The FTX revelations have sent tremors through the market during the last two weeks. The news has seen damage to the industry’s reputation and to investors — retail and institutional alike — who had exposure to FTX and the estimated $10bn hole in its balance sheet. There are still plenty of details that have yet to emerge — but so far, the picture is one of alleged extensive fraud aided and abetted by profoundly poor governance and management practices.
Dawn has made two investments so far in the digital assets space. In 2021 we led the Series B for Copper, a custodial and settlement platform, and in 2022 the Series A round for Elwood, a trading platform.
We backed both companies believing strongly in the long-term growth and potential of digital assets, their value for financial markets, and the vital importance of robust, secure and sophisticated infrastructure to serve institutions as the ecosystem matures. Both companies continue to see exceptional performance.
The past few days have challenged us to look again at our market thesis. FTX was a darling of the industry. It only recently commanded a $32bn valuation and ‘SBF’ was an increasingly influential voice in both regulatory and political circles. Now insolvency proceedings are underway and lengthy legal disputes will follow. It is being talked about as the crypto market’s ‘Enron-moment’.
But we believe our thesis remains intact. The failures of a bad actor such as FTX should not be seen as the failed promise of digital assets and decentralised finance more broadly. Daily tracking of cryptocurrency prices and fears of a ‘crypto winter’ — a sustained period of lower and stagnating valuations — miss the point. A rising tide certainly raises all ships, but there is already more talent and more constructive activity in the ecosystem than ever before.
We are still right at the start of the opportunity for digital assets, which have enormous potential to create fairer, more liquid, and more efficient capital markets. Settlement and FX remain outstanding opportunities for the technology. We are early in the innings for stablecoins and CBDCs (Central Bank Digital Currencies) as stores of value and modes of transfer. The tokenisation of traditional asset classes promises to unlock previously illiquid markets — just last week, BCG estimated that $16tn of assets will have been tokenised by 2030.
The market structures of traditional finance comprise a patchwork of online and offline regional systems and trusted intermediary relationships that have been built up over decades. But they regularly break down and struggle to interoperate. By contrast, digital asset rails are natively global, digital, permissionless, programmable, composable and transparent. They are available everywhere an internet connection exists. And by building trust through open-code and distributed community-led governance, they also reduce the need for trusted intermediaries to transfer value between parties. DeFi (Decentralised Finance) has the potential over time to become an alternative rails for global finance.
Today, crypto remains an emerging asset class. There is no doubt that much of today’s volumes are for speculation — but it is already a highly traded and tradable asset class. And over time, we expect these maturing use cases to drive an increasing melding of TradFi and DeFi as institutions take advantage of revenue opportunities and cost efficiencies that are enabled by digital assets. This will significantly grow the market.
It will require cross-asset-class infrastructure to support a 24/7/365 digital asset trading market. This is what Copper and Elwood are building, and it’s where we continue to seek new opportunities.
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In the meantime, to recover from the reputational damage sustained and to realise its potential, the industry needs to refocus on building trust.
To this end, interestingly, recent events have in fact strengthened the case for decentralisation. Like FTX, a procession of over-exposed centralised lenders such as BlockFi and Voyager have collapsed in this year’s falling market, with BlockFi announcing yesterday that it has filed for bankruptcy. Depositors, lacking transparency on liabilities at these platforms, were hurt. Meanwhile, it has been business as usual for DeFi market-makers and lending protocols such as Uniswap, Aave and Compound that operate transparently through an open code base and community-led governance. DeFi has proven to be remarkably robust and offer greater customer protections through the market turbulence.
But centralised players will also remain core to a functional ecosystem. And the FTX saga has re-emphasised the importance of robust risk management, strong governance, compliance and clearer segregations of duties for these players to ensure fair and transparent markets. When people are involved and decision-making is centralised in the hands of the few, checks and balances are vital.
We believe this is a tailwind that will benefit platforms like Copper and Elwood that were built ground-up for institutional clients and that have assumed digital assets market structure and regulation would more closely resemble traditional financial markets over time.
We have already seen a greater focus on risk from all market players — whether traditional or crypto-native — and by extension the credentials and capabilities of their service and infrastructure providers in the last few months. FTX’s collapse will only accelerate this shift in perspective with increasing regulatory scrutiny on market practices and participants.
Secure custody is central to Copper’s proposition, and they have consistently emphasised the dangers of counterparty risk with exchanges. In the wake of FTX’s collapse, the company has seen record volumes on Clearloop and customers are now vocally advocating for exchanges to join Copper’s off-exchange settlement network to limit their counterparty risk.
In the medium-term, we believe that whether driven by client demand or regulation, there will be a far clear segregation of duties drawn between trading venues and custody/settlement solutions — just as there is in the traditional financial markets between exchanges, custodians and clearing houses — to reduce conflicts of interest and protect end-customers.
At the same time, Elwood is benefitting from a shift in counterparty consideration as clients move to distribute their risk across a broader variety of liquidity providers whilst their end-to-end portfolio management proposition is supporting clients with deep analysis of their risk exposures right through the trade lifecycle.
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The coming weeks will see more headlines and new stories as details of the ongoing FTX saga and its wider market impacts emerge. But the long-term value proposition for digital assets in financial markets remains undiminished.
We expect to see an accelerated demand for robust, institutional-grade infrastructure that sets the standards for best market practice. So if you’re building in that space, we’d love to hear from you.
