There are hopes that the collapse of crypto firm FTX will be a watershed for the industry to move from speculation to utility.
Bosonic, a decentralized financial market infrastructure (dFMI) company which aims to help eliminate counterparty, credit and settlement risk for digital assets, hosted a webinar on 30 November on ‘Lessons from the Collapse of FTX.’
Panellists agreed that although digital assets are new, the lessons being learned are old. For example, CLS was set up in the foreign exchange markets to remove settlement risk after the failure of FX trades affected the banking system. Ironically, CLS is probably now under threat from the ability to digitize currencies and to transact instantaneous atomic swaps.
Tuhina Singh, chief executive of Singapore-based Propine, said on the webinar that the crypto industry has two separate types of players – the first consists of decentralized protocols and applications while the second consists of centralized service providers. Propine has a licence which authorizes the firm to custody digital securities, crypto and fiat currency on one platform.
Singh continued that problems occur when centralized service providers become regarded as decentralized players and then try to avoid being audited and regulated.
“That is when they become weapons of mass destruction like FTX,” she added.
Singh continued that a big lesson is that centralized service providers, especially if they are systemic, must adhere to proper risk management, governance, audit and regulatory requirements.
“This a watershed moment where we will see the industry move away from a speculatory phase to a utility phase,” she added. “We will see use cases emerge, such as tokenization, in a more efficient and better model.”
FTX’s customer assets were not held with an independent custodian and were not segregated.
Singh highlighted that most conversations about digital asset custody revolve around managing keys but there are several other wrappers that come into play for institutions including reliability, scalability, legal frameworks, statutory capital requirements and asset servicing. In addition, she explained that self-custody may be appropriate for managing your own assets, but should not be used by firms managing assets on behalf of a beneficial owner.
Giorgia Pellizzari, head of custody at HEX Trust, a digital asset custodian for institutions based out of Hong Kong, said on the webinar: “I believe that 2023, and hopefully all the years to come, are going to be golden years for custodians. From being possibly the least sexy part of the digital asset space, we are finally becoming relevant.”
Phil Enness, global head of business development for JPM Coin at JP Morgan, said on the webinar that new technology brings new capabilities, efficiencies and transparencies but the necessity for the segregation of duties and responsibilities, and the appropriate level of regulation does not change. He continued that the rationale for custody has not changed, even if assets are digital, and relate to balance sheet, trust and security.
“The crypto industry can learn from that and rebuild from the ground up with the appropriate level of trust, credible partners and with a clear segregation of duties,” Enness added.
Rajeev Tummala, digital assets product lead at HSBC Securities Services in Singapore, highlighted on the webinar that custodians are used to transformations in the representation of assets and have already moved from paper to materialised assets.
“The fundamental need for custody is not going to change,” said Tummala, “We all agree that there will be new ways of custody for digital assets but the fundamental need for separation of duties will still exist.”
Rosario Ingargiola, chief executive of Bosonic, argued in the webinar that the technology already exists to eliminate the need to trust counterparties.
He said: “Bosonic is the only company in the world whose clients traded with FTX up until literally the minute they shut the exchange off, with no risk to them whatsoever. This is because the technology stack that we have built provides an alternative to central counterparties or Tier One banks offering prime brokerage and credit intermediation because they don’t exist at scale in the digital asset space.”
Bosonic is never a counterparty to trades but provides technology to eliminate counterparty, credit and settlement risk. The company licences a blockchain ledger system to custodians so they have the tools to calculate net settlement and automate movements. Once assets are tokenized and on a ledger, they are visible to trading counterparties in the network for all downstream applications that the Bosonic Network provides including real-time peer-to-peer trading that self-clears and settles at the custodial level.
Ingargiola described the cascade of settlement failures following the collapse of FTX as a credit crisis. He said: “Eliminating counterparty credit risk by using the right model and technology is available today.”
However, Lars Holst, chief executive of GCEX exchange, argued on the webinar that market participants cannot just trust technology. He said: “I still fundamentally think, perhaps because I’m getting old, that it starts with the people because tech can be manipulated.“
Simon Barnby, CMO at Archax, a fully FCA regulated digital asset exchange, broker and custodian, said on the webinar that the industry should not wait for regulators to solve the problems the have emerged.
“As an industry we all need to do the right thing,” he added. “Shocks like this shake out the bad actors, and those of us that survive will do things the right way and adopt applicable regulation, as and when it comes.”
