May 7, 2021

METACO TALKS

Custody 2.0: Paving the way for digital asset adoption at scale w/ Peter HOFMANN

METACO TALKS with Peter Hofmann, CEO of Custodigit, a company backed by SIX Digital Exchange, Swisscom and Sygnum offering an investor-grade custody solution targeting regulated financial institutions. Previously, Peter worked in different senior positions in the financial services industry for companies like Cap Gemini, KPMG, IBM, PostFinance and several startups
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Welcome to METACO TALKS – Live conversations with the people operating at the frontier of crypto innovation: entrepreneurs, bankers, investors, fund administrators, traders, analysts and other crypto and digital asset market participants. Our objective is to help the broader ecosystem navigate this complex environment and unlock the market opportunity.

This podcast is hosted by METACO – the leading provider of security-critical infrastructure enabling financial institutions to enter the digital asset ecosystem.

Our guest is Peter Hofmann, CEO of Custodigit, a company backed by SIX Digital Exchange, Swisscom and Sygnum offering an investor-grade custody solution targeting regulated financial institutions. Previously, Peter worked in different senior positions in the financial services industry for companies like Cap Gemini, KPMG, IBM, PostFinance and several startups before. Peter has a long-lasting experience that bridges financial services, technology and innovation.

 
Disclaimer: This is not investment advice.

Play video recording | Digital Asset Custody 2.0 w/ Peter HOFMANN

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Full transcript

Seamus: [00:00:09] Welcome to Metaco Talks. I’m Seamus Donoghue, the VP of Strategic Alliances at Metaco. Metaco Talks is now a weekly discussion on topical issues and thought leadership in the digital asset space. It’s a live streamed conversation. You can ask questions, so please do. Use the chats during the conversation. After the call, it will also be available as recordings. They can be found on a website and also the major platforms: YouTube, Apple Podcasts, and Spotify. Please subscribe and leave a review.

Today’s title of Metaco Talks is custody. 2.0, paving the way for digital asset adoption at scale. We have our guest, the CEO of CustoDigit, Peter Hofmann. Welcome Peter.

Peter: [00:00:47] Hi, Seamus. Thank you very much for having me.

Seamus: [00:00:50] It’s good to have you here. I love the background, it’s nice to feel like we were both in Switzerland. It’d be great to start, you and I obviously have met many times, but we haven’t talked on a personal level. I’d love to hear your story, how you got into the crypto space before we get into the topic at hand.

Peter: [00:01:08] How I get into the crypto space. I’m an engineer by heart, so I got always attracted by crypto. At that time, I also have to say, I was working in the innovation field at Swisscom. We did have a trend throughout for the financial service industry. Somehow I came across, I would say 2014, something like that, across blockchain in general and Bitcoin. Being an engineer, I got fascinated. I started opening up an account that Coinbase, and started that my journey with the whole crypto space and later on then digital assets in general.

Seamus: [00:01:50] You invested when first?

Peter: [00:01:52] First, I would say six years. Not 100% sure about the year, I remember the price was somewhere around 300 to 350. That’s when I started. I guess that has been around 2014/15, something like that.

Seamus: [00:02:09] CustoDigit now is just a pastime to keep you busy, because you’re retired financially now?

Peter: [00:02:15] No, I remember that. We did then have a spike in the Bitcoin price and that’s where I sold everything. I had to start over again.

Seamus: [00:02:25] I think we’ve all been in that journey. One or two times your returns is normally a home run in most markets, but not in crypto performance!

Custodigit, I have a little anecdote. I was in Singapore prior to the founding or during the founding of Custodigit. I had a colleague who was one of the founders of Sygnum. I remember him mentioning that he had struck a partnership with Swisscom around custody, I guess that was part of the genesis of Custodigit. I’ve always been curious around, how did Custodigit come about? What is Custodigit?

 

About Custodigit

Peter: [00:02:57] Let’s start with the question: what is CustoDigit? CustoDigit is an enabling platform for regulated financial service providers so that they can provide digital assets services to their end customer, and don’t have to tackle all the technical challenges of keeping private keys safe, or how to actually integrate trading, propriety, and all that. It’s taking away the hard edge on that side for the regulated financial service providers.

I mentioned before, Swisscom is quite an innovative company and they want to grow. They have set up a special digital business unit. That’s where they are focusing on growth opportunities outside of the core business.

At that time, I was actually within that group and I was somehow into DLT, into crypto. I came up with the idea that we should have somehow a platform for the banks, that they can get much easier into cryptos than before. I came up with the idea, pitched it to management, got the first founding round so that we can start developing a concept around. Then a coincidence happened. At the Singapore FinTech festival, we met with Steph and Mathias and the whole crew around Sygnum. They were looking for such a platform because they needed to start their journey. That’s how we get together and then decided, let’s build it together, Sygnum being our first customer. Filling in also what’s required, what the requirements are, and building it up from there. That’s pretty much the whole story.

Seamus: [00:04:49] It was a bit of a serendipity. Was this 2017 or when was this?

Peter: [00:04:52] I would say that was ‘17 or ‘18. Late ‘17, I would say.

Seamus: [00:04:59] Normally the FinTech festival is November, that makes sense. It’s quite an intuition in 2017 to think that there was a use case for banks? What brought that on? Were you seeing banks do anything in this space, and why would you expect the bank would embrace what was considered say still kind of a dark web asset at the time?

Peter: [00:05:20] It was. But luckily that’s changing, quite dramatically I would say. I was working my entire life in the financial service industry, always at the intersection between technology and the business. I see, although a few see it differently, that regulated financial service providers do have a big asset. That’s trust.

What we have seen also with all the FinTech trends, they may start outside of the traditional players, but then when it’s getting really big is when the traditional players are coming into the space as well, because they can really foster that up. I always believed in that story; that what was missing is regulation and the trust part in it. We have seen slowly also in Switzerland at that time, that the regulator is moving forward on it. Not that he is in the journey, but that he is moving forward. We saw that was the absolute best opportunity to get into the bank.

We also, Swisscom having as a founding partner, of course you have to play in the regulated space. That was a precondition. It was also an ideal leverage of the assets Swisscom is having. They do have customer relationships to several banks. Of course, in Switzerland, actually they are operating the application architecture of around 80 Swiss and international banks in their data centers. It was more or less an obvious move to do it that way.

Seamus: [00:06:59] That does make sense. But it’s still very forward-looking I would say for a very large institution like Swisscom.

Peter: [00:07:08] Yeah, that’s maybe a good point. The timing, that’s always, if you draw business cases you anticipate that the change will happen earlier, but you underestimate the impact in the long run. But that’s a good point on Swisscom itself. That’s maybe also something you need to know. In telecom you have special dynamics there. 90% of the revenue sources change every 10 years – 90% of your revenue. Compare that to the banking industry, that’s a totally different game

Seamus: [00:08:48] That I wasn’t aware of. Can you give some context? Why or how is that?

Peter: [00:07:52] Just to give you an example, maybe you remember SMS in the old times?

Seamus: [00:07:58] Of course, paid messaging.

Peter: [00:08:00] Paid messaging, huge business for Swisscom. But it fell apart from one day to the other, pretty much. You have constantly to innovate as a telecom provider. That’s also in the DNA of Swisscom. They are constantly looking for new services. That’s the major difference between being a telecommunication company and being a financial service provider.

Seamus: [00:08:28] That’s interesting. We have the surface of a very conservative large institution, but they have to be nimble in terms of reacting and forward-looking. Fascinating.

You had this moment of serendipity in 2017 at the FinTech vessel, how did that relationship with Sygnum evolve to what it is now, and where is that relationship now?

Peter: [00:08:48] The relationship is fostering. We are working together more or less on a daily basis with Sygnum. I’m also happy that we can contribute to the success of Sygnum. They have, in my opinion, really found a place in the space and doing well and prospering.

Interestingly, I don’t if you have seen the latest press announcement we did during December last year? Our ecosystem grew with an additional member, the SIX Digital Exchange joined as well. That’s great. You now have, in my opinion at least, the perfect combination of an ecosystem with a young, nimble digital focused bank in it – Sygnum. We do have Swisscom as a tech provider who knows how to operate security-sensitive infrastructures, and we do have someone who is bringing in the knowledge and the strategic view on a market infrastructure. It’s great to work with all of them together.

Seamus: [00:09:51] It’s a very interesting mix. You have the first crypto or FINRA regulated crypto bank, and you’ve got the SIX, which is the largest exchange in the payment infrastructure in Switzerland, and yourself together as one team. What’s the go-to market on that consortium?

Peter: [00:10:09] Go-to market on that, we do have different services and they are also independent. We do have Sygnum bank which is providing banking services; to be a little bit more precise, it’s the SIX Digital Exchange. As they join our ecosystem, they do have the digital platform they’re building right now as a market services, but there’s close collaboration between all the parties.

It’s also good, in my opinion, because with the virility in the Swiss ecosystem, we are keeping, but really moving forward in the maturity of the whole service and the infrastructure which is available in Switzerland for digital assets. Let’s put it that way.

 

The future role of financial services providers

Seamus: [00:10:58] You’ve mentioned the context of the Swiss ecosystem and availability in the Swiss market, but is there a global play here as well? How do you guys look at the global opportunity?

Peter: [00:11:07] Of course there’s a global play as well. We are being an infrastructure provider in the end, or a platform provider. You normally do have fixed costs, quite a lot. You have to build the stuff and set it up, and then to operate it in an economic way what you need is float. At the moment, if you see the volumes, although I looked up Bitcoin market cap is 1 trillion now, even above 1 trillion, you need to have float on such a platform. That’s also, especially from a CustoDigit point of view, where we also have a view and go-to market on the European market as well.

It’s also, in my opinion at least, I don’t know how you see it, it’s getting moving in the European market. You do have a regulatory change coming up in Germany. With Mika, even the regulation and the European union, there’ll be set 2024, if I recall it correctly. It’s an interesting time.

Seamus: [00:12:28] Yeah. I would say it’s not just there, I think most jurisdictions now are aligning. We’re seeing even what was the lag, the US market, really moving to the forefront of movement there; every major firm is embracing it.

You made an interesting comment. You talked about the vision that you thought was obviously going to be regulated at some point would be a catalyst. But to me, one of the biggest, most important ones, is the size of the market, as you mentioned.

In 2017, it was very hard for institutions to care, because transactions, just the liquidity wasn’t there. But when you’re talking about a $2 trillion asset class, or as you mentioned $1 trillion for Bitcoin alone, this is a viable. Particularly out of that, Coinbase can have a $70-80 billion market cap in a $2 trillion asset class! It’s becoming something that’s hard to ignore.

Peter: [00:13:13] Absolutely.

 

Custody 2.0

Seamus: [00:13:14] Why don’t we move on? The topic was custody 2.0, what does that mean? What is custody 2.0?

Peter: [00:13:24] It’s a good statement you made. What we see right now in the market is that a substantial volume is coming in. We see it’s not only the early tech savvy retail customers going into digital assets, we at least from our perspective, see now the institutional investors’ interest in that asset class, and you are facing a totally different question and challenge.

If we have a look in the past, it was all about how do we keep those private keys safe? You remember the days with the non-electric sticks? That’s how we started. Let’s say custody 1.0 was about having some kind of an enterprise application, very securely stored, the private keys have an integration with the execution venues.

If we now have the context of institutional investors coming into the play, different volumes, different ticket sizes on trading transactions, different questions are coming up. Questions are coming up: how do I build an efficient market infrastructure? How do I ensure settlement in an efficient way with bigger tickets? How do I provide the liquidity? How do I integrate that then into existing core banking applications?

That’s now, from my point of view, the questions we have to face and solve in custody 2.0 in order to have a market infrastructure ready that we can actually move to the next level of adaptation in the digital assets.

Seamus: [00:15:07] If I take what you’re saying, it’s not just about keeping the keys safe, t’s about the full breadth of services that you can build around custody as well. In the traditional asset space, you see managing corporate actions, the board and sec lending and everything in between, or trading of course. Do you see that as the kind of table stakes in this space now for custody 2.0 as well? That it’s not just custody strictly speaking?

Peter: [00:15:33] For me, the custody is a little bit misused in the crypto space or there are different understandings. If you we are talking about keeping the private key safe, I call that safekeeping more; and the custody for me is more regulated services. But in my interpretation, I always take custody and the whole brokerage trading topic together, because it’s somehow interlinked.

Back to your point, I do have the observation and feeling that the security part of how to keep those private keys safe, that’s solved. Or it is seen to be solved. It’s not an easy thing to do, don’t get me wrong. It’s an engineering discipline how to build a secure and safe system in order to keep them safe, but the challenge is solved and now we can move on.

Seamus: [00:16:27] I agree on this. There is relatively standardized OPSEC around that as well. We’ve got that part done. Extensively it should be done in most institutions. For you, are you regulated? That obviously leads to the question, given the focus on regulation.

Peter: [00:16:40] Custodigit itself is not regulated, because we are providing a platform to the regulated financial services industry, which is then providing regulated services to their end customers. We are really a tech platform provider and don’t need the regulation, and we do have that even in writing.

We engaged with the regulator early on during our journey. I don’t recall exact when, but we did have a lot of discussion and even got a letter from the regulator in Switzerland.

Seamus: [00:17:20] Is it the same approach in other markets, engaging with the regulators and understanding how to be that platform provider in those markets?

Peter: [00:17:28] Yes. From our side, we do that, engaging with the regulator early on, on our journey. Of course, then first liaison with some lawyers who can guide you through the regulations coming up. I don’t know how you see it, but in most countries the regulation is still a little bit influx and you need to know what is the latest thinking, in what direction is the regulation going on?

That’s how we normally do it, with some lawyers who know the current state of the regulation and see the direction it is going. What we see from a structural point of view, is that most of the countries go in a similar direction as Switzerland is – that you have that model where you don’t need a license if you are a platform provider. If that would be different, it will be also an interesting question. A lot of those banks are using core banking system. The question will be: does then the core banking provider need to be regulated as well, if that would be the case?

Seamus: [00:18:35] I think that’s a good analogy. The framework we often think about is: well, you’re just delivering a service as a platform.

With that framework, what is the typical client you’re facing? Or how have you seen that client evolve, or the type of client evolve, since you guys have been the market? Who are the early customers and who do you see now get in the market, and what’s driving that decision process?

 Peter: [00:19:02] What we observed is, as I mentioned before, the sentiment around cryptocurrency specifically, or let’s make one step back, I have seen that the financial service industry was always interested in the tokenization part. They understand why it’s seen as a big opportunity for process of efficiency, but also opening up new asset classes.

What I’ve seen in the last 9 to 12 months, that the sentiment on the cryptocurrency almost changed 180 degrees. It’s getting accepted, more or less an accepted speculative asset class. That sentiment changed, in my opinion, in the financial service industry. What we see right now is that a lot of the big banks are making their minds around how and what they should provide to the end customers or to the customers in general, starting projects. Then we have the midsize banks and there we see quite a lot of movement right now. They are starting projects and having the decision if they want to move into cryptocurrencies as well.

I would say that’s an interesting move we have seen, that they are at the crossroads now. It’s yes or no. In the last 12 months they have moved quite a lot on that journey, I would say.

Then we see the smaller banks, which also want to complement their product portfolio with digital assets in general, a few of them are also focusing. I call them edge cases, but very interesting cases, where they see that an interesting business case can be realized.

Seamus: [00:20:55] What do you mean by an edge case? Can you give an example of some of those edge cases?

Peter: [00:20:58] For example, we are in a project where we do the tokenization of art, so opening up a new asset class. But it’s not only opening up a new asset class, also process efficiency is in. An interesting part is as well, for a bank that they can ensure that the assets are under management will even increase with this new asset class for them.

That’s an example of a little bit of an edge case, but with a bit of a viable, rational behind how to make money and how to provide added value.

Seamus: [00:21:36] I always wonder if this is just a technical exercise to prove it’s doable, is there a demand for, I want to buy a 1 million fraction of a Monero or a Pipo? Is there an end demand for this type of thing?

Peter: [00:21:54] Yeah. Maybe the use case I just described comes from a little bit different angle. Yes, there seems to be a demand, but it’s not only that you own a small part of a Monero or whatever. It’s also interesting in certain segments, the inheritance case.

It’s a different angle slightly, but a very interesting one, how you can actually bring in a process efficiency if you have to split it up in inheritance case. It’s also quite interesting from a banking perspective; normally that would be then an outflow of assets under management. With such a model concept, you can ensure that asset under management stays with the bank. or even additional assets under management are coming in.

Seamus: [00:22:44] If I understand what you’re saying, the asset doesn’t necessarily have to be liquidated. It can be liquidated in portions to those that inherit it that require the liquidity, and the others can maintain their painting their grandfather purchased or whatever?

Peter: [00:22:56] Exactly. That’s at the stage, in my opinion, the tokenized assets are right now. The first viable use cases are really emerging and getting traction. Although, in my opinion, it will take a couple of years still to get substantial volume in that specific market. But there is added value in tokenization.

Seamus: [00:23:27] Those are value propositions I hadn’t thought about, which are quite persuasive.

We should go to some of the questions here. We have some questions I should go to. You mentioned around what the demand you’re seeing from clients. Can you put that in the context of – one of the questions is what IT solutions are you providing to Sygnum? What do you provide for Sygnum, and what’s the offer that you guys can offer to a bank now that’s going to market?

Peter: [00:23:50] That’s a good question. We provide a SAS platform to Sygnum, for example, but also to other regulate financial service industry providers – which is an extension of the existing application core banking they are having for digital assets.

With our platform, you can actually provide custody services to your end customers. You can provide trading markets service to the customers. That’s the main two use cases which are covered by our platform, and as a bank you’re getting all the functionality you need in order to run your business processes in an efficient, compliant, and secure manner.

Seamus: [00:24:35] Does the client have to manage themselves, if any?

Peter: [00:24:39] The core banking, the fiat side of course, and with our SAS service, he doesn’t need to manage any tech on his side. We are taking care of all the technical challenges and the hitches which come with that.

Seamus: [00:24:50] That’s a nice friction elimination. We do know from our own experience that it’s non-trivial managing a tech service.

We’ve got some other questions, maybe a bit very specific. I don’t know if you have a view basically around the cryptocurrencies, whether things like Bitcoin or tokenized Swiss francs or off balance sheet in case of bankruptcy. Is this something you want to touch on?

Peter: [00:25:18] Say it again.

Seamus: [00:25:20] Can you confirm the cryptocurrencies or Bitcoin, or tokenized Swiss francs, or off balance sheet of a bank in case of bankruptcy? This is more from the banking side or the tech provider, but if you have a view you can address that.

Peter: [00:25:36] I would have an answer, but it’s a lengthy one.

Seamus: [00:25:39] Oh, please. We have a few minutes left, two or three minutes would be good.

Peter: [00:25:46] Although regulation is changing right now, we implemented a fully segregated concept with our platform. The current regulation foresees that if you are implementing a fully segregated concept, that a bank does not have to underlie it with equity on their side with the 800% rule. That was one of the reasons apart from security, why we have implemented a fully segregated model in our lab. I hope that answers that question.

Seamus: [00:26:26] It does. But also Switzerland have evolved.

Peter: [00:26:29] They are evolving. As far as my knowledge goes, this 800% rule will change over time.

Seamus: [00:26:26] Yeah, you can manage an omnibus account and still have segregated assets.

We have time for one more question here. It’s about top three skills you would suggest for people that want to get into this industry and benefit from the new technology. Given where you’ve been in your career path, any insights?

Peter: [00:26:59] Passion, I would say. At least that’s my case. I was always fascinated by DLT, or to be more precise, by digital assets. The industry is moving so fast; and to keep up and be on top of the latest development, in my opinion, you need to have some passion for it. Otherwise, you cannot keep up.

What’s definitely helping, from my point of view, is if you’re having a financial service industry knowledge. What’s going on right now is that digital assets are going into the way of the existing processes banks have in place and getting integrated. If you don’t know DLT, cryptocurrencies, it’s always good to have the knowledge, how the traditional world is functioning right now. If you have a good understanding of DLT or at least have an understanding of DLT and cryptocurrencies, how it works, what the specific characteristics are, that helps as well.

Seamus: [00:28:05] I fully agree. I think the passion for the space and financial literacy, you’re off to the races here. We’ve got a couple minutes and then we’ve got to wrap it up. I’ve got one question which I would like to ask. What model do you think will win out? Traditional banks get in the space, or will the new entrants eat the banks? As they say, basically the banks in the end are just too slow.

Peter: [00:28:26] I do have an unpopular answer to that. Both will win. We have seen that in the past with innovation in the financial service industry, and in my opinion the same will happen also with digital assets. There will be a few new entrants; we will make it. You have seen Coinbase for example. But banks will not go away. They will embrace digital assets soon, or as soon as it’s getting really substantial to them. They do have the advantage or the assets of having the trust, of having existing customer relationship, which they then can leverage.

Of course, also in the financial service industry, a few may miss that trend, and actually they will lose that revenue or that business. But in general, I would say there’ll be a coexistence of course, as we have seen before the innovation in the financial service industry.

Seamus: [00:29:28] Good insight, Peter. The time’s up. It’s been good having you here, I appreciate the time and the insights. Would love to have you back again in the future.

Peter: [00:29:35] Thank you very much, Seamus. It was a pleasure.

Seamus: [00:29:38] Thanks Peter.

Thanks for joining Metaco Talks. As I said, the recordings after this will be available on YouTube, Apple Podcasts, and Spotify. Metaco Talks will be back the next edition with a special four-member, a two by two. Check the website for the timing. I look forward to seeing you next time.

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