The IPO of Coinbase earlier this year was a moment of great symbolism. The listing of the world’s largest cryptocurrency exchange is another manifestation of crypto going mainstream. But it also underlines the disruption blowing through financial services.
A direct listing, it cuts out the usual intermediaries as decentralized finance also threatens to do, while its market capitalization of $50bn made the company, less than 10 years old, one of the 20 largest financial services company in the world – bigger
than the largest banks in France or Brazil.
This is the moment to invest
Financial institutions now know that they need to play in the digital asset market, for both offensive and defensive reasons. In the years that I have been discussing digital assets with financial institutions, the skepticism and the misgivings have been
steadily dissolving. At first, it was the realm of criminals. Then, it was a fad. But with heavyweights from Fidelity to JP Morgan all making big bets on the space, and the threat of disruption from Coinbase and others looming large, most financial firms realize
that now is the time to invest. Investing is the only way to protect their existing roles - as custodians, exchanges, issuers – as well as to stake their claim in a market that will boom as tokenization opens up a much larger pool of assets.
But knowing that your firm needs to invest in digital assets infrastructure is not the same thing as knowing exactly what its proposition or business model should be. Like any nascent market, the digital asset market is evolving and changing quickly. Investment
cases are changing. It was tough to make the case for investing in crypto asset custody a year ago, but since then the market has grown over four times.
Value propositions will also inevitably evolve. Not many people know that Coinbase started out as a Bitcoin payment processor before it realized that there was a lot more money to be made as a Bitcoin broker. And so, similarly, financial institutions are
likely to change strategy over time - about, say, whether to tokenize assets directly or whether to create secondary market for tokenized assets.
So the key for any institution will be to be keep its options open, which to a great extent will be synonymous with not creating legacy technology.
Creating optionality and avoiding legacy
Financial institutions spend more money on technology than any other industry. Part of the explanation lies in the fact that financial services is an information intensive industry: its product is both digital in its manufacture and increasingly in its distribution.
But the other reason is that financial firms spend so much money maintaining and updating legacy systems; an outcome of bad historical decisions to invest in proprietary and overlapping solutions.
Digital assets give firms the chance to start afresh; to rebuild the future of their businesses without the legacy. However, it means not repeating the same mistakes – jumping into technology decisions that will cultivate the same expensive legacy IT estate.
The temptations and the risks abound. If a financial institution moves into the digital assets market, it will immediately be faced with choices:
- Should it self-custody (be in charge of storing the private keys that secure the digital assets) or should it outsource that function to a bank or custodian?
- If it opts for self-custody, how should it secure the keys? With a hardware security module or with multi-party computation (a software alternative)?
- Should the solution be hot (connected to a network) or cold (only accessible physically)?
- Should it leverage public distributed ledger technology (DLT) or permissioned ledgers?
- Should it run its solutions on premise or in the cloud?
Each one of these binary decisions risks closing down options and creating legacy infrastructure. For example, if an institution opts in one location to have an on premise self-custody cold storage solution and then decides in another location to use a sub-custodian,
it will have created a data fragmentation issue reducing efficiency and adding friction to customer experience.
Orchestration is the answer
The solution lies in financial institutions choosing orchestration systems.
An orchestration system is like a computer operating system in that it manages many-to-many interactions. In the same way as an operating system sits between hardware and software applications, an orchestration system sits as the heart of an ecosystem consisting
of customer channels, trading venues, custodians, settlement networks and other constituents.
It buys a financial institution massive optionality at a low premium cost.
Any decision a firm takes now about technology or business model does not bind it permanently (or expensively) to that path. If, for example, a financial institution chooses to become a custodian and then changes direction, an orchestration platform can
easily make this change because it aggregates logic away from underlying applications as well as provides the necessary connections into third-party providers; a case of plugging and unplugging. Similarly, if an institution decides on direct distribution,
but then moves to distribute via intermediaries, this again is easily resolved since an orchestration platform also separates the logic between interaction and manufacturing, meaning changing or add new customer channels is simple.
New business models
If the optionality were not sufficient compelling in itself, financial institutions should also think of the business models that would be difficult or impossible to execute without orchestration. In retrospect, all of the big technology business models
– from Google to AWS – all seem self-obvious. They are logical platform and aggregation plays in a networked era.
Well, DLT is making money networked in the way that the internet made communication and information networked. New business models will emerge and the only thing we know for sure is that they will be based on facilitating the interaction of value between
an ecosystem that – for the foreseeable future – will have to bridge between the old world of centralized finance (CeFi) and the rapidly emerging of DeFi.
Boiling the frog or leapfrogging
If, looking around at the pace of change, you think your institution may be like the proverbial frog oblivious until now about the rising temperature, it is not too late. Many of your competitors that acted earlier, led by industrial-age procurement team
and processes, made the classic mistake of selecting monolithic applications. By choosing orchestration instead, you can introduce the flexibility that will enable your firm to navigate this fast-changing space more successfully – allowing you in time to leapfrog