These past weeks have brought to light what we call matters requiring attention (or MRAs) in the financial sector. MRA stands for a practice that is not in line with sound governance, internal controls, and risk management principles. These issues that need attention can have a negative impact on the industry and raise the risk profile.
My focus has always been on technology and innovation-led models — systems and interconnected elements in blockchain-powered business networks — which rewrite the transaction systems that underpin many industries, including financial services. Recent events have prompted a growing number of naysayers to voice their dismay at the extensive mismanagement, poorly-defined and misgoverned systems and general misrepresentation. To understand the causes of this situation, to dissect the failures and to provide guidance on how to learn from them, I will be taking a systemic approach to the industry.
Let’s start by understanding the market structure and its meaning. This will shed light on the inefficiency of the current crypto market structure. It will also allow me to argue for a better-defined structure that aims at systemic fairness and robust information flow for risk profiles. A convincing innovation narrative is needed to revive the industry.
Understanding the current financial market structure
Modern financial markets are essentially a network of interconnected market participants that help in capital accumulation and investment. These market participants perform specific functions such as clearing, settlement, clearing, liquidity provisioning and central bookkeeping. Many of these entities do not have a vertical integration because of capital constraints, regulation or function. This prevents collusion and unilateral investment decisions. Although different products might be governed by different markets the basic financial primitives are universal. Products such as stocks, futures and options, as well as currencies, all need to be traded and cleared. Other functions like collateralization, lending, borrowing, and lending, also require their settlement.
Financial markets only work where there is both capital supply and demand. This is crucial. Information between interconnected participants today is a function sequential batched relay system. This asymmetric dissemination creates not only opacity, but also inefficiency, in terms of liquidity requirements, systemtrust costs (in the form of fees, and opportunity costs) and system trust costs.
These issues of trust and time are solved by blockchain and distributed ledger technology systems. They have the characteristics of immutability, asymmetric dissemination consistent information and indeterminability. This allows for trust and instant transaction processing. What went wrong? Why is the problem that we were trying solve getting exponentially more complicated and common in crypto capital markets.
Similar: Understanding the systemic shift in financial services from digitization and tokenization
The current market structure — The history of the promise and limitations of crypto
As an experiment, the Bitcoin (BTC), system was created out of the global financial crises as a prescriptive approach for rethinking the financial system. It is a reimagined way to organize the world and decrease dependence on a few large hegemonic economics.
The system was based on the principles of decentralization to share power and trustless protocols so that no one entity could have absolute control over a monetary system. It was based on participation in the creation, acceptance, and recognition of a global currency. The rules of supply and demand were applied according to equalitarian principles.
Related: A new introduction to Bitcoin: The 9-minute read which could change your life
Bitcoin was a catalyst for the creation of a few financial systems that could address the inefficiencies found in the current system. Ethereum added programmability to the simple asset transfer that Bitcoin introduced. It also introduced complex financial primitives to apply to otherwise straightforward rules for moving value.
This was the beginning of a rebirth of the internet. It wasn’t designed to move any value, but just information. The industry was now thriving with promise and innovation. Layers like provisioning scaleability and privacy (layer 2) were added. Although there were some naysayers in the industry, the crypto industry was able to bring innovation without apologies. It began to create a new wave technological development that would empower an ownership economy. This is very similar to the participatory and global egalitarian economic system promised with Bitcoin.
Many innovative projects were born to solve problems. We could see the spread of innovation through the ecosystem, with many new applications, use cases and solutions for many of the problems that result from lack of trust, cost, and the exploitive opacity and monetization of data and information that is only available to a few.
Related: Bitcoin’s Velvet Revolution – The overthrow and restitution of crony capitalism
This revolution attracted new talent from various industries. Many projects were socialized and did not adhere to the original principles or add to technological innovation. They used the language and enthusiasm of the community. However, their structure had a centralized layer with all the problems of the current system but with all the benefits of distributed ledger technology-based transaction systems. These projects offered financial product innovation using the same financial primitives. They solved the problems of trust, capital efficiency, risk, time and opacity and promised egalitarian access. However, they did not have the market structure or guardrails that the current system offers.
Designing a new crypto capital markets structure and compelling innovation narrative
The history of the crypto market has been one of grassroots changes. Entrepreneurs and the community drive these changes. These forces will again drive the industry to pivot and change, resulting in a stronger foundation. To achieve this, however, the industry must have a solid market structure and be free from any current transactional systems. It is important for the industry to not only coexist with existing market structures, but also to offer a bridge vehicle to current asset types. These are some of the imperatives that I consider necessary MRAs to create stronger and more resilient markets.
There are many definitions of “Stablecoin”, and many types. Therefore, the industry should spend significant effort to rethink stablecoins or any other fungible asset that can be used as a medium for exchange. Stablecoins facilitate large volumes of digital asset trading. They allow traditional fiat or fungible sovereign currency to be converted in digital assets including crypto assets. This has brought liquidity into the market. They have also inherited the fiat problems (as a reserve currency) and started to offer linkages to traditional financial markets and to inherit the opportunities (and challenges) of traditional financial markets.
In addition to the compliance and regulatory burden that fiat can impose on a crypto financial system that is largely unregulated, complexity in value systems can also cause problems in asset valuations and risk matrix. This makes it difficult for emerging asset classes to thrive and realize their full potential. The industry should view native crypto assets such as BTC, Ether, (ETH), and other ubiquitous crypto assets or currency baskets as fungible assets. These assets can be used as store of value, medium of exchange, and unit of account.
Provision of robust crypto market data
Market data can be described as the broadest term for financial information that is necessary to carry out research, analyze, trade and account for all financial instruments on global markets. Crypto presents a new challenge because it is a 24/7 operation that can generate data at a speed and veracity never before seen. These data capacities and velocity have created analytic challenges in data collection and aggregation as well as modeling and insights. Data is information that is used to calculate the price/value/risk calculation and other macro factors like inflation, money supply, global events that affect commodities. It essentially makes a market efficient, or aims at being efficient.
To prevent certain participants from profiting from information asymmetry such as insider trading, regulatory moats are in place. The gap between value (what you get) and price (what it is), can be bridged by crypto market data. This is a must-have for all layer-1 projects, but it should also be a requirement for any projects that provide financialization of tokens as a service.
Related: A significant shift from Bitcoin maximalism towards Bitcoin realism
Establishment of a self-regulatory crypto organization
It is essential to establish a self-regulatory organisation (SRO) that includes major industry players and layer-1 protocols. This organization has the power and ability to set industry standards, professional conduct guidelines, and regulations to guide the industry in the right direction.
SROs can be effective because of their domain expertise. They also preserve the industry’s reputation and interest by providing guidelines and safeguards for both new and existing participants. Enforcement and violations can be addressed by broader education and appeals made to the community supporting a project. This can be particularly effective with robust crypto market data, which provides insight into transparent data and the correlation between activities in the industry on related markets. This will allow the industry to work with policymakers and regulators, as well as forge new partnerships.
The crypto industry needs to decouple in order to offer both variety in its investment landscape as well as a model that allows for efficient and resilient asset classes, transaction system and a market structure. Stablecoins have elements of global macro strategy, increased correlation and require a rethinking of the industry’s ability create value on its merits. A new fundamental model will allow the market to develop a compelling innovation story and provide a new independent asset type with solid fundamentals. This aligns with the fundamental principle which led to the creation of Bitcoin-driven crypto innovations. In scientific terms, decoupling refers to the reduction of resources needed to generate economic growth and decreasing environmental deterioration.
Related: The decoupling manifesto – Mapping the next stage of the crypto journey
Modern financial market structures are essentially a network of interconnected market participants that help in capital accumulation and investment. A sound market structure is essential for the industry. It must also be free from any current transactional systems. Industry imperatives include coexistence with existing market structures and providing a bridge vehicle to current asset classes.
I have already discussed MRAs as essential to stronger and more resilient markets. Changes to correct the industry’s volatile and unstable nature include, but are not limited to: a) Rethinking stablecoins, liquidity, b), robust crypto market data to facilitate market functioning, and c) Creation of a crypto selfregulated organization and enforcement via community actions. d) Decoupling crypto. This basically means that the industry will be able to create value on its merits. It will also create an innovation narrative and provide markets with a new independent asset type with solid fundamentals.
This article is not intended to provide investment advice. Every trade and investment involves risk. Readers should do their research before making any decision.
These views, thoughts, and opinions are solely the author’s and do not necessarily reflect the views or opinions of Cointelegraph.
Nitin Gaur joined State Street Digital recently as its managing director. He is responsible for digital asset and technology design with the aim of transitioning the financial market infrastructure as well as clients to the digital economy. Nitin was previously the director and founder of IBM Digital Asset Labs. He is committed to creating industry standards and use cases, and making blockchain work for enterprises a reality. Nitin was also the chief technology officer at IBM World Wire, a cross-border digital asset payment system. Nitin founded IBM Blockchain Labs, and was responsible for establishing a blockchain practice within the company.