14Aug 2018

Rebuilding the Financial System From the Ground Up

by Henrik Andersson

Image: ICE, the owner is NYSE just announced a crypto platform bringing crypto to Wall Street. Smart contracts will bring Wall Street to crypto.

Applications for Crypto and Blockchain technology can be divided into use cases that on one hand provide incremental improvements to existing processes and on the other hand offer completely new and groundbreaking use cases that weren’t possible before.

The former group includes implementations of private, permissioned blockchains. It also includes the potential tokenisation of existing investment products such as real estate. These have the potential to incrementially improve exchange of information, settlement times, make previous illiquid markets liquid and fractionalise all kind of assets. As an example, the stock exchange in Australia, the ASX, is implementing blockchain technology for their settlement system. Two years ago it was supposed to be implemented in 18 months. Now they are targeting a launch at the end of 2020 which will take settlement times from T+3 to T+1, an improvment, but hardly a revolution. Meanwhile, Bitcoin has provided global settlements in 10 minutes for nearly a decade.

At Apollo, we think the more interesting use cases are the groundbreaking possibilities of crypto rather than the more incremental, blockchain improvements. This includes fundamentally distrupting how ‘money’ works; the creation of native digital goods; smart contracts that can disintermediate a number of industries. Put simply, the real revolution is about digital ownership and contracts between parties without a trusted third party. This wasn’t possible before Satoshi Nakamoto put the wheels in motion almost 10 years ago.

We believe a particular low-hanging fruit for smart contract technology is financial contracts. Some of the areas being built right now include;

  • Lending and borrowing. This will first happen with cryptocurrency. Dharma provides a peer-to-peer lending market in crypto based on smart contracts. Apollo Capital just partnered with Compound to provide liquidity for the lending and borrowing of crypto assets. Compound will provide a trustless (without a trusted third party) way using smart contracts to increase the price discovery in crypto assets. Investors in Compound include the likes of Bain Capital. dYdX is another Silicon Valley firm creating price discovery through smart contracts. As an example, they are set to launch tokens that represent a short position in a particular crypto assets — we will then be able to trustlessly take a directional bet or a leverage long position by simply buying a single token.
  • The next evolution will happen once we marry smart contract technology with stablecoin technology. Some very smart people at organisations such as Circle, TrustToken, MakerDAO, Basis and Fragments are working on creating a stable cryptocurrency that is pegged to fiat currrency, a basket of fiat currencies or in the future, CPI. Once we have a reliable and trustless cryptocurrency that is stable, not only will merchant adoption for the first time be feasible but we can start doing lending, borrowing etc. pegged to our everyday currency.
  • Derivatives are well defined contracts that can be entered through smart contracts. With smart contracts, we can take derivative positions peer-to-peer without counterparty risk. Firmo is an example of a start-up creating a programming language for these type of contracts. Once Oracle technology (these provide a method for ‘real world’ data to be referenced in smart contracts) is developed, we will be able to make trustless derivatives based on any asset. Prediction markets like Augur are related to this development. Augur’s prediction market based on the Ethereum blockchain recently went live.
  • We have been writing about how all assets will eventually be tokenised. Once we have tokenised real estate, we will be able to put real estate in smart contracts which will open the market for mortgage-like products to be based on blockchain technology.
  • Oracles and smart contracts can provide the basis for insurance products that are running on a blockchain without a central company or decision maker — this is a potential Nick Szabo explored on the podcast with Tim Ferriss. One smart contract/DAO based insurance project is Nexus, they will start with insuring smart contracts. In the future we might see a wide range of insurance products being build on blockchains.

The future of finance might look radically different. The technology is here and the first applications are being built right now. Kevin Kelly describes in the book The Inevitable the unstoppable force of the momentum of an ongoing technological shift. Kevin explains that banning, prohibiting and trying to stop the inevitable is ususally counterproductive. We can and should regulate but change is inevitable. Crypto assets and blockchain technology is not going away, it is a force for good that can unlock tremendous value by disintermediating today’s trusted third parties. Some might say the future financial revolution is inevitable…

Henrik Andersson

Henrik is the Chief Investment Officer at Apollo Crypto and is the fund manager for the Apollo Crypto Fund. He also acts as the fund advisor for the offshore Apollo Crypto investments funds, the Apollo Crypto Frontier Fund and the Apollo Crypto Market Neutral Fund. Henrik's expertise in traditional financial markets comes from spending a decade on Wall Street as a vice president in institutional equity sales. His exceptional understanding of DeFi comes from co-founding two successful DeFi protocols, mStable and dHEDGE.