The Power of Balance Sheets: Incumbents, Digital Assets & DeFi w/ Simon TAYLOR

📅 Friday, 8th of July 2022 | 10AM CEST | 9AM GMT | 4PM SGT 

For this  METACO TALKS episode, we were joined by Simon TAYLOR, known among many others as co-founder of 11:FS, author of Fintech Brain Food newsletter, and most recently Head of Strategy & Content at Sardine – an API platform providing compliance and instant settlement to the crypto & DeFi wallet industry.  

Simon started as a software engineer in Telco, before moving to payments and delivering one of the first Mobile Banking Apps in the United Kingdom.

Throughout his career, Simon has worked across consumer, SMB, cash management, capital markets and crypto/digital assets, with clients like HSBC, Barclays, Meta, Stripe.

At Barclays, Simon launched RISE, the Innovation Accelerator, and was Head of Crypto R&D.

Today Simon advises Governments, Regulators and some of the world’s largest Banks, Financial Institutions and Corporations on how Fintech and Web3 will impact their business in the short, medium and long term.

Simon’s Fintech Brainfood blog is one of the most popular in financial services, and Simon is a regular guest in major media outlets like the BBC and Bloomberg.


Topics covered

  1. How will DLT and Web3 impact banks and corporates in the short, medium and long term

  2. Understanding balance sheet power and why Top Tier banks are best positioned to capitalize on digital assets

  3. DeFi as the new infrastructure of finance 

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Zoom webinar | Fri, July 8th | 10AM CEST | 09AM GMT | 04PM SGT

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Full transcript

[00:00:07] Seamus: Welcome to the 32nd episode of METACO Talks. Today we’re speaking with the one and only Simon Taylor, known among many others as co-founder 11:FS. Co-host of Blockchain Insider Podcast, author of FinTech Brain Food Newsletter, and most recently Head of Strategy Sardine in an API platform, providing compliance and instant settlement to the crypto and DeFi world industry.


I think it’s probably safe to say Simon doesn’t need an introduction, but we will get to that. His writings and thoughts on topics such as FinTech innovation, digital assets, web 3, are widely shared and appreciated, including myself; as well as his career in technology and consulting for major banks and tech companies.


Simon, great to have you here. Welcome to METACO Talks.


[00:00:43] Simon: Thanks for having me. I’m excited to talk about any and all of those subjects, any opportunity is really fun. I’ve been a fan of what you guys are doing for quite some time, in METACO. I’ve not had the caffeine, it’s still early. But I’ve been in fan of you guys for some time, thank you so much.


[00:01:05] Seamus: Thanks. As I was saying just before we started, I keep updated based on your Brainfood newsletter that comes out every week. I’ve got my narrow field that’s hard enough to track, and you help me keep up to date with the rest industry.


One thing I want to ask you, you’re a self-described massive FinTech nerd; what keeps you excited about this space?


[00:01:24] Simon: I don’t know when it happened, but at some point I figured out that if you really understand finance, compliance and you just tweak the dials on it a little bit, you can have this massive impact on millions of people, and that gets me really excited. Once I understood that anti-money laundering is the main way we try and prevent things like human trafficking or terrorism, it’s the main weapon against Russia, I was like, wow, so if you understand that you understand everything that’s happening in the world. It became endlessly fascinating.


But on the other side, when I worked in banking, I worked a little bit with a team that’s in NGOs and was trying to work with the World Food Program. I was trying to look at the problems they had, just trying to make sure that farmers were getting paid at the last mile. They would send pop money in at the top, and they didn’t know if the farmer was getting paid. How is this possible in the 21st century?


It’s this endless riddle of complexity. It’s the incentive system for all of society and humanity. If you stop tweaking the dials on it, maybe you can have a big impact. I’d like to understand the dials, but more than anything I want thousands and thousands of people who work in the industry to see it as an incentive system, to build a better incentive system for humanity, so that we have this outsized impact on our own futures.


[00:02:48] Seamus: That’s a great articulation of many of the reasons a lot of us got us into this industry. We’ve seen for decade now or longer the FinTechs have been attacking the finance base, trying to address these issues as you described. We’ve both got a background in the banking space. Bank’s future, you referenced in one of your last newsletters, just to be dumb pipes? Is this still a real thought risk?


[00:03:11] Simon: Well, interest rates are back. You could be on the golf course by four o’clock. Mortgage, income’s going to be a lot better. See those silly FinTechs were always going to go away. They didn’t know anything because the market was always going to correct, wasn’t it? FinTech was never going to absolutely kill banking because balance sheets matter and scale masses. But at the same time, FinTech has at a minimum dramatically changed the distribution of financial services, and the incumbents have caught up. That’s made it not just cheaper, but I think it’s made the experience better for people. It’s enabled us to prevent fraud, it’s given us right tech, it’s delivered some stuff. That’s quite nice.


But what we haven’t really addressed is the infrastructure. We’re only just starting to get at the manufacturing side of finance. The amount of billions and billions of VC dollars that have been chasing the manufacturing of finance are fundamentally starting to change things. We’ve got some neobank on the consumer side and neobank on the SMB banking side. But if you scratch beneath that, you’ve got this ecosystem of new providers that have also been born, that yes, provide services to FinTech companies, but in providing services to FinTech companies they’ve also become mature enough to provide services to a lot of incumbent banks as well. I think that’s a big opportunity.


But also all of these companies out there that have got millions of customers, that have got massive market demand, that are not profitable, may not have a diverse balance sheet but may be an interesting distribution model for people that do have a balance sheet. If the market is turning banks into dumb pipes, but there is this fraud problem, there is this infrastructure problem, there’s a cost problem, there’s all of these sorts of things, and balance sheet matters and we can unpack what that means, then maybe the smart pipes of the future are the ones that enable finance to happen at the point of need. They enable embedded finance. They enable everybody else in the market. Rather than trying to force everybody into the branch force, everybody into your captive mobile app, why don’t you power the entire economy? Why don’t you power every finance experience? That’s difficult if you run a retail part of a bank to really get your head around. But if you are more in the capital markets division, if you are more in the cash management, transaction banking division, that’s a great business.


[00:05:56] Seamus: Good summary. Let’s unpack that, those advantages you described, the balance sheet, cost of funding is no longer zero, and scale. What are the specific opportunities for incumbents?


[00:06:06] Simon: Yes, interest rates have grown up, but even if we assume that over the longer term interest rates are low and may stay low, and that some of the macro forces that kept it that way around monetary policy stay the same (maybe they don’t, maybe we reassure all manufacturing and inflation is here to stay), if that’s the case, great. But let’s assume it’s not, and let’s take a worst case scenario. The banks that have done particularly well even in the worst times, have been the ones that have intentionally grown their balance sheet; that have focused on their cost of funding, have focused on their ability to lend, they’ve focused on technology and investing in that over the long term horizon. Rather than thinking about technology is something that has to rise to keep with compliance, to keep up with the market, to keep up with competition, they’ve gone, “How do we get strategic and get out in front of that?”


But the reason the balance sheet was always powerful, as you say, you alluded to it with cost of funding, if I want to lend to you, I have to fund that lending somehow, especially if you don’t pay me back. How do I fund that? Well, Banks in particular have this amazing thing called a banking license, that allows them to take deposits from other customers and then potentially use that as a source of funding to do the lending.


Yes, they have to hold a certain amount of deposits and they have to do it in certain ways, and puts them on the hook for stricter regulations, but that is still by far the cheapest way to fund lending in the market. We’ve seen a whole shadow banking sector emerge where there are other forms of people buying, selling that on a secondary market. But if the classic model there is the larger your balance sheet the more diverse it is, then the lower your cost of funding. You look at the big global banks who not just serve consumer, but they serve businesses, wealth managers, corporates, sovereigns, they are diversified in the segments they serve. They can potentially be diversified in their geographies. As the global market moves, it’s like having a balanced portfolio of stocks, equities, bonds, and different asset classes. You are hedged against how the market moves from your balance sheet perspective.


The banks have always done that quite well. That hasn’t been particularly helpful in the past decade. It could now be extremely helpful for this next decade, but it will be helpful if they just show up, if they just do their job. But the opportunity beyond that is there’s all of this demand in FinTech, there is all of this demand in non-financial services to use financial services as a way to increase engagement, to increase revenues.


Shopify saw 50% of their revenues over the last six or seven quarters come from financial services and payments. It’s increasingly looking to get into lending. Amazon has done some partnerships to do it. Sure, but they’re a very big organization. What about everybody? What about all the other businesses that could be powering up what they do and using financial services as the lubricant to what happens on their platform and what problems can we solve for customers in doing that? How does your balance sheet, how does your regulatory perimeter need to enable that?


I think that’s where we talk about being smart pipes. You’re intentionally making yourself the most attractive APIs in the market. Not ‘we have an API’.


[00:09:46] Seamus: Yes, it happens to me sometimes.


[00:09:49] Simon: Or, ‘we have 50 APIs’. It’s not how many you have, it’s how good they are and how much developers love them. I think to be fair to most in financial services, they’ve got that joke. But I’m a veteran of 2013/14 PSD-2 and everybody going, “We have an API!” No. Then also open banking where APIs were being forced on the bank. Now it felt like a defensive thing that was regulatory, which never feels good. Let’s actually see this as an opportunity and let’s have it as a strategic management focused opportunity over multiple years, not, “Hey, we’re going to fund this for 12 months, see if it works.” Not one of those big death stars bets as well. The death star bets, the implementation of the big CRM, the one customer view, every bank has these and they never succeed.


I’m talking about small iterative things that then when they catch fire, you double down on them. Because what often happens in banks is small iterative things that catch fire eventually get killed by that other department who does something a bit like it. That takes real part at the executive level, and a little bit of Naval gazing, honestly. Are we willing to do this to capture this once in a generation opportunity, or are we just going to show up and do our job and collect a paycheck?


[00:11:21] Seamus: Well, I think you made a strong case, just showing up does result in the dumb pipe opportunity. But if we look specifically at digital assets and web 3, what are the opportunities for banks or incumbents in that context?


[00:11:34] Simon: Again, I always think about the spectrum from consumer all the way through to institutional. Let’s start with consumer because it has some person on the street resonance. You can then apply some of the insights further up the stack to the more institutional base. Across all of it, there’s still demand. It may not be what it was at the peak of the bubble, but there is still demand. What people have understood from a consumer perspective is, wait a second, I can do things in this space that I couldn’t do before. I think one of the primary things is I can directly cost my assets, as in Web3.


Being your own bank is hard. The reason being your own bank is hard, I don’t know if you’ve ever tried to carry around all of your net worth if it’s heavy. It’s probably a little bit of a personal risk, a security threat. Banks and custodians play a useful role in society. They store the stuff that really matters to you in this one space, and will make sure it isn’t stolen. But the way custody works in web 3 is so powerful because it’s created this global CRM of assets. It’s created this instant, always on view, which Nike shoe has been bought in this NFT marketplace, and who has the most USDC? For commercial confidentiality reasons that might not be all you want. But there are also examples where that’s extremely powerful and it is something you want.


Where things are happening in the public blockchain space, we see this amazing explosion of new business models starting to appear, that could have material value to consumers. I get excited by what it would mean when somebody can start to run digital pieces of art, digital pieces of music. If web 2 was all about mobile, social and cloud; and the business models were really about subscriptions, they were about that always on Netflix, they were about Amazon web services, app stores and take rates and centralization; then web 3 moves away from that more captive model to that model that’s a bit more user-centric. Instead of logging in via Google, logging in via Apple, the service now logs into the individual, because nobody has more information about Seamus than Seamus does. Google has a lot of information about you, sure, but you have more. You know where all of your banking is. Now we’ve got open banking, but guess what? It doesn’t know everything the government knows about you. It doesn’t know everything Google knows about you. You are the ultimate primary key to all of your data.


With that, if you could invite an algorithm into you, potentially we could build incredible new services and experiences. But in order to do that, we have to fundamentally reorient the design choice, the design principle of the internet. Instead of logging into something, instead of user name and password, it logs into me. That’s why having me custody my own assets, sometimes manage my keys, is extremely powerful. But then if I lose my keys, my goodness, I am out of luck! I think the role of something that is trusted, that has a brand, is to really think about the manufacturing and the distribution of finance and trust and risk in that new world.


What does the manufacturing look like? Well, instead of creating a loan and turning it into a piece of paper that goes into a filing cabinet somewhere, or issuing it on a database, you issue it as an EOC 20, that goes and sits on Ethereum or Polygon or Solana. That becomes a secondary market, then you have secondary lending and everything that sits around that. You’re tokenized by default. That’s on the manufacturing institutional end. You can start to see that really what’s happening in financial services is people are coming from real world assets down, and they’re starting to think about, how do I take a corporate bond and turn that into something that is a token, and that can start to live in this way so that it can be directly custody. It can move instantly, we can have a global CRM of who they are, that it can be automated. That the taxation, corporate actions, everything can just be baked in as software. I reduce my admin, I reduce my operational costs, sure, but I create these new business models.


 But the other side is the wild and wonderful, which is what will artists create? What will people create? Then there’s the middle ground, which is person on the street going, “It’d be really nice if I could just get a better price on a mortgage right now.” Or instead of going to a price comparison website and entering 10 bits of information, I’ve got all of the information anyway, why don’t I just sign a transaction and invite your algorithms to give me the best price? Instead of that, living in Google servers or Apple servers or Facebook servers, it lives with me and I’m the primary key to it. That means I don’t necessarily need the biggest database in the world, I need a security model around key management and so on.


That’s where the distribution end changes. The distribution becomes much more about managing keys than managing assets. Instead the 1800 models of having a very large branch that was very hard to break into for thieve to steal the actual cash, now I need to be very good at key management and very good at key recovery. People who are managing that technology become critical, and that becomes critical to day to day operations. If we find ourselves in world in 5 to 10 years’ time, which I entirely believe we will, distribution becomes about key management increasingly. How do I help my customers protect, recover, manage their keys, manage their assets, and how do I manufacture assets in a way that is compatible with this new world?


[00:18:01] Seamus: There’s a lot to unpack there. Your final comment about keys, I couldn’t agree more. This notion that what are crypto assets now, a trillion-dollar market, peak to 3 trillion, it’s still potentially smaller than market cap of Apple. It seems almost an experiment, but eventually if all assets sit on chain, do we all want to walk around as you described with all our keys in our back pocket? Probably not. These other functions become critical and you probably want somebody trusted, so that it’s not that if I lose my keys I’m toast.


I think this notion of CRM of assets is super fascinating. To me, the biggest issue is how we get there. Do the banks have a role in bridging these assets, bridging what we know as real world assets, the 500 or 700 trillion opportunity?


[00:18:47] Simon: Yeah. The problem that the infrastructure has is that it lacks liquidity. The reason it lacks liquidity is it lacks trust. The reason it lacks trust is because there are untrusted actors there managing the risks. If anything, you’ve got something that resembles the 1800 railroad boom in the United States where anybody can create a bank and anybody can lend unlimited amounts. Whilst the boom is happening, any old entrepreneur can come along and buy a plot of land and get a loan from a local bank which was started by somebody else. There was just no control over who could print money, there was no office of the control over the currency. That’s why that was built.


That’s what’s happening. You’ve got this unfettered capitalism experiment happening, with none of the lessons of the last 200 years of financial services booms and busts. They’re speed running everything that could go wrong. But the interesting thing with that is they’re still doing it. They’re building it on this new technology that’s global, that’s 24/7, that’s permissionless, and it’s composable. There’s no way today that if Chase builds a feature, Barclays can use it. You might not want to live in that future. Maybe you don’t. But in DeFi, if Uniswap builds a feature, then SushiSwap can absolutely copy it and use it instantly. In fact, some third developer can do something that talks to SushiSwap, and then take Uniswap in a single transaction. In fact, they could do something that goes and takes a loan out at one place, goes to SushiSwap and makes a trade, and goes to Uniswap and makes a trade in a single transaction, at the click of a button. That programmable, permissionless, composable, global, 24/7 infrastructure is running. Forget about the price volatility for a second, the infrastructure works and it is working. That’s incredible.


Now as it’s been built to be more secure and as it’s been built to manage hacks, that’s going to get really interesting in the next couple of years. But nobody’s going to bring the liquidity to that whilst it’s that. But the reason you get volatility is a function of lack of liquidity. You pour enough liquidity on something and what happens? Suddenly the volatility starts to even out, you get market makers, you get people that can stop to become price makers as price takers. We’ve seen this movie; we know how it happens. That is a giant opportunity.


One of the reasons that some of the folks at JP Morgan put out a statement at a recent consensus conference, that their goal in the Onyx project is to bring trillions of dollars of real world assets into this infrastructure, that is global, that is 24/7, that is programmable, permissionless and composable, is they see giant opportunities there. There are rumors, and we don’t know if it’s true, that Goldman is looking to bring their prime brokerage services into the exchange FTX. One of the things that’s powerful about FTX is it has the most amazing cross margining capability. You can use anything as collateral and it will cross margin any asset that you have in real time, 24/7. You don’t have to have like every 24 hours a collateral position that’s tiered. But you know the market, as soon as it opens it’s going to do this, you can see the pricing. No, it’s just taking margin as and evening things out as it goes. That’s way more efficient from a capital perspective, and that efficiency is powerful. I think the transparency is powerful as well. You can see a lot of what’s happening in markets.


I think we will find ways of building commercial confidentiality into it. We’ll build secret networks, we’ll build secret transactions. But actually the global public blockchain will be ultimately the things that win out and tokenization will become powerful. If I was an institution, there’s the manufacturing side, which I think we’re seeing a lot of activity. How do I step into tokenizing? But the distribution side is the conversation that’s not had enough focus. How do I help my customers, whether they’re institutions, write down and manage all of the risks, all of the things that could go wrong with direct custody, dealing with their keys, that could go wrong with somebody has not delivered on a sale? Go back to the reason Visa and MasterCard exist. It’s easy to give somebody money, it’s hard for them to deliver the goods 30 days later. What happens when something goes wrong? That is the role that banks often find themselves playing. I think that’s still an opportunity to play in this. But do you do that as software? And how do keys help you do it?


[00:23:39] Seamus: Very good questions. Let’s step back to your comment about manufacturing. The comment you made about JP Morgan around tokenizing the real world assets, it’s clearly a huge opportunity. When we talk to clients, they often talk about, “But it’s been the big opportunity every year for the last five years. What’s the catalyst?”


You’ve talked about liquidity. Ultimately the biggest issue with tokenizing these assets is a lack of liquidity. It’s fragmented, maybe it’s lack of standards around how to do it. How do you kick start this? Where does it start? Does it start at a specific product? Is there a low hanging fruit in this space to get it going?


[00:24:14] Simon: There are standards. I was a co-founder of an organization called GBBC Digital Finance, global digital finance. There are standards around how you tokenize assets. There are standards around how you manage custody. Those global standards are adopted by many organizations, including METACO, and very well considered by the global regulatory community and policy community. I think the standards exist at least at the principle level.


The technical standards, perhaps there’s that. There’s the practical challenge of, A, the psychology, and B, what do we do with everything we’re doing today? This is often what happens in a bank, which is: we can do a pilot, but can we really do that? Nobody wants to be first. Everybody wants to be second to market. It’s a chicken and egg thing. It takes a little bit of bravery and a little bit of consistency, and I think it takes an asset class that nobody’s looking at, but could get a lot of attention.


For instance, there’s a lot happening in the web 3 space now around parking carbon credits and tokenizing those and building a secondary market for them. Because the cost of actually managing a carbon credit is the same as managing any real world assets, but the demand in businesses for them often far outstrips supply, and the transparency around them is frankly shocking. Like, did that thing really do that thing? What if we had a global CRM for every carbon footprint, and we could start to build a software and who owned it, what did they use it for? What will plant a tree that will grow in 30 years’ time? Or is that doing carbon capture? Is it doing some whole removal of carbon? Not all carbon credits are created equal. If you increase the data transparency, there’s a big buyer for that level of data out there right now.


I think it’s about getting the commercial opportunity that drives new revenue, that is achievable, that has the infrastructure just there ready to go, and essentially all you have to do in the first instance is pile liquidity onto it. You would send a swift transaction to an existing custodian who can help you buy those assets and do some of the heavy lifting for you, and you could exchange that liquidity for those carbon credits and add an exchange like FDX or somewhere else. Boom, just go do that. Just start with something really simple and learn. Learn what the risks are, learn who the buyer is, learn what the opportunity is, and just do it. But do it meaningfully and do it consistently, and then do another asset class and then another one and then another one. I think everybody’s like, “Where do I start?” Well, pick somewhere and do it and commit and get on with it. Because nobody needs another POC. Nobody needs another pilot. Somebody needs to get the finger of out their box and get on with it. We all know the opportunities.


[00:27:22] Seamus: That it’s a good message, just do it and let’s bootstrap it.


[00:27:25] Simon: If I was to play the other side of the argument, what does that mean from a tax position? What does that mean if something goes wrong? That’s the hard part. But do it at scale, do it in a sandbox, do it with regulatory oversight. You can do this. My entire job when I worked at the bank and as a consultant to banks has been to just give people the ‘don’t worry, you can do this’ message. Like, but what about this challenge? That is a material challenge and we should address it and think about it, and explain what you’re concerned about and let’s work through it together.


My experience of banks is they often get so big that most people don’t know what questions to ask, and the void is scarier than actually attacking the void and trying to figure out those things and trying to move forward meaningfully. If you manage the actual amount of volume and gradually ramp it up and you watch the risk and you take a really risk based approach, I think nobody can be mad at you in 10 years’ time for having done that gently and having the ability to have a kill switch if you suddenly see that something’s really going wrong. But do it and commit. If you did pull the kill switch, go back and plug that back in if you think you’ve fixed it. Because I think it’s this iterative approach that we really need to get better at as an industry, when doing experimentation that turns into real products.


We’ve got the machinery and the machine works, and every now and then we tweak about the machinery, spend millions of dollars to change that tweak. We think the only way to get anything done is with that machine and that way of building things. There’s another way to build thing. There’s another way to build teams. That’s why I think it’s so powerful that many organizations are setting up separate teams, and giving budgets to go do this. But the two have to be really well networked and communicated internally.


[00:29:15] Seamus: I’d love to learn from the FinTech space. Touching on your distribution side, you referenced the IMF April 2022 global financials stability report. Great quote in there around DeFi having near zero marginal and operational labor cost. Is DeFi inevitable from a banking perspective embracing it, and to what degree do you think some of the association DeFi has had with some of the failures, at least from a perception perspective over the last few months, will impact regulators’ focus on DeFi?


[00:29:54] Simon: Yeah, it’s interesting. My breed of regulators and policy is that stable coins are actually drawing the issue. That’s still the bigger concern, and there’s a whole conversation to unpack around that. The perceived market failures, again, I think comes back to the 1800 piece in that we need people who know what we’re doing in this space.


I don’t think that the right answer is to copy and paste the learnings from the crashes of the 1930s and the 1870s onto 2022. I do think the answer is to learn from the principles and the insights, but to use modern technology to upgrade how we manage risk. Some of the ways we manage risk are materially ineffective, specifically around anti-money laundering. Imagine if we had a global CRM for assets, how might that help us with things like anti-money laundering? Maybe that would be an upgrade. Maybe we should start with what the technology is capable of, and then start to think about how we manage risk; rather than go, how do we manage risk today, do that. No. How do you drive a car? Oh, so that’s how you fly a plane! No, it’s fundamentally different. The physics are entirely different. There is still a value in experience of not crashing into trees, but we’ve got to learn the lessons from it.


On the distribution side, I think there’s a lot of lessons we can learn. Go back to the question, I got excited by that.


[00:31:29] Seamus: No, as you’ve described, the excess speculation, that tide’s gone out, we’ve seen there’s been a lot of growth on DeFi. But the perception in the market seems to be DeFi failure, which I don’t think is accurate.


[00:31:44] Simon: No. In fact, if you look at block 5 Celsius Voyager, most of the things that are going bankrupt, they are lenders. They look like a lending business that just happens to use DeFi. Unfortunately, they look like lending businesses that took degenerate levels of risk, because everything was going up. They were over-leveraged, over-borrowed, doing everything on margin, making every mistake in the book. Interestingly, if the global financial crisis hadn’t had a bailout, I think it would look a little bit like that in DeFi.


Banks, you don’t get to get away with this. You’ve got a bailout, DeFi hasn’t. Let’s just keep that in mind. DeFi’s infrastructure is still working. The infrastructure’s still global, it’s still 24/7. It’s still there. Uniswap volumes continue to increase. That’s the crazy thing here, go look at the data here. The wonderful thing about the global CRM, if anybody’s watching or listening you want to open another browser tab and go and go look at some of the dashboards of Uniswap. Just search for ‘Uniswap’. Because this data set is global, enthusiasts from around the world have built their best internal data dashboards and open sourced it. You can just go look at how OpenSea perform, how Uniswap perform, how everything that’s happening in all of these markets, the data is just there for you. That’s cool. Like how cool is that? That’s amazing.


DeFi is still running. A lot of the lending issues are around people doing stupid things, but there are things that are not stupid that continue to survive and thrive. DeFi yes, the question in being early than there is in just about anything. If you are early but correct, it’s the same as being wrong. I have an understanding for some level of timidity, but I also believe that the infrastructure, there are some no-brainers that will just work today. That’s why I start with tokenizing real world assets. I think there are some no-brainers on the manufacturing side. On the distribution side, the DeFi platforms is where it takes nuance. It takes understanding the wheat from the chaff.


Why are the operational costs and the labor costs so low? The operational costs are so low because Uniswap, which is the largest exchange in crypto, it’s larger than Coinbase, larger than Binance, larger than FTX, has 60 staff. Coinbase has 3000 staff. Those staff are often voted for because they come from Uniswap Lamps, which is a separate company. There’s a foundation that sits over the top, and then there’s a decentralized entity in which the users of that platform get to vote who those 60 people are or if that company continues or gets fired. It looks a little bit like catalyst Wikipedia, in that the users of the platform get to decide who runs this market structure. If you’ve spent some time in market structure, wouldn’t that be nice?


This is a really different way of funding the way things happen. It’s hyper efficient because Uniswap is running on Ethereum, and now Polygon and a few other chains. It’s using wallets. It’s using all of these building blocks. You haven’t had to build an entire stack from front to back. I haven’t had to build a car production plant to build the car, because what I really want to do is build software that sits inside the car. You get this hyper specialism, where they just do the one thing they’re really great then they use the infrastructure to do everything else. That’s how the operational and labor cost are.


They’re also not on the hook for a lot of the things that regulated market structures are in financial services today. They don’t do KYC; that’s done somewhere else. They don’t do anti-money laundering; they don’t do all that stuff. I can hear these trigger words going off inside of a bank, “So that we can never work with it then!” Hold your horses. The reason they’re so efficient is because they do that bit. But what if somebody else is as efficient that does the anti-money longer bit? What if somebody else is as efficient that does the fraud bit, the key management bit, and so on? This is what we’re seeing.


We’re seeing the specialisms start to emerge. What you’re getting is this composable market structure, where you ask yourself the question, how many parts of your business are a cost of doing business? Really think about that. How many activities do you do because you have to do them, and how many do you actually want to do? What are the profitable revenue generating bits of your business? Who are the specialists out there that could do that thing far better than you can with far better results?


That was one of the reasons I joined Sardine, was because they are the fraud, AML experts, the payments experts. I do believe we’ll see many more specialists like start to solve for the DeFi protocols and how that meets where the regulated institutions are who have balance sheet power. We’ve got a liquidity problem, but an infrastructure that works and is extremely efficient. We’ve got balance sheet power and lots of liquidity.


[00:37:22] Seamus:  Simon, we’re running longer time but I’ve got to ask another question. I think the direction you’re describing, this composability, the opportunity for specialists, the opportunity to provide solutions, our view is very much around a future for banks where let’s say custody is embedded into DeFi, solving that key management problem. It’s not just about self-custody, but you have a trusted party that can be trusted with the backup, all the processes you described. But equally, the banks typically have a role of intermediation, which is pretty expensive; and they could move a lot of the core structure of that into the DeFi space and reinvent their business model et cetera.


But I don’t know if it’s internet, intranet thing, but there’s this battle in the market right now. Is this going to be permission DeFi? Or are the tools there, as you described, that you can go to a pool and evaluate the ML risk, and make a risk judgment on that pool and interface with it? Our view is much more the latter, but we see a lot of experiments whether it’s compound or around.


[00:38:26] Simon: You’ve got to start somewhere. Even Square, Revolut and Robin Hood when they entered crypto trading, they didn’t wall garden. I get it, but that’s not the end. That’s a means to an end. Let’s get everybody comfortable. I think the future is regulated pockets of DeFi, but I think it’s has to be forwardly compatible with the technology rather than backwardly compatible. Look forward to what the technology can bring you, look forward to how it can manage risks, and start at what it’s capable of, and then the risks that it presents and manage those according; rather than starting at how you do things today and trying to do them. There are some walls around what you legally are responsible to do, but you are legally responsible to do them.


Sometimes it’s quite prescriptive, but most of the time it’s up to you to figure out how you do it. in those cases, that’s where you start at the technology and think about effectiveness. If I do it this way, can I look at the data and see that it’s more effective this way or more effective that way? How do I improve my effectiveness with a global CRM that’s transparent and 24/7?


[00:39:45] Seamus: 100% agree. We were at the .04 a number of weeks ago, Adrian was debating with a number of regulators about the regulatory aspect. Are you going to regulate the code, which is DeFi, which sounds crazy, or is it going to be the points where you access it, the banks potentially as the bridge into DeFi and you regulate those endpoints?


[00:40:06] Simon: Exactly in the market as well, just like we see specialists in trading, specialists in lending, specialists in all the parts of the value chain. I think there will be a DeFi equivalent of reg tech. There’ll be all that stuff, and I’m very excited by where that could go.


 Imagine if you have the world’s best compliance and risk teams, and imagine if they were available as a bit of software. That’s where I start to just really excited.


[00:40:39] Seamus: That’s a good point to wrap things up on. It’s been a super interesting discussion.


On that topic, we mentioned earlier you’ve recently joined sardine as head of strategy. You want to tell us a bit more about what they do at Sardine?


[00:40:51] Simon: Sardine is the world’s best fraud team available as an API. The team is the team that built the risk and compliance backend for Coinbase, and then same for Revolut and, led the US growth of Revolut. They’ve been on the front line of where the new scary risks are, and then realized that this was an infrastructure business. They’re in the business of confidently moving money. It’s easy to move money, it’s hard to know if it’s going to the right place. Is it being defrauded, is something going wrong?


They’ve collected the largest widest data set of fraud risk. They have some of the biggest clients in crypto, like FTX, Moonage, Transact Wire, but also very big FinTech companies like Brex, and increasingly some of the large banks as well. That spectrum gives them a very unique data set to the sophisticated emerging types of fraud and AML risk, and they’ve built the entire suite. It’s from your fraud team to your compliance team as a single API with a single dashboard. That I think is going to be hugely exciting to be a part of, because it’s very hard to see what’s happening in traditional finance and manage it, number one. It’s very hard to see what’s happening in crypto and manage that, especially for regulated financial institutions that don’t know that space. They’re just often blocking it and they’re frustrating their customers and losing customers in the process. But now imagine trying to put both of those pictures together, crypto companies see crypto and FinTech companies and financial institutions see finance. But who sees all of it?


Sardine has a single view as to managing that risk and getting the best numbers charge back and so on. As a result of having that, they’re able to move money in real time in and out of crypto, because they can get so confident about where the money is come from, the use of it, is this a fraud or is it not, that they’re actually getting into real time settlement and managing some of the liquidity risk to get that done. It’s hugely exciting for me to learn about that whole sector. I’ve worked in risk a little bit, but I’ve never been quite so close to it. I’m around just this amazing team of people. I’m very excited.


[00:43:10] Seamus: Very exciting opportunity. I’m sure we’ll be engaging with you to find out. Simon, it’s been great to have you on here. I’d recommend everybody to sign up for your stack Brainfood.  As I said, it’s my essential weekly reading. It should be everybody’s, I think. Thanks for your time, we’d love to have you on again in the future.


[00:43:26] Simon: Great, would love it. Thank you, Seamus. Appreciate it.


[00:43:28] Seamus: Yep. Thanks. To our guests, thanks for joining and hope you enjoyed this episode. Don’t forget, the recording will be available on all your favorite channels as well as on our website. Thanks for seeing you. Ciao!

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