[CHAINALYSIS PODCAST EPISODE 55] Revolutionizing TradFi: Exploring Stablecoins, Tokenization and Crypto Regulation

Episode 55 of the Public Key podcast is here! Tokenization is all the hype, but many are asking what are the real use cases. We decided to answer that question and more with our guest, Tim Davis (Principal, Blockchain and Digital Assets Lead, Deloitte), who shares his insights on regulatory architecture, stablecoins, and TradFi’s interest in tokenization. 

You can listen or subscribe now on Spotify, Apple, or Audible. Keep reading for a full preview of episode 55.

Public Key Episode 55 preview: Tokenization could be the way institutional adoption of crypto happens

Real-world asset tokenization could be a game changer for institutions and investment firms looking to use blockchain technology to expedite the settlements of financial products. 

In this episode, Ian Andrews is joined by Tim Davis (Principal, Blockchain & Digital Assets Lead, Deloitte), who has been working in digital assets since Coinbase founders were still working out of their garage. 

Tim dives head-first into crypto regulatory architecture and how intelligence is the key to effective legislation in the digital asset market. He also provides insights on stablecoins, tokenized deposits, and the global use cases he has seen blockchain-based technology utilized. 

He clears up some of the tokenization hype by providing solid examples of how blockchain technology could revolutionize the entire TradFi industry.   

Quote of the episode

“I think we want to bring crypto out of the shadows…I mean, consumers around the world see so much value in this that they’re so anxious to adopt it, but it’s never gonna be an adequate solution while you’re doing something that’s sort of quasi-legal in order to have to use it.  So really, we really hope governments embrace the technology.” – Tim Davis (Principal, Blockchain & Digital Assets Lead, Deloitte)

Minute-by-minute episode breakdown

• (2:45) – How Deloitte started in the digital asset space early on, helping crypto natives grow their business
• (6:45) – Understanding why the crypto regulatory architecture in other countries is simpler than in the USA 
• (12:45) – Discussing how to bring intelligence to regulators in order for them to make effective crypto legislation and put in proper guard rails 
• (18:01) – Stablecoins, tokenized deposits, and CBDCs may be possible solutions to the broken legacy payment systems around the world.
• (23:40) – Tokenization is all the hype, but are there real-world use cases?
• (28:45) – How can regulators and the private sector work together to provide a safe yet innovative environment for cryptocurrency to flourish 

Related resources

Check out more resources provided by Chainalysis that perfectly complement this episode of the Public Key.

Speakers on today’s episode

• Ian Andrews * Host * (Chief Marketing Officer, Chainalysis) 
• Tim Davis (Principal, Blockchain & Digital Assets Lead, Deloitte)

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Transcript

Ian:

Hey everyone, we’re back for another episode live from LYNX. Joining me on Public Key today I have Tim Davis who is the blockchain and digital asset practice lead at Deloitte. Tim, welcome to the show.

Tim:

Great to be with you, Ian.

Ian:

Oh, excited. I would guess almost everyone listening to this podcast has heard of Deloitte, a major international corporation. You all do a lot of things, but I’m going to guess that most people would not immediately think of digital assets as an area that Deloitte has a ton of expertise in. Why don’t we start there? Talk a little bit about what does your team do? What’s the overall approach to digital assets at Deloitte right now?

Tim:

It’s a great question. We have been in digital assets, which may be even more surprising, for 10 years.

Ian:

I’m shocked.

Tim:

We were involved at the very outset of this industry. We have over 2000 people that focus on this every single day around the world, it is very much now a global practice. We started very early on working with crypto natives, really just helping them grow their businesses and learning along the way. And I think what we have found is that all of that early insight with the crypto-native community has now been very helpful for us as we’re talking to institutions. Because institutions really want to understand how it gets done practically, they don’t really don’t want theory. And so a lot of that hands-on learning that came out of the crypto-native community is really at the essence of what institutions now are looking for in terms of advice.

Ian:

I think yesterday you were telling me, you all were working with Coinbase when it was just Brian and a couple of the early team members in the garage era of the startup there at Coinbase. What was the type of work that you were actually helping them do?

Tim:

Early on companies need help with just legal structuring, tax advice just to get themselves set up so they can grow in a way that they’re not going to regret how income and revenue is being recognized down the line so some of those initial structural decisions are quite important. And then as they grow we sort of try to grow with them in terms of what’s next needed. They eventually may need an audit, they may need other types of controls advice, they may need some consulting help as they’re looking to build. We try to sort of just be there at each life stage, right, so that we’re helping them just take meaningful steps forward.

Ian:

And as you look at the business today, that 2000-person army of digital asset expertise, is that … How do you think about segments between crypto-native companies versus banks or other institutions that are trying to enter into the digital asset space?

Tim:

We have crypto natives as one sector, we have the financial services institutions so the big regulated institutions typically. We have clients that are looking to just deploy blockchain and so this is typically data transformation projects that don’t oftentimes even involve digital assets, right, they’re just looking to move data in a way that transforms the business. And then we have another sector that’s sort of corporate America and government. As both corporate American government are looking to adopt digital assets, we have teams that focus there too.

Ian:

So you’ve got the whole spectrum. How has that changed over the last year? I sense in our business at Chainalysis, obviously, there’s been chaos I think would be a fair characterization in the crypto-native space. The interesting impact of that chaos has been … And around the world, it seems like government agencies that maybe didn’t consider digital assets a priority are suddenly very interested in building expertise. We’re getting calls from prudential regulators all around the world, as an example, who 15 months ago were sort of like “The digital assets sort of thing in our jurisdiction, we don’t really need to understand the space or build any expertise.” That’s changed dramatically. Are you seeing a similar thing?

Tim:

I think it has. It has. And, obviously, as you implied, really for both reasons. Both of the desire to foster innovation but also to properly regulate the space. That really is, I think, what we’re seeing in the rest of the world now the sort of desire to find that right balance, right, because they don’t want to sort of go either way too hard. They don’t want to be too permissive and they don’t want to be too strict, that creates capital sort of not wanting to start their businesses there.

Ian:

Talk a little bit about the outside the US regulatory perspective. This is one of the things I was interested to get into because I think Deloitte being such a global presence … I live in the US I get a narrow American-centric view of the world. But I think the current regulatory perspective, relative to crypto, outside the US, is very different than what’s been happening over the last few months here in the US.

Tim:

Other countries, whether you see it as a benefit or not, I’ll leave that to debate … The regulatory architecture in other countries is simpler and so that allows … Take the UK as an example, the FCA. You have one regulatory agency that oversees all sort of financial conduct, and that allows them a level of executive decision-making that can put plans forward without as much sort of democratic sort of debate as to which way we go and which agency leads. That is certainly what we’re seeing is attractive to a number of our clients is just to have the clarity on the roadmap going forward. We see that clarity is coming with MiCA, going to get passed in Europe, we see it in the UK. We see other important jurisdictions … I mean, Singapore, Hong Kong, and even Japan is now beginning to roll out new regulatory regimes around things like stablecoin.

Ian:

Let’s talk about Japan a little bit because I think there’s been a number of announcements from some of the crypto native companies, exchanges specifically, who are pulling out of the Japanese market. And it wasn’t clear to me when I read those headlines, was that because of regulatory pressure or because of cost-cutting? Because it was happening in the moment where we saw lots of tech companies all around the world cutting projects that were not short-term profitable. I couldn’t parse that apart. I don’t know if you have a perspective on the Japanese situation.

Tim:

Not specifically on that question. I haven’t seen the same headline. But the Japanese market has always been a very well-regulated market, right, so they always sort of make sure that they’re leading sort of with a sort of strict regulatory regime. But at the same token, there has, for many years, been quite a vibrant crypto community in Japan. It’s just encouraging to see that this industry is really flourishing in other parts of the world. And it’s sort of a little bit of just given the right sort of responsible guardrails with the right sort of encouragement. Companies see the real benefit in this technology and I think consumers begin to see it as well. And we’re still at the very early innings.

I do think back to the early days of the internet, right, and we’re still struggling with some of the things that the internet brought us like viruses, and malware, and hacking, but no one would debate the amount of value that the internet has brought to civilization. I think we’re sort of in those early years of the internet, in crypto years, where we’re still dealing with some of the fallout, right, in terms of … And sometimes it can be easy to sort of lose the vision of really we’re on this journey of being … Transforming society for the better in many ways. We’re making systems more efficient, we’re adding more trust to the way that companies can do business with one another. It’s a very exciting journey, right?

Ian:

There’s a great chart out there that maps the number of users onboarded to the internet and to the sort of digital asset, blockchain, crypto ecosystem. And I think we’re roughly at late ’90s like ’98, ’99 timeline on the internet adoption curve. So if you can rewind back in time to 20, 25 years ago roughly and think about what the internet was then, it does feel a lot like where we are with digital assets right now. There seems to be some promise if you’re optimistic, but if you’re a pessimist you can certainly call out all the faults and say this thing’s never going anywhere, right? It depends a lot on your perspective. We’ve heard a lot coming from the Middle East. Is Deloitte doing any work there?

Tim:

We are.

Ian:

The Emirates seems to want to create a global financial hub built around digital assets.

Tim:

I think it’s not only the Emirates, I think Saudi Arabia has project NEOM so they’re looking to sort of capitalize on it.

Ian:

NEOM’s the digital city initiative?

Tim:

Yeah. It has aspects of actually a digital economy to go with the new city as well. Partly because of some of the conflict in the world and the sanctions that have come with it that there’s a reallocation of capital to different parts of the world and new opportunities. It’s one of the things that’s sort of helping us with this new dawn of what’s possible for the next sort of even 100 years, let’s just say, in terms of how do we redefine how we do business and how can we better use technology for good to sort of help overcome some of the problems? It’s very easy to look at crypto because the headlines might suggest there’s just as much bad as there is good. I’m very optimistic about this, that we will eventually figure out ways to effectively regulate some of the bad. We’re only just scratching the surface on some of the good and the transformation that will come from this.

Ian:

I think you have a unique perspective on this. You were born in Zimbabwe and you’ve spent time all around the world. You made the comment to me yesterday that people critique digital assets frequently for the volatility, but volatility’s sort of a relative concept. So if you operate largely in dollars … Yes, Bitcoin prices seem volatile relative to the dollar payer, but for many currencies around the world it’s actually a source of stability. Talk a little bit about that.

Tim:

Your perspective on the world is where you’re coming from. I think we criticize Bitcoin because of its volatility relative to the US dollar. Now, the US dollar is still very much the global sort of reference point. As you said, I mean, in countries that have high inflation … And if you’re a citizen just looking for some stability … You are attracted to things that give you some sort of independence from a system that’s just simply not working for you. Now, I think we still are quite a ways away from regulatory regimes that’s going to accommodate. Although this is certainly a possible outcome, that things like these distributed systems get shifted to sort of the sort of gray, sort of quasi illegal, right, where … And I think as we think about these regulatory regimes, which are adapting, the one big question that is still out there is can a regulatory regime accept distributed systems? Because the thing with regulated financial systems is this concept of accountability is all the way through them, someone has to be accountable for everything that’s sort of operating.

And then you bring in this idea of a distributed system where well, the accountability’s a little fuzzy, right, it’s actually the crowd that’s sort of accountable, and through some mechanism it just simply works. It’s an education problem but it’s also, I think we have to think … And it’s probably the burdens more on the industry to bring ideas to regulators to say, “Here’s how I think you could regulate this.” Now, a lot of it is really what Chainalysis does, right? As we’re talking about it in this conferences is it’s how do we bring intelligence to regulators so they can effectively sort of see what’s going on?

Ian:

I mean, that’s such a great point about the shift in concept and understanding, right? I think decentralization is thrown around in this space as a … There is direct value in decentralization. I think that may be a little bit misleading to people. It’s like well, no, we have institutions because of lessons learned in the past, right, which is when you have no one that is directly responsible and accountable bad things can happen. Your money’s not in the bank when you go to withdraw it, right, to draw a very simple example. If we look at the crypto ecosystem over the last few years we sort of have arrived at almost crypto institutions, very big exchanges that dominates the landscape of how most people interact and engage with crypto. But we have this DeFi ecosystem that’s really pushing the boundary of no middleman, self sovereignty in terms of investment and borrowing. Do you see that as the continuing growth area, or do you think we end up with an institutional layer wrapper in DeFi and that becomes more of a backend infrastructure?

Tim:

I do see potential in DeFi. We’ve got to somehow figure out a regulatory regime so that DeFi can become accepted and legal. If it ends up being a centralized-only regime we would’ve significantly muted the value, right? To your point, there’s tremendous value in these decentralized systems. We need to do a little more thinking about what are the governance models in decentralized systems so that they can stay sufficiently decentralized. There’s still a little bit of wonkiness relative to how some governance decisions get made in decentralized systems, and they’re certainly subject in some cases to sort of undue influence from some quarters. And particularly when the enterprise is small it can be influenced by big dollars sort of buying their way into governance tokens, things like that. There’s still a ways to go. And I really hope that we have this marriage of some centralized institutions participating actively and working with DeFi institutions.

And maybe we end up in an area where a DeFi institution or facility has to get somehow certified. We may end up having DeFi entities that are certified by various regulators around the world where that regulator would issue a digital certificate to that. As a participant sort of smart contract, you could actually have the smart contract have a wrapper that has a digital certificate from a certain regulatory agency that says, “This carries a certain level of certification from that agency.” You can use it with confidence. And if you don’t have an outcome, if you have a bad experience, you can go register a complaint with that agency. Now, that’s sort of way off in the future and sort of-

Ian:

The thing that occurs to me as you describe that is, who is the individual that takes the smart contract through that process? At some point there’s somebody signing a document that says … Attesting or asserting to the … This is how the smart contract works, right? All the institutions assume there’s a person, the CEO that signs to the bottom. I think a lot of the DeFi protocols today would say, “Well, there is no person because there is maybe a legal entity, a decentralized autonomous organization that owns or operates the protocol but that is not an individual.” So how do we go through that certification process?

Tim:

But it could just be a vote of the governance holders. And so you would set certain requirements to say, “Let’s just say it has to be a super majority.” And so then you have the vote, the vote gets recorded. And maybe it’s something that has to get revisited on an annual basis where the governance holders have to re-vote, do they want to continue to re-up with that particular institution?

Ian:

This is fascinating. Any bets on who would be the first institution that would enable something like this?

Tim:

I don’t know. My sense is that it is likely to come from some of the smaller economies that are trying to compete for commerce. I think we all have a role to play in terms of making sure that those are robust. Because if you start something and it’s a bit of a failure then it just sort of crates the idea for some time to come with other larger entities that are willing to try the same thing.

Ian:

I’m curious to shift the conversation maybe to the real-world impact of some of this technology. I feel like we spend a lot of time talking about the theory, but payments is one area that I think you all are spending some time doing work that could potentially have some very meaningful impact. How do you think about digital assets and payments?

Tim:

I mean, the payments system globally is terribly inefficient. It uses, in some cases, technology that’s 30 years old. I mean, it’s almost pre-internet. I mean, money does not move globally at the speed of the internet is one phrase that’s oftentimes used. So there’s no reason why it shouldn’t right? There’s no reason why it should take two to three days to get money transferred from one part of the world to another part of the world. Blockchains offer a tremendous way to control that. The Internet’s, obviously, already there but then you have this additional layer of control. Whether it’s stablecoins, whether it’s tokenized deposits, whether it’s some outcome of CBDCs that are DLT-based, there are, obviously, a number of CBDC research initiatives going on that are not DLT-based, that’ll be ledger-based. The future is still very unclear. We have a number of initiatives like Fed Now coming online next year, if it sticks to the schedule, where it will bring a level of sort of instantaneous settlement capability.

Still, a big debate about does a CBDC-type offering in the US, does it even come to pass? I know there’s a lot of debate about that right now. And how does that compare with what the facilities of a Fed Now system have to offer? There is a certain value, I think, in having corporates have a level of direct control. There’s one vision that says, “Well, everything has to sort of run through the government.” There’s another vision that says, “Well, companies have a level of direct control,” and this is sort of more of the crypto-decentralized sort of view of being able to control their own money. I think at the end of the day there has to be some marriage, right?

I don’t think we’ll ever see a true sort of decentralized sort of value transfer that is in a regulated … I think there’s some level of accountability that comes for sort of significant flows of value around the world that has to be happen and get reported up through regulated institutions, right? Anytime that you’re offering something that’s outside of that regulatory context you’re not going to have the right reporting oversight and so it’s always going to be on the gray fringe and sort of unregulated, possibly illegal. That’s the first step is I think sort of finding the pathways within these regulatory institutions. There are a lot of big banks right now that have technology that’s ready to actually execute on this vision and it’s just waiting for some of the regulatory pathways globally to be figured out.

Ian:

Interesting. So there’s banks who have systems that are capable of doing instant or near instant settlement, not three days for a wire or an ACH to settle.

Tim:

Absolutely.

Ian:

And they’re holding that back because?

Tim:

It’s really more the regulatory permission to sort of … There’s also, obviously, a level of competition, right, between the banks in terms of … Some work that is I think still needed is standardization, right, in terms of … And there are payment standards out there that we’re working towards. I think with the right sort of will, and I think with governments understanding the value to their economies of facilitating these payment flows … And as the term is sometimes used, increasing the velocity of money, this has a tremendous benefit to these economies in that you don’t have to have as much money held that sort of sit and not really working.

Ian:

That’s interesting because I’ve been wondering about the … There’s a lot of countries around the world where there’s strict currency controls like preventing foreign exchange, and it’s often an attempt by the government central bank of a country to maintain a certain exchange rate relative to the dollar or the Euro and so it’s very hard for people to move assets in and out of the economy. We hear all sorts of stories about how crypto stablecoins or Bitcoin is being used to bypass currency controls for international commerce out of these economies. I could imagine a world where crypto-adoption becomes pervasive potentially as a grassroots movement. We see some of this in our data Chainalysis where some of the most crypto adopted countries are those where this condition exists, but that ultimately undermines, I think, the fiscal monetary policy of the government, right? It’s sort of forced globalization in some ways which I could imagine being destabilizing in a negative way. Now, that’s without commentary on is the government in any of these countries good or bad, right, it’s just like do we want that to happen?

Tim:

And I think you’re exactly right we don’t. We want to bring crypto out of the shadows. As you said, I mean, consumers around the world see so much value in this that they’re so anxious to adopt it but it’s never going to be an adequate solution while you’re doing something that’s sort of quasi-illegal in order to have to use it. We really hope governments embrace the technology. And it’s a little bit like if you remember the Napster days, right, where everyone was sharing songs. And it really took the offering of a legal alternative, where you had to then pay for your rented music, to really make it … It’s untenable and then much more easy to prosecute the folks who win. Now, we don’t have a legal alternative right now and that’s hopefully what we can get to.

Ian:

Our CEO Michael Gronager makes that exact point all the time. He’s like “We’re very much in the Napster days of the internet where people are having to skate on the edges of legality in order to use crypto in many concepts.”

Tim:

Hopefully, governments see the benefit of serving their consumers, and this is a consumer trend that clearly consumers want. And so it’s a case of well, how can we help them do it in a regulated safe way?

Ian:

I’m hearing a ton about real-world asset tokenization. What’s going on there?

Tim:

So this is a big trend, and I think a lot of the big banks see the opportunity to tokenize real-world assets. So essentially what the idea is, is that you could offer an array of both more efficient but sort of programmable financial services and markets around real-world assets where they’re just not available to that type of service today because they’re not in a digitized token form that can be offered in that way.

Ian:

Give me an example of what you mean when you say real-world assets.

Tim:

The general philosophy is that where banks want to start is in what’s considered near liquid so bonds as an example. And then eventually over time, they’ll move to less liquid assets that might include real estate, and then eventually other types of assets that are even less liquid than real estate. But essentially, if you got to go back to the 2008 crisis, a lot of the initial cause of the crisis was a lack of transparency that these financial assets were getting sold in tranches and very dependent on a credit rating in terms of what was actually in there. With this new tokenized technology, you now have transparency to the individual assets in each of these tranches. So as you’re selling a group of mortgage-backed securities or something like that, you can have transparency to … In essence, every single mortgage in that portfolio. You can actually have algorithms that run that actually come up with your own independent assessment as to the quality of what you’re buying and selling. So you’re no longer having this dependence on a third party where-

Ian:

No, this is really interesting. Because I’ve heard people talking about tokenized real estate, and there’s a couple companies out there who have actually … They’ve managed to put a house on a on chain as an ERC-20 or something, a similar type token, but it’s been for the retail transaction, right, so the individual is buying an NFT that grants them rights to an LLC that holds the deed to the house. And I’ve thought that seems like a lot of work for not really a materially different experience. And people have argued with me like “Well, it opens different pathways for lending.”

But what you just said is actually much more interesting, which is the mortgage behind the house. Let’s say you do a normal standard mortgage in the United States, generally, the originator of that mortgage packages it up with other mortgages, sells it on to a couple banks or the US government, who then turn that into a collateralized debt obligation which contains hundreds of thousands of mortgages potentially. And those get traded back and forth between all sorts of financial institutions, but you can’t really see what’s in them easily today. If each of the individual discreet mortgages were actually represented as a token or even a slice of the mortgage potentially because I think you could maybe then fractionalize.

Tim:

You could separate the servicing rights from the underlying asset and things like that.

Ian:

And so all of a sudden now I have a similar financial instrument but with a much greater degree of auditability transparency.

Tim:

Exactly.

Ian:

That seems really powerful.

Tim:

And just much greater efficiency and control. So from a regulatory standpoint, it’s a much better answer. The banks end up being much more informed and competitive. At the end of the day, it reduces the risk for the banks so the banks should then be able to actually offer better rates all the way down to the end consumer.

Ian:

It seems like it could also allow people who want or are willing to take on more risk for a better rate. It broadens the likelihood of getting financing because you’ve again got more transparency.

Tim:

We’re talking about sort of at the macro end of the market. But at the micro end of the market, it opens opportunities in developing nations as well where you can put an asset sort of as collateral behind a loan in a way that you wouldn’t be able to get a loan easily. The ability to sort of be able to tokenize … Now, what we need is the legal systems that actually connect the legal system to the blockchain. And so the example you started with of someone saying, “Well, I’m going to sell my house on the blockchain and create an NFT.” In most cases, the actual legal underpinning of that arrangement is still based on wet signatures on pieces of paper, not on the blockchain so the blockchain doesn’t represent ultimately the legal arrangement. We do need to have some sort of evolution either in the law or in the regulation that allows this asset tokenization trend to come about.

Ian:

Is that the barrier to the institutional side, the CEOs, where we’re seeing those mortgages being tokenized? We’re still needing some work done on the legal side.

Tim:

We see tokenization happen today in the OTC market but the liquidity is small, right, so you’ve got sort of small parcels of liquidity. So it’s almost in a test case where it’s proving that the technology works. I think we do need both the regulatory framework to do this at scale and some evolution of the actual law as to things being able to be actually represented on the blockchain as the legal record.

Ian:

Great. Hey, maybe as we wrap up the conversation and head back to the conference, when you look out over the next couple years what are you most excited about in this space? What do you see as the big innovation that’s going to have outsized impact?

Tim:

We’ve touched on some of it. We’ll see the banks I think recognize that there is a competitive necessity to be in this space. I’m hopeful that the banks and firms like ours … I mean, we all have a role to play in helping regulators understand sort of how this can be regulated, and it really needs to be, right? As opposed to, in some cases, we sort of sit back and we wait for the regulators to just come up with regulations but they need a lot of industry help so this is public-private partnership. I’m really excited about that, that we will begin to see more of this collaboration between industry and regulators to come up with responsible frameworks.

I think with a lot of the crypto asset and virtual asset rules around the world there will be a lot of lessons learned, right, in terms of what’s working, what’s not and so it’ll be fine-tuned. But the benefit will accrue to those regulators that have actually put some regulations out there to say, “Okay, here’s how we want to do it and we’re going to monitor it closely.” So there’s definitely a value in the learning, right, and being along for the journey. We’re very excited about that.

I think we will just continue to see the actual benefits of crypto impacting more and more of the masses of society. And I think it’ll have to come through a regulated sort of frame so it’ll have to probably come through the banks. With regulation where the banks will then be able to offer regulated services that take all the advantages of crypto and offer it to the retail public that way. And that way you’re buying a service from an enterprise you trust but it has all the benefits of this. As opposed to right now there’s just too many risks and dangers to trying to sort of get a meta mask wallet and saying, “I’m going to try” … And any number of things can go wrong, right? We’ve got to move away from that world to a world where we’re sort of finding the right balance where it’s not all just competitive. We want to keep you just as a customer where it’s really transforming and bringing all the benefits of this economy to the end consumer but in a regulated safe ways.

Ian:

Makes a ton of sense. Thanks for joining us on the podcast, Tim, enjoyed the conversation.

Tim:

Great to be with you, Ian, thanks. All right, Bye-bye.