulov: I would actually say that the Asia Pacific is somewhat a newer market for us. We’ve entered that market last year — pretty much like 12 months ago. I do think that there is a lot of opportunity and potential in the Asia Pacific market. Clearly, there are jurisdictions in the Asia Pacific markets such as Singapore, Hong Kong, Thailand, that there are fairly tight cooperations between big commercial institutions and the regulators. And also, it’s very clear who is the regulator, which is also helpful. So that gives those institutions potentially an advantage compared to their American peers. In the United States, it’s not a secret that there is a large amount of regulators and it’s not always clear — or in most cases. Bigger financial institutions have at least a handful of regulators that they need to clear, and that makes things challenging.

At least from the little that I’ve seen so far, in some cases, the Asian institutions have more modern infrastructure because — to a certain extent — they started their digitization journey later. For example, when you look at the different core banking systems that they use, there are actually the newer generation of platforms that are in some cases actually even cloud-based and so on compared to some 30 or 40-year-old infrastructures like IBM infrastructure that you would see in the United States [and] Europe. So that makes things a bit easier.

Lau: That is a great point. Anyone who has flown through LaGuardia will understand this metaphor in New York. You’re flying into the biggest city in the United States — LaGuardia — and there are smaller airports in Asia that are light years ahead in terms of modernity, efficiency, all the rest. I don’t know if you’ve ever flown into LaGuardia.

Shaulov: You don’t need to go to LaGuardia. I think you just need to basically fly to JFK and the Singapore Airport.

Lau: Night and day. Even Calcutta, India, which I had the pleasure of flying through. Believe it or not, just the impression that people have when you’re flying, oh, you’re flying to Calcutta, India, and you should see this airport compared to LaGuardia. Anyway, I digress.

But your point is well taken. Asia has leaped ahead in terms of being at the later stage of digitalization. We are also seeing a lot of countries hoping that blockchain will allow it to leapfrog in the development economic game. We have heard very clearly from China that blockchain is going to be integral to economic growth and is part of their strategic implementation and investment in a way that we aren’t really necessarily hearing about that from the West, more from the private side, but from the government side, less so. Does that make your job harder?

Shaulov: The simple answer is yes. From our standpoint, we have — right now — two missions. The first one is really to support the innovators. We are working with the most important crypto native firms out there, supporting them from an infrastructure standpoint, and that’s integral to making sure that we continue and basically, linearly growing this ecosystem. The nonlinear growth really will come from us helping to drag in the big players, the big banks, big companies. Once you have a big bank that is coming in, they come in with their reputation, they come in with the client there and it’s much easier for them to basically bring more money to the table. And honestly, also, they sit on most of the assets in the wall.

Clearly, regulation, risk and compliance are the main gates right now for this to happen. We do spend time. We do spend a significant time with the regulators, educating them. And a lot of the stuff that we are doing is really trying to smoothen it out. In reality, this is what makes this process take like, 12, 18 months and not three to six months, as you would assume. From a business plan standpoint, from incentives, from aspirations, it’s all there. Now, you basically need to clear gates that our risk compliance and regulation and that’s challenging.

Lau: The Bitcoin volatility, the prices in crypto, we experienced the highs of the highs. And now those institutions and those publicly traded firms are now reporting that some of their crypto holdings is now putting them in a loss position. Has that dulled, or, kind of left some cold feet from institutions picking up crypto getting into this space?

Shaulov: I was actually concerned about it about a month ago, a month and a half ago. I shared my concern actually with my team and our investors, and to my surprise, the answer for that is no. And I’m basing it not just on sort of, people that might have just a very narrow incentive. It’s based on conversations with the number twos in some of the biggest banks in the world. Then I asked them that question specifically. They said, `Look, it’s not helpful, but this is not the reason why we are doing it. The reason why we are doing it is because of the really big picture of not only Bitcoin — if the price of Bitcoin is 30,000, that the price of Bitcoin is 60,000.’ And honestly, unlike other people, I don’t know how to predict where Bitcoin is going to be a year from now. I’m a cybersecurity professional at the core. I’m not a financial analyst. So I leave that those predictions to other people. But what I can definitely say is that the reason why those people investing and the reason why those people are committed is not because of the price and because of the FOMO (fear of missing out). It is because they see a real opportunity that we discussed earlier around, being first, second, third mover doesn’t matter, but basically being in the leading pack around it.

Lau: And back to where this all started, whether it’ll be figured out in a lawsuit or otherwise. We’re talking about cutting-edge space here. 

What is next for Fireblocks for this industry? You’re working with some of the top teams in the world, both on the institutional side and on the blockchain side. And now we’re starting to see DeFi institutional interest in DeFi picking up. Where are we headed to? Where are we headed to when it comes to this space? 

Shaulov: Institutionalization or institutional access to DeFi is probably within the two most strategic things that we are currently investing a lot of our resources in. There are still a lot of questions, and we are now, I would say, writing a few, small-scale experiments in terms of figuring out how to make it accessible to both the different layers of the institutional segments and through the different types of products. The two main challenges is clearly the regulatory challenge — the compliance, and which is just unclear, it’s in flacks. There are many people that are smarter than me that can talk about all the FATFs and FinCEN and what they’re going to do, and what they are not going to do. There are real concerns from the regulators that need to be addressed properly and there are also real concerns from the community that they want to see innovative solutions that align with the behavior of the signal or behavior of this asset class and not someone coming in with a solution from the 70s that doesn’t even work for the traditional financial space and tries to apply to any technology. There’s still work to be done, but the regulatory aspect is, one to basically make people make a high-end, highly regulated institution more comfortable to join in.

And the second aspect is really making it seamless. To reflect on the lawsuit and what we discussed, although DeFi is clearly less risky than what was done over there, but it’s still cutting-edge. With Fireblocks or without Fireblocks, there is still a lot of technology risk that is associated with smart contracts and the access to smart contracts, and the unexpected behavior of those things. And we do spend a lot of time in terms of figuring out what is the best way to make this accessible to the public, to the institutions, and how to make it as secure and seamless as possible.

Lau: Very famously said it’s the known unknowns that we are living in at this moment, and I’m going to apply it to the technology space because that is exactly what I think defines how exciting this innovation space is. 

Michael Shaulov, it was a pleasure talking with you, and thank you so much for joining us on the show and sharing a glimpse as to what is truly cutting-edge and what we’ll be able to see in the next 12 to 15 months. Appreciate it a lot.

Shaulov: Thank you so much.

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