Introduction

The blockchain technology bears the potential to reinvent fundamentally practically every industry where it is applied in an intelligent way. In this post we will elaborate on the use of the technology by going over a number of examples. Each of them serves to emphasize that SCALABLE provides end-to-end solutions that can be utilized successfully within industries that are vital to the performance of the global economy.

Use Cases

The Venture Fund Industry

The Issue

The amount of funds raised by Venture Capital funds in 2018 was historic with 2019 not far behind, according to the 2020 Year Book of the National Venture Capital Association [1]. Raising money is no longer simply a domestic activity. Investors amass from all over the world and fund administrators are not equipped to scale to meet your needs. 

Meanwhile, investors are always asking for better liquidity during a fund’s lock-up period. Before the creation of efficient and suitable distributed ledger technology (DLT), ensuring liquidity was next to impossible.

The Solution

Nowadays, companies like Andra Capital, through their token Silicon Valley Coin (SVC) allow the investment in leading late-stage technology companies as it represents ownership stake in the Andra Capital’s Fund portfolio. The proceeds from the sale of the token are invested in the companies of the fund, investors receive dividends equal to the percentage of tokens they hold in the fund, and the token can be traded on the open market. 

Never before in the history of the capital markets has this ever been possible – to allow, en masse, to provide liquidity by investing in new private companies during their highest growth stage, and be granted the ability to speculate on whether they will be successful. All of this is made possible by the use of DLT as it enables:

1. Enhanced liquidity;
2. Accessibility;
3. Increased transparency;
4. Automated investor onboarding across the globe while following securities and other applicable regulations;
5. The trading of the token on Alternative Trading Systems (ATSs) or Multilateral Trading Facilities (MTFs).

The Banking Industry

The Issue

Over the past decade, the investment banking industry profits have been battered by stricter  regulatory regimes and the pressure to innovate by spending tens of billions of dollars on technology. Deutche Bank (DBK), for example, who have lost over 82% of their value over the past 5 years note in their 2019 Annual Report [2]:

“Cost reduction is an essential element of our transformation strategy. We aim to reduce our adjusted costs to € 17 billion in 2022 while continuing to invest in technology and strong controls.”

For the same period of time Goldman Sachs (GS) lost ~19%, Morgan Stanley (MS) lost ~6.2%, Wells Fargo (WFC) lost about 44% of their value and the Dow Jones U.S. Banks Index fell to an over 5-year low after the recent market collapse. The banking industry is in a multi-year decline, while spending on technology and compliance continues to rise. Creating the bank of the future requires automation and new financial products. 

Distributed Ledger Technology

DLT has been gaining grounds not only in the fund industry but also globally. 

Stablecoins

An October 2019 Bank of International Settlements report [3] recognizes the importance of stablecoins (digital tokens that represent 1:1 the value of a fiat currency such as the U.S. Dollar). BIS notes that:

1. “Stablecoin initiatives have highlighted shortcomings in cross-border payments and access to transaction accounts.
2. …stablecoin arrangements may increase efficiency of payments… “

In this light, a number of companies have already issued their own stablecoins including JP Morgan [4], Gemini Exchange, and a number of companies have collaborated (Barclays, BNY Mellon, CIBC, Commerzbank, Credit Suisse, ING, KBC Group, Lloyds, MUFG, Nasdaq, Santander, SMBC, State Street, UBS,Commerzbank, KBC, ING, Lloyds, Nasdaq, and Santander) to create the Utility Settlement Coin (USC) [5].  

Real Estate Tokenization

Real estate tokenization, similar to securitization of assets for the purpose of dividing it into shares, is done to provide investors from all over the world with access to mortgage portfolios anywhere. Similar to the case of the fund industry, one may create a token for part of a single real estate or a token for a portfolio of real estate assets. These real estate tokens are then tradeable on exchanges or ATS. In this way the underlying asset becomes much more liquid as it is accessible to a wider range of investor groups – effectively creating a new asset class.

Only accredited and institutional investors had frictionless access to real estate investing before tokenization was possible. Although investors can buy and sell real estate investment trusts (REITs), however they have high minimum buy and often represent a huge portfolio of companies rather than a single property or a new project.

Real estate tokenization eliminates intermediaries, making it easier and more affordable for investors to trade real estate and for owners and developers to raise capital. Investors can trade tokens almost instantly and for a very low fee (similar to stock market trades).

Startups

Recent Development

In 2019 $888 billion was raised across 1,064 private equity firms – the most private capital ever raised in a year according to 2019’s Private Fund Strategies Report from PitchBook [6].

Startups are raising more and more capital from private markets leading to frictions between early investors and employees seeking liquidity on their shares. When they try to liquidate their shares, they must deal with attorneys managing the company’s first right of refusal on prior employees shares is a job in and of itself. Meanwhile, raising capital from traditional investors is a unique way to scale a business much more quickly. 

How can one align investor incentives with customer needs?

The Solution

Tokenization of one’s company equity gives investors and employees liquidity after shares are vested. With DLT it is possible to sell equity on one’s website directly to customers and other key stakeholders. In this way business owners can skip investment banks and list their tokens for trading 24/7/365 trading to an ATS like OpenFinance or SharesPost.

The benefits of tokenizing private equity can be summarized as follows:

1. Global Market Reach. Attracting a new breed of investor through the global nature of DLT. However, when security tokens are issued, they should be distributed only to eligible investors. The onchain representation of the securities must be permissioned tokens in order to apply compliance during transfers.
2. Automated Servicing. Dividend payments can be set up automatically and all types of corporate actions can be executed from the platform. In other words, issuers can benefit from easily managing operations such as corporate actions and reporting and in turn increase transparency and operational effectiveness.
3. Compliance Assurance. Legal requirements are embedded via smart-contracts in order to ensure that only eligible parties can participate. The issued tokens are in many jurisdictions considered securities or representation thereof. As such, securities laws and regulations apply. Using blockchain global compliance is ensured both during the issuance and throughout the lifecycle of the financial instruments.
4. Near Instant Transferability. The blockchain technology enables settlement after trading to be reduced to near real-time. For investors, this means that these assets can be transferred seamlessly at low cost and with compliance automatically enforced.
5. Custody. These tokenized securities are centralized financial instruments utilizing a decentralized infrastructure design. This means that the issuers have full control at any point in time to their token supply, while investors may never lose their access to the tokens even if they no longer can access their wallets. In other words, the custodial fees for issues and investors are next to nil.

Mutual Funds & ETFs

The Opportunity

According to PWC’s 2019 Mutual Fund Outlook [7], mutual funds should focus on strategic positioning, providing value for money, and implementing integrated data-driven technology platforms. The reason for this is that assets under management (AUM) are growing however the industry is moving towards passive management, with 50% of AUM expected to be passively managed by 2025 (up from 36% in 2018). In their 2020 Asset Management report [8] they note:

“…traditional active management will grow at a less rapid pace than passive and alternative strategies, and the overall proportion of actively managed traditional assets under management will shrink.”

By 2025, PWC “expects the front, middle, and back-office to be replaced by a single, ‘integrated platform’ that has been transformed by technology” like blockchain, artificial intelligence (AI), and process automation. These technologies are going to “handle most data maintenance and reporting requirements from counterparty exposure reporting to fund administration.”

The Solution

Similar to the venture fund and the startup fundraising industries, mutual funds and ETFs would benefit from the use of blockchain much in the same way – by the creation of new financial instruments, instant transferability, custody, compliance and servicing automation, and broader investor reach. A transfer agent is used to automate investor onboarding, while managing transfers and trades of security tokens issued using DLT.

Financial Institutions

During the boom of the digital assets space of 2017 over $1.2 billion was raised which was accompanied by skyrocketing Bitcoin prices. Contemporary financial institutions such as trading venues, brokers, and custodians must utilize technology that reaches investors on a global scale. According to a 2019 PWC’s Global Crypto M&A and Fundraising [9] report the  investments and M&A deals in digital assets and blockchain infrastructure companies exceeded $1.7 billion between 2018 and 2019 H1.

According to the report and recent market events we have observed, financial institutions invest in exchanges, brokerage technology, primary market infrastructure, order routing technology, compliance tools, and custody solutions (e.g. wallets). All of these investments were made with focus on integrating blockchain technology in existing systems or building a new solution from the ground up utilizing solely DLT.

References

[1] https://nvca.org/wp-content/uploads/2020/03/NVCA-2020-Yearbook.pdf

[2] https://www.db.com/ir/en/download/Deutsche_Bank_Annual_Report_2019.pdf

[3] https://www.bis.org/cpmi/publ/d187.pdf

[4] https://www.jpmorgan.com/global/news/digital-coin-payments

[5] https://www.ledgerinsights.com/utility-settlement-coin-funding-nasdaq-joins/

[6] https://pitchbook.com/news/reports/2019-annual-private-fund-strategies-report

[7] https://www.pwc.com/us/en/industries/financial-services/library/pdf/pwc-fsi-mutual-fund-outlook-act-now.pdf

[8] https://www.pwc.com/gx/en/asset-management/publications/pdfs/pwc-asset-management-2020-a-brave-new-world-final.pdf

[9] https://www.pwc.com/gx/en/financial-services/pdf/pwc-global-crypto-deals-h1-2019.pdf

Introduction

In a related post we have described what it takes to set up a digital asset exchange. Similar to traditional financial markets, exchanges and brokerages differ significantly in the digital assets industry.

What is an Exchange?

SCALABLE defines an exchange as a standalone system, where the liquidity pool, as well as the custody, are fully reliant upon the operations team of the operator. This means that the owner is responsible for two main attributes of the exchange:

1. Ensuring that, among others, (i) there is a wide range of different participants on each market (e.g. mom-and-pop, retail traders, and independent algorithmic traders), (ii) there are dedicated market makers who are responsible for providing best execution, (iii) there is active market surveillance team, and (iv) there are deep and liquid order books.
2. Own custody operations team, which has to establish and build the processes and procedures related to customers funds management – for example, “hot” – “warm” – “cold” wallets structure, required balances on each, as well as staff accessibility and segregation of duties.

Both attributes point out certain benefits and disadvantages of operating an exchange.

Benefits

1. Operators get to choose the market makers and to monitor their activity.
2. Operators can operate in a jurisdiction of their choice without worrying about the matching of orders between individuals from countries where digital assets are regulated and those from unregulated jurisdictions.
3. Unless a third-party provider of custody is chosen, the client funds are fully managed by the operators themselves and do not need to rely on the security measures of the provider.

Disadvantages

1. Finding and signing and tracking the performance of experienced market makers can be a daunting, time-consuming, and expensive adventure.
2. Making sure that there is sufficient liquidity on each side of every order book entails locking of large amounts of capital in highly volatile assets with highly limited and potentially costly hedging opportunities.
3. Monitoring the trading activity of each market requires a dedicated team able to screen through financial data and alerts 24/7/365.
4. Establishing a custody operations team and structuring the management and procedures must be done by professionals with a deep understanding of DLT, finance, and cybersecurity.
5. Ensuring diversity of the liquidity pool is clearly the most difficult business and lacking it hampers profitability. In other words, if there are only retail traders who are on average liquidity takers and there are an insufficient number of liquidity makers (e.g. maker makers, machine learning (ML) arbitrage traders, and institutions), then orders will execute slowly, spreads will be large, and customers will eventually switch. 

What is a Broker?

In contrast to an exchange, building a broker is a relatively quicker and less costly task. This is because the custody operations are built and connectivity to the liquidity pool is established from day one.

Broker Features

1. Liquidity breeds liquidity. The pool that SCALABLE clients connect to is among the deepest and most liquid in the industry. Its diversity is unparalleled as some of the participants are instant exchanges, a number of brokers, a large number of retail traders, over two dozen institutions, market makers with nearly two decades of experience across traditional and digital assets markets, and hundreds of ML-algo traders. This means that large institutions will be able to trade with minimal price impact, while small orders will be processed nearly instantly at best prices.
2. The dedicated market makers are obligated to post quotes among the narrowest spreads in the industry and are scrutinized for misperformance by the liquidity pool monitoring team.
3. Market monitoring is done by a set of proprietary tools and a dedicated team with proven experience in market microstructure and market practices, ensuring best execution of any order.
4. The custody operations are readily established and the broker operator does not need to worry about security, segregation of duties, and day-to-day management.

As it becomes evident from the aforementioned, setting up a broker is a different story from what one would expect when it comes to establishing an exchange.

Setting up a Broker with SCALABLE

Setting up a broker with SCALABLE is somewhat different as compared to establishing an exchange. In comparison to our previous , as outlined below, here one can observe that much fewer steps have to be taken to establish a broker. 

1. Establish a Target Market – define the countries and customers you want to reach. 
2. Define USPs and the Marketing Strategy – define one’s own unique selling points and find out what is the marketing strategy that would highlight these points as starkly as possible in the eyes of the future customers.
3. Form Departments – structure the marketing, support, and compliance departments – much fewer than those required to run an exchange.
4. Take Care of Legal – make sure that you know well what are the legal obstacles and how to work them out early. In the case of a broker these are usually fewer.
5. Provide a List of Requirements to SCALABLE – define the trading pairs, APIs, interfaces customization, trading fees and etc.
6. Technology Deploy – the system is deployed within up to 30 days depending on the requirements.
7. Establish Processes & Procedures – make sure that the processes and procedures for testing and running the exchange are set up, such as development of UAT plan, the support guides and FAQ.
8. Launch the Marketing Campaign – launch the marketing campaign and test its effectiveness to see if your USPs and Marketing Strategy are in sync.
9. Launch the Broker – launch the exchange and monitor traffic, respond quickly to customer inquiries, and optimize the marketing approach.

Conclusion

We have worked with brokers across different jurisdictions, with various technological requirements and highly diverse legal structures. We have always managed to help them tackle all the tasks aforementioned with ease. This is something we are committed to practicing as the adoption of DLT is becoming ever more profound.

Introduction

Navigating through the volatile and new digital assets class is challenging even for industry veterans. Building, maintaining, and running an exchange is definitely considered one of the most daunting tasks.

Building Your Own Exchange

In general, there are two ways one may set up a digital asset exchange. 

The first, is to establish experienced development, management, and operations teams, and then take between one to two years to build a robust technological solution that is secure and scales efficiently. The following questions (at a minimum) should be asked before making such a decision:

1. How would one ensure that there is sufficient budget to maintain the development efforts before and after the launch of the exchange?
2. How can one find at least 50 developers who are experienced in building low-latency, high-throughput, financial trading systems and with knowledge of distributed ledger technology (DLT)?
3. Where does one find a management team that has experience in finance, DLT, and has profound technology focus and understanding of how to manage development teams?
4. Who would be in charge of the technology infrastructure who has also already built and operated at least one such platform?
5. How to build a team that would take care of retail and institutional support?
6. Is there somebody who understands the inner mechanics of a digital asset exchange and with extensive experience in cybersecurity?
7. Who would be in charge of legal?
8. Do we do marketing in-house or do we hire a PR firm?

These questions and the difficult answers often prevent new entrants from building a platform on their own and opt for the second option.

Collaborating with a Technology Provider

Buying a readily available technology solution without the team behind it is more often than not suboptima, as the technological complexity of these systems is staggering. In the past, some white-label providers have proven unreliable at best and even unsecure. When choosing a technology provider one should consider the following questions before making a decision:

1. How scalable is the technology and what is the cost of scaling?
2. Have they ever been hacked?
3. Who are their established clients?
4. What is the execution latency?
5. What is the average platform downtime?
6. Do they have robust SLAs?
7. Do they provide an intelligent liquidity solution?
8. Do they provide basic and advanced connectivity and low-latency solutions like REST and WebSocket APIs as well as FIX and co-location, respectively?
9. Do they provide a well-built, native mobile application for Android and iOS?
10. Do they provide KYC/AML modules?
11. Do they have a dedicated market surveillance system?
12. How is the custody structured and is there a possibility to integrate third-party custody?
13. Do they have any established certificates such as SOC2?
14. How many digital assets do they support?
15. Do they support fiat integration?
16. How long does it take to deploy the entire system?
17. Do they provide more than just technology?
18. What is the total cost of deploying and running the technology solution?

Finally, there are few among the technology providers who are willing to create a shared venture together with their clients, a synergetic relationship that ultimately leads to the build and launch of a successful digital asset exchange. This implies that the provider is willing to go above and beyond just providing the technology solution. To succeed, they are willing to work with their clients on user acceptance testing, the structuring of retail, and institutional support, tackling regulatory obstacles, competitive positioning, and finally marketing.

Setting Up an Exchange with SCALABLE

After having deployed a number of exchanges and brokers, we have established a roadmap that outlines the milestones towards the path to building and running a successful digital assets trading venue.

1. Establish a Target Market – define the countries and customers you want to reach. 
2. Define USP’s – define your unique selling points, which are valued by your customers.
3. Form Departments – establish market monitoring, compliance, support, marketing, custody, and strategic management teams.
4. Outline a Marketing Strategy – outline how you want to present your product and company to your customers.
5. Tackle Legal – make sure that you know well what are the legal obstacles and how to work them out early.
6. Provide a List of Requirements to SCALABLE – define the trading pairs, APIs, interfaces customization, trading fees, third-party integrations, KYC requirements, mobile application customization, and etc.
7. Technology Deployment – the system is deployed within up to 40 days depending on the requirements and is ready for user acceptance testing.
8. Establish Processes & Procedures – make sure that the processes and procedures for testing and running the exchange are set up, such as development of UAT plan, the support guides and FAQ.
9. Structure Custody Operations – establish how the custody operations will be built and define the segregation of duties.
10. Invite Market Makers – clients will need liquidity from day one, therefore one must have liquid order books.
11. Create a Market Monitoring Team – this team should use market surveillance tools to monitor the market activity to identify and prevent market abuse.
12. Launch the Marketing Campaign – launch the marketing campaign and test its effectiveness to see if your USPs and Marketing Strategy are in sync.
13. Launch the Exchange – launch the exchange and monitor traffic, respond quickly to customer inquiries, and optimize the marketing approach.

While the list above is by no means exhaustive, it gives an idea of what is the process of preparing, deploying, and running an exchange. SCALABLE works with its clients on-site, not only on the technology deploy and maintenance but also on all other issues be it marketing, testing, legal, support, or liquidity provision.

Conclusion

SCALABLE has launched a number of successful exchanges who have been in the business for years and have established themselves as industry leaders. We believe that this practice can be extended to all of our future customers.