The Crypto Business Case for a Bank

 

Seamus: Hi, welcome to METACO TALKS. I’m Seamus Donoghue, VP Strategic Alliances at METACO.

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Now, today’s discussion. Very happy to have Alexander Bechtel who will discuss the crypto business case for a bank. Alexander is the head of DLT and Digital Asset Strategy at Deutsche Bank. Until last August, Alex was studying and teaching at the University of St. Gallen. He’s been an external consultant to the ECB and a visiting researcher at Stanford University. He has given up his life of academia to steer one of the largest banks towards its digital asset future. Welcome, Alex.

 

Alex: [00:00:56] Thanks a lot for having me, Seamus.

 

Seamus: [00:00:59] I would love to hear your journey from academic – and I’ve probably mentioned here also that you’re on the opposite side of the mic this time, you also have your own podcast called Bitcoin, Fiat & Rock’n’Roll – how you’ve gone from those roles to now a senior banker, focused on crypto and DLT.

 

Alex: [00:01:16] My plan was always to stay in academia and become a professor and I invested a lot of time into my PhD in order to make this happen. My PhD took me at least five years. Usually, if you plan to go back to business after your PhD, you do this in three years, so it was not the most intelligent thing to stay in academia and invest five years and then go back to business anyway. I started working on these topics also from an academic side, digital currencies, blockchain etc. two or three years ago. I realized that there is so much happening in the business currently and I think my impact can be way bigger on the business side than on the academic side, because academia unfortunately is always four to five years behind the business side. That was one main reason for me, why I decided to drop the academic career, start a career in banking and try to steer a big ship like Deutsche Bank into the digital asset and currency world.

 

Seamus: [00:02:20] How is that transition, moving from academia to one of the world’s largest banks? You now are effectively steering the supertanker. Is it a bit of a culture shock?

 

Alex: [00:02:29] Yeah. My day-to-day work has changed massively. Before, I was most of the day sitting in front of my laptop and thinking basically, doing data analysis, coding, and now most of my day is sitting in calls, which I don’t like that much, to be honest. I always try to block enough time because the actual work is still the thinking, I believe. I always try to keep the calls as short as possible, but that is something that has changed – way more managing and talking, and less thinking. I’m trying to come back a bit more towards the thinking part.

 

Seamus: [00:03:04] Of course. How difficult would you say it is to do something truly innovative in a large organization or a large bank as you’re at now?

 

Alex: [00:03:13] What I’ve realized is that this massively depends on the leaders in the bank. I’m very happy that I have someone like Stefan Hoops within the corporate bank of Deutsche Bank, who is really becoming a thought leader currently when it comes to blockchain and crypto. He’s brave enough to say: “I have understood that there is something serious going on and it’s time to react or maybe even act as a bank, and we need to get active and dive into that space.”

 

Seamus: [00:03:44] As a company, we talk to a lot of banks and one of the things we always struggle with is building the business case to get in this space. Obviously, that’s one of the topics we had in the title. How is Deutsche Bank going over some of the hurdles we always hear about, the reputational risk of Bitcoin is too speculative, it’s not a store of wealth. There are many arguments, there’s a lot of FUD, and obviously we’ve seen a lot of your peers come to market. How has Deutsche Bank addressed them?

 

Alex: [00:04:12] I wouldn’t say that we have already completely overcome this, we are still struggling and fighting with these problems. These are still hurdles for us, in particular since we are such a huge institution. Our long-term plan as always, we think beyond crypto, right? We want to play a part in this general tokenized assets and currency world. I believe that there will be a bigger role to play in this world than the pure crypto world for banks, but still there is for sure, also a role in the crypto world. But, when we talk about Bitcoin and other cryptocurrencies, it’s less the problem that we need to get used to the technology, it’s more that we need to get around these AML CFT issues. Where does the coin come from? Who is holding? What do we need to know in order to accept the token? These are really things we are working hard on at the moment.

 

Seamus: [00:05:06] Yeah, we’ve heard there are some great tools out there for chain forensics, but the question is how to assess the risks based on that information, which is still a learning phase for all the banks.

 

Alex: [00:05:17] I have to be honest. At Deutsche, we are really at the start of this journey. We have started working with this last August and we are still in this learning phase. We have decided that this is an important topic and we have started the learning phase, but we are still in the midst of it, I would say.

 

Seamus: [00:05:35] Just interrupted with a question here. How do you manage innovative projects within a larger organization so that they’re not killed off by what he describes as the corporate immune system?

 

Alex: [00:05:45] That kind of goes into the direction of what I’ve said earlier. What’s necessary in such a big institution as Deutsche Bank is that the leaders of the bank are in. It’s really tough if you work against your upper management and that’s something, by the way, I made clear before I started here. The deal was I joined Deutsche and I said, let’s maybe wait for three to four months before we talk about my contract. So, I started working there three to four months without talking about any contract or pay because I wanted to make sure that exactly this does not happen, that I run against walls for years. So I said, let’s get to know each other for three to four months. I want to make sure that you are serious about going into blockchain and cryptocurrencies and digital assets. I’m still there, as you can see, so I’m convinced that the top management in the corporate bank is serious about it and that I won’t run against walls. I can tell you, a lot has happened within Deutsche Bank over the last months already, so I’m happy with how it’s going.

 

Seamus: [00:06:55] Maybe start talking about it more specifically, what was the catalyst? To what degree is getting involved driven by peers moving client demand, or as you said, just having a vision of a future opportunity? What is driving the media business plan and the catalyst to get moving?

 

Alex: [00:07:15] I always like to joke that it’s only me who kind of made this all possible within Deutsche that so much has happened over the last months, but to be honest, I think 95% is just the market sentiment and the clients. Starting with a Bitcoin prize which went through the roof over the last few months, and it’s not a secret if I tell you that, also our clients get in touch with us and ask us whether they can store their Bitcoins with us. We have many companies now starting to think about tokenizing assets, which contact us and say let’s do something together. So, there is so much happening in this space and not only externally, but also internally. People are realizing we need to get active and this helps me a lot in driving these topics internally.

 

Seamus: [00:08:05] That makes a lot of sense. I imagine we’ve seen a lot of banks look at Bitcoin specifically as a bolt on asset, another product they can offer. But looking at tokenization, I imagine the core proposition of the banks has really been around trust, intermediation, balance sheet. How do you look at that and what’s happened in this new space? Moving from what the financial system is really based on (trust, intermediation), we have all these exchanges, because we didn’t have no way to trade with each other. And now with the whole sort of DeFi Stack, still early, but maturing, potentially introducing a stack that’s trustless, that you can have peer-to-peer trading, peer-to-peer lending, peer-to-peer deposits, many of the functions the banks do. How does the bank look at that business model potentially evolving?

 

Alex: [00:08:52] That’s a good question because, in the end, blockchain is a direct attack to any intermediary, or mainly financial intermediaries. The question is:  is there a role to play for financial intermediaries in the future and in the future of financial system? I believe there is an important role, otherwise I would not have joined Deutsche Bank recently. I’m also convinced that the role financial intermediaries, not only banks, but financial intermediaries in general, is going to change, the role of these institutions play. It’s one of the most important questions banks have to ask themselves, which role do I want to play in such a system? Because if a certain fraction of borrowing lending will be decentralized, clearing and settlement will be decentralized. On the other hand, I do not believe that we will wake up tomorrow and financial intermediaries will be gone. So this whole space is very experimental. It’s super exciting. If DeFi enables us to make our financial system more democratic and efficient, I’m all in for it. It does not make sense to endlessly improve the carriage if the car is around the corner. The question I’m always asking myself, is it really that DeFi is the car and the current more centralized financial system is the carriage, or is this maybe a bit too simplistic? And there are good reasons for both of them coexisting. This is where I’m going, but I believe, at least for quite some time, DeFi might have a role in the system, but also CeFi, so Centralized Finance might have a role in the system. You see this already today. The main means of payment that’s used in the DeFi world are centralized stable coins. There are also decentralized stable coins around the corner, but currently we are using Tether, we’re using USDC etc. I’m convinced that many DeFi users in the future will use trusted third parties to store their tokens, for instance. There are good reasons for CeFi and DeFi to coexist.

 

Using adaptors between DLT and payment systems

Seamus: [00:11:00] I have very much the same view around the coexistence and the need for trusted counterparties. Not everybody wants to manage their own keys as much as that’s the theme, not your coin, not your keys, it’s a lot of responsibility and it’s not trivial. It’s still a fairly complicated exercise. Always having the option to manage your own keys is also a way to keep the system a bit more honest. You mentioned stable coins. How do you look at that space evolving from the banking perspective? Because, when I look at the McKinsey banking study last year about payments and they talked about globally and Europe in specific, about 40% of bank earnings comes from payments. I would imagine looking at stable coins, that could be fairly disruptive there. How do you think that’s going to play?

 

Alex: [00:11:44] Yeah, absolutely. That’s exactly how we look at it. When we talk about stable coins, we mainly look through the payment glasses on this topic and stable coins are a nice way of bringing our current fiat monetary system into the DeFi or blockchain world. We believe that this might be a role banks will be playing in the future as well, either by issuing their own stable coin or by at least offering payment solutions for existing stable coins. This might even be a CBDC in the end. For instance, I wouldn’t say that we have a lot of customers coming to us with this topic, but this is something the industry is communicating that parts of their business processes might be running via blockchain in the future.

There’s a business process and at some point in this process, there is a smart contract which triggers the payment. I usually use an example by Bosch. When there is an autonomous driving car driving to a charging station, recharging, and at the end of the charging process, the car pays the charging station. A classical machine to machine payment, maybe this is going to run via blockchain or DLT in the future. The problem is – today it’s not possible to make the car, pay this payment with a Euro or US dollar. We have two solutions to make this happen. One thing we can do is to build a technical bridge or an adaptor between the smart contract and our current payment rates, such that the smart contract can communicate with say Par Tips, Target, whichever service they use in the end. That’s something we are working on and I think this is a very interesting solution because it addresses most of the use cases we have in mind currently. The more elegant and frictionless solution to this problem would be to say: the smart contract sits on a blockchain. What the smart contract can do – it can move around tokens. So, why can’t we also bring the Euro and the US dollar as a token onto this blockchain to make it frictionless and to let the smart contract settle this payment? Then, I believe we’re in this stable coin world where we somehow need to repackage our Euro, which we as banks are already issuing, and make it available as a token on chain.

 

Seamus: [00:14:07] It’s kind of the view of a programmable money in many ways.

 

Alex: [00:14:09] Absolutely, yeah.

 

CBDC’s and digital euro use cases

Seamus: [00:14:11] There are many theses around how the stable coin market will evolve. We’ve got things like Tether – obviously the largest, has a lot of traction in particularly in Asia, although there’s some concerns about the credibility of it. Then we have things like Circle’s USDC, JP Morgan’s coin, so there are a lot of different ways. And then we have Asia or the DSF project out of China’s, which is very much about surveillance and control. Across the spectrum of options, it is potentially a stable coin that’s privately backed by US dollars a way to sustain the kind of US dollar or basically the Western fiat system, or is that the way we’re going to go, or is it going to be something more centrally sort of surveillance, sort of dystopic, sort of a potential of a Chinese solution?

 

Alex: [00:15:02] I always like to distinguish between, when I talk about digital currencies, three versions or forms of digital currencies. They can be nicely distinguished when you look at the issuer. Currently, we have digital currencies that are issued by the state or by central banks, this would be CBDC. We have digital currencies that are issued by the private sector. This includes the stable coins you’ve mentioned, Tether etc., something like DM, and maybe in the future also bank issued stable coins. Then, the third version is a form of digital currency without an issuer, which would be the decentralized cryptocurrencies like Bitcoin. Coming back to the theme of coexistence, I believe that all three are going to co-exist in the future, hopefully solving different use cases.

We have Bitcoin, you can debate about what Bitcoin exactly is, but it could be something like digital gold or a decentralized form of a payment. You have the private stable coins where for sure, Tether is going to play a role, maybe also banks are going to play a role in the future. And then you have the CBDCs, which are issued by the state. And I’m always an opponent of saying it’s really important that when we talk about CBDC, that we think about which issues are CBDCs trying to solve. It makes no sense if CBDC becomes another digital means of payment that gives us maybe the seventh checkout option on Amazon. Just to have another option to pay digitally, this is not interesting, right? I think CBDC should try to solve problems that are not being solved by the private sector or public sector today. I always think of mainly two things, which is we cannot pay offline digitally, that’s one thing, that’s just not possible today. And we cannot pay anonymously digitally, currently.

Whenever someone asks me why we need a CBDC, I usually bring up these two points because this is something the private sector is not offering today. I also do not believe that the private sector is going to offer anonymity and offline payments in the future, because you cannot earn money with it. It’s not something you can monetize. That’s a classical market failure. The private sector has no incentive to offer offline payments or anonymous payments, and that’s a classical task of the central bank in the end.

 

Seamus: [00:17:26] That’ll be interesting to see how they address that anonymous payments. As much as it’s a market failure, it’s also a technical hurdle, those offline payments, from a digital perspective, as well.

 

Alex: [00:17:35] Absolutely. I’m working with some colleagues on a paper where we try to propose a way to enable anonymous payments and at the same time, and that’s the difficult part because digital anonymous payments are possible already today. Look at C-Cash for instance. What’s not possible is digital anonymous payments that are regulatory compliant in the sense that you need a certain threshold probably, and if you cross that threshold the anonymity is gone. And that’s the difficult part; make it anonymous until a certain threshold, let’s say 10,000 Euro, and you’re across 10,000, it’s not anonymous anymore.

 

Seamus: [00:18:19] One question here. Why haven’t we mentioned DAI? Anything about programmatic decentralized stable coins?

 

Alex: [00:18:25] Currently, mainly Tether used the CI use in the DeFi world. But if you’re consequential and say I’m in for DeFi, you should use DAI and not Tether, so I totally agree.

 

Seamus: [00:18:42] We talked about tokenization of payments, but someone’s also asked us here, do you see an opportunity for offering new asset classes to tokenization? And how do you identify these opportunities?

 

Alex: [00:18:54] That’s exactly what we are looking for as a bank. We believe that this is going to be the most interesting thing happening in banking, or I believe that this is going to be the most interesting thing happening in banking over the next 10 to 15 years, that we will start to tokenize everything, maybe. We are not talking only about tangible assets, but you could also think about intangible assets, future earnings, I believe there have been NBA players in the US, tokenizing their future expected income, selling it immediately. You could think about students, tokenizing their future earnings, and financing their studies. Almost anything is possible.

How do we identify the possibilities? On the one hand, we have customers and partners that are approaching us with ideas, of course, and on the other hand we are brainstorming here in house and think about what’s the most interesting thing for us. I believe this market is extremely nascent there is not much going on, we are in a testing phase currently, but we definitely plan to be part of this testing phase and get prepared for when the market flies at some point.

 

Seamus: [00:20:01] That makes a lot of sense. We have very similar visions about what you can do longer-term with tokenization. We see a lot of publicity around tokenizing security markets. I would think for most of the Western world, security markets work pretty well. Is that one of the end games? Tokenizing the corporate structures that we know, or is it really about potentially using the whole concept of Dows and how you could reinvent the corporate structure altogether, through the space?

 

Alex: [00:20:33] That’s a difficult question. First, I believe that classical equity or stocks will be the last assets we are tokenizing, because this market is working very smoothly. A lot of liquidity, it’s fast, it’s cheap. There is very little incentive to tokenize this market. I think we will begin with less liquid assets, maybe things that are not even tradable today. That’s definitely something that is going to happen. Now, the question is, how does the market infrastructure look like in the future? Will it be completely decentralized? Will it be centralized and maybe still organized by exchanges with permission, maybe environments where certain banks and actors can join to trade? That’s for me an open question. If any one of the listeners has a good answer, please get in touch with me because this is also something I’m wrapping my head around. I believe for quite some time, both are going to develop in parallel and I’m not sure if any of the two, like a more centralized trading venues and completely decentralized venues, are becoming the winner or if this is also coexisting in the future.

 

Seamus: [00:21:39] One of the questions was exactly that, how will DB work with DeFi? One of the things I’ve often wondered is if you have this trusted infrastructure, but you have the ability, there still will be a need for trusted counterparties. Is that a bridge for your clients into that space? You can move, you can shift your model that isn’t so much balance sheet focused, but much more fee-based. Is that not a potentially a better model in the future?

 

Alex: [00:22:02] Yeah, and something that’s important to understand is that our clients…I’m coming from the corporate bank, so when I talk about clients, it’s mainly corporates, right? And corporates are not interested in doing all these financial, like borrowing, lending on their own. We’re not only talking about very simple loans, we are talking about way more complex stuff in the end. A bank is more than only a gateway into the financial system. It’s also a consultant, it’s a partner, you do things together. This may not be underestimated, this is a very, very important reason why our customers like to work together with us, because they appreciate our consultancy services around financial issues. This is something that will also remain in existence in the future.

 

Cryptocurrencies in the context of monetary policies

Seamus: [00:23:01] That makes a lot of sense. You say the last thing you look at are things like securities markets, looking at these other assets that you described, basically making the unbankable assets bankable. What’s the regulatory environment for a bank to get involved with those types of activities? How do you read that market? How do you read the regulatory environment for that?

 

Alex: [00:23:21] I mainly am observing what’s going on in Germany and we have electronic securities in Germany, which are made possible, then we have the BaFin license which allows us to offer a digital asset custody. For us, as a regulated financial institution, it’s the prerequisite to doing anything, that needs to be regulation. This is also why we cannot become a big player in the DeFi space now, because it’s pretty unregulated currently. Regulation always has to come first and then Deutsch Bank and also other big banks can follow. The regulatory space is something we are observing very closely. Also, for instance, the MiCA regulation, the markets and crypto assets proposed by the European commission. We also give feedback to regulators, what we believe makes sense and does not make sense. That’s currently, also for me personally, seeing what’s happening within the bank, one of the most important topics: how do we square this world and our business in this world with existing regulation?

 

Tokenization as a main driver for banks to adopt crypto

Seamus: [00:24:30] Around the tokenization mark, how long do you think this takes to become a reality? And to what degree is that part of the current business base? Do you look at crypto and eventually the other one comes for free later on? How are you looking at that?

 

Alex: [00:24:41 I’d say we are looking at both currently. The big advantage of the crypto market is the market exists, it’s growing quickly, and you have a business case there. It’s very difficult to come up with a business case on tokenized art or tokenized real estate at the moment. I’m not talking about Deutsche Bank now, but in general, for financial institutions, what makes most sense and what I can observe, most of them are doing this, start with crypto, get used to the technology, maybe start earning money, in order to be then ready to go as soon as this wider tokenized assets and currency market kicks in, because the big advantage is that the IT infrastructure, the underlying technology for classic cryptocurrencies and tokenized real estate is similar, if not identical to a certain extent.

We can already start making or gaining experience in the crypto market, which will then be very valuable for this wider tokenized asset market. That’s also something we need to understand in order to understand who our competitors in the future will be. When I say we, I mean the whole banking sector, because I believe that firms like Coinbase will be a huge competitor for classical banks because they are already in the crypto space for seven or eight years. They know this technology, it’s their business already, and they are trying to move into classical banking services. So I see them as one of the major competitors for the banking industry in the future.

 

Seamus: [00:26:21] That’s an interesting point. Just earlier, around your description of the evolution of the market, starting with crypto, moving into tokenization is exactly what we preach very much because that’s what we see our clients do as well. Interesting comment on Coinbase. Coinbase, it’s rumored to have, or we’ll see when it actually goes for the direct market listing, potentially a hundred billion dollar market cap that would put it in the top 15 largest banks in the world. We’re talking about them as competition, but their M&A is heating up in the crypto space. Any risk Coinbase buys a bank? Or is that just buying too much legacy baggage and they can reinvent that space?

 

Alex: [00:26:58] Interesting point. I’m not sure if Coinbase has a banking license already. I think they do, I’m not sure, I don’t want to say anything. This is something that is going to happen if they don’t already have one. I’m not sure if they have to buy a bank, because they are coming from the crypto side. They can slowly extend their product suite towards classical banking products, but still in the DLT and crypto space. I can’t speak for Coinbase, but I do not think that they want to go in the really classical legacy banking. It’s way more exciting for them to think about products in the crypto space. Since we are also thinking about products in the crypto space, this is how we become direct competitors then.

Seamus: [00:27:42] The valuation has definitely told them that they’re doing the right thing so far.

 

Alex: [00:27:47] Absolutely, it’s impressive. I think it’s Goldman Sachs size roundabout, and that’s impressive. It shows that they are doing a good job. Congrats to them, it’s good to see that their business model is working.

 

Seamus: [00:28:01] We don’t have time for too many questions. One last here: how can the identification problem with crypto tokens and assets outside the blockchain can be solved when you have several tokens pointing towards the same asset? Is it a technological solution or guaranteed by contract in the traditional space or regulation? I think this is really about tokenizing real world assets and ensuring they’re not done in multiple times, where we’ve seen the commodity lending market, for example.

 

Alex: [00:28:29] This is probably where the trusted third parties come in. I’ll make a general point because I believe this is important. When we talk about Bitcoin, Bitcoin can exist and work completely decentrally and without any trusted third party. This is where most of the people come from, I believe. But as soon as you connect the blockchain with the real world, it’s almost impossible to make this work without any trusted third party. It can be an Oracle, but in a lot of cases, and tokenizing assets is one of the cases, you will have institutions standing behind this. You have someone who tokenizes this asset, and as soon as real world comes into play and they want to connect real world with blockchain, there are trusted third partners which take over certain roles.

 

Seamus: [00:29:14] There is a bridge of trust to the untrusted, that makes a lot of sense. Well, Alex, that’s all the time we have today. It’s been a pleasure talking to you. Thanks for coming on the show today. Given you have a podcast is there a way people can find out about your podcast and how can they reach out?

 

Alex: [00:29:31] I have a website or you can simply google Alexander Bechtel. I have a website with some information. The podcast unfortunately is only available in German, so at least for the German speaking listeners. You will also find that on my website and otherwise feel free to get in touch with me via LinkedIn. I usually try to respond as quickly as possible.

 

Seamus: [00:29:50] Thanks, Alex. It’s been great having you on here.

 

Alex: [00:29:52] Thanks for having me, Seamus.

 

Seamus: [00:29:56] Thanks for joining. The next Metaco Talks will be on April 16^th. Because of the Easter holiday, we’re delayed a week. Our guest will be Alexander Lipton. He is the co-founder and CIO of Sila. Sila is aiming to overhaul the financial service world by using advanced APIs and distributed ledger technology. That’ll be a one-hour special episode or special event at Metaco Talks, hosted by our CEO, Adrien Treccani. So, until then, thanks very much for joining.