In this episode of Unchained, Charles Cascarilla, CEO and cofounder of Paxos, explains how the 2008 financial crisis led him to crypto, what financial plumbing has to do with GameStop, and how Paxos is leveraging blockchain technology to change financial services. In this episode Charles discusses:
- his work experience prior to Paxos and how the financial crisis in 2008 opened his eyes to Bitcoin and blockchain (01:07)
- what it was like to work in Bitcoin during the early days compared to now (4:02)
- why Paxos decided to focus on building solutions for institutions rather than targeting the retail market like Coinbase (11:38)
- the relationship between Paxos and PayPal + why PayPal customers can’t send crypto directly to their wallets or crypto addresses yet (19:37)
- how Microstrategy and Tesla are bringing Bitcoin mainstream (25:31)
- what really happened with GameStop and Robinhood and why financial plumbing matters (30:34)
- how the Paxos Settlement Service is bringing greater transparency to financial markets by using blockchain technology (39:02)
- what other assets he thinks will be tokenized (50:32)
- stablecoin regulation and why this might be as good as it gets for Tether (58:36)
- why Paxos chose to pursue a New York State trust company charter instead of a BitLicense (1:06:15)
- what changes he would make to crypto regulation for 2021 and beyond (1:09:28)
- what’s next for Paxos (1:15:12)
Thank you to our sponsors!
Download the Crypto.com app here: https://crypto.onelink.me/J9Lg/laurashinpodcasttesla
Coindesk Profile: https://www.coindesk.com/charles-cascarilla-most-influential-2020
Previous interview with Laura: https://unchainedpodcast.com/chad-cascarilla-on-paxoss-partnership-with-paypal/
Presentation at Microstrategy’s Bitcoin for Corporation’s conference: https://www.microstrategy.com/en/bitcoin/videos/paxos
Blog post on the GameStop saga: https://www.paxos.com/what-lehman-brothers-gamestop-and-the-next-financial-crisis-have-in-common/
Interview with Frank Chaparro: https://www.theblockcrypto.com/post/61823/the-scoop-paxos-cascarilla-coronavirus
Paxos Settlement Service: https://www.paxos.com/securities/ + https://www.reuters.com/article/us-crypto-currencies-paxos/paxos-to-launch-settlement-of-u-s-listed-equities-after-secs-no-action-letter-idUSKBN1X727M
Series C Fundraising: https://www.theblockcrypto.com/post/88133/142-million-series-c-paxos-crypto-stablecoins
Wall Street Journal write-up: https://www.wsj.com/articles/blockchain-makes-inroads-into-the-stock-markets-1-trillion-plumbing-system-11573131600
Plans to tokenize precious metals: https://www.theblockcrypto.com/linked/15413/paxos-plans-to-put-precious-metals-on-the-blockchain
Paypal’s crypto-focused business unit: https://www.theblockcrypto.com/post/93668/paypal-crypto-business-unit-earnings-2021
Paypal’s Q4 earnings: https://www.coindesk.com/paypal-2020-results-outstanding-finish-to-a-record-year
Stablecoin rankings: https://stablecoinstats.com/
Tether whitepaper: https://tether.to/wp-content/uploads/2016/06/TetherWhitePaper.pdf
Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host Laura Shin, a journalist with over two decades of experience. I started covering crypto five years ago, and as a senior editor at Forbes, was the first mainstream media reporter to cover cryptocurrency full time. Subscribe to Unchained on YouTube, where you can watch the videos of me and my guests. Go to YouTube.com/c/UnchainedPodcast, and subscribe today.
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Today’s guest is Charles Cascarilla, CEO and Co-Founder of Paxos. Welcome, Charles.
Hi. Great to be on here, Laura.
You got started in bitcoin super early. Why don’t you tell us your background before bitcoin, and then I’ll ask you how you got into bitcoin?
Yeah. Sure. So, my background is really almost entirely in financial services. I started working at Goldman Sachs and Bank of America, really covering financial services companies from the sell side, and then I went to the buy side and was an investor, and then I started my own asset manager in 2005 with my co-founder Emil Woods, and that specialized just investing in financial services companies.
And we came across bitcoin after going through the financial crisis and getting a lot of things right about it, and saw bitcoin at 3 or 4 cents, and was immediately intrigued by the technology. Certainly would never imagine we’d be at, you know, high $40,000 price of bitcoin here, which is, obviously, really exciting for everybody, but we really thought the technology could be transformative, not just bitcoin, and that got us to start Paxos about seven years ago now.
And so, I’ve also heard you say that what you saw in the financial crisis got you interested in bitcoin, so why don’t you connect the dots for us there?
Yeah, so, I think some of the key themes that we captured as investors was how the electronification of markets changed price discovery. It changed how you traded in a really fundamental way, and you went from, basically, being on the floor to microseconds in about 10 years. This was a huge amount of innovation, and in that same time, you basically went from T+5 to T+3 settlement.
So, almost nothing changed in the middle and back office, but everything changed in the front end. When we came across Bitcoin and blockchain, we immediately recognized a possible way to solve those problems in a new way and in a way that could really fix the infrastructure and the plumbing, which, you know, very desperately needs it. We’ve seen that in Lehman Brothers, we’ve seen it with GameStop, and frankly, we’re going to see it in the next financial crisis if we haven’t upgraded, that the plumbing is actually really exacerbating the crises.
And in certain cases, actually creating them, and Bitcoin and blockchain offer pass forward because you’re getting real-time movements of assets, not real lags in them, and so, coming out of the financial crisis, when we saw this technology, we immediately thought, here is a way to know who owns what when, and that’s not possible in today’s financial system.
I know that kind of shocks everybody, but you don’t really know who owns what when. I mean, it’s a fairly basic concept, but financial markets were set up from an infrastructural standpoint to promote liquidity and trading, not to promote clear ownership and chain of title because of lots of weights of history going back 50 years. That’s what really fascinated us about this technology: we could see a way to change, fundamentally, how the financial system would operate and to make it fairer and safer.
Yeah, so, we’re going to tie together a lot of the strands that you just mentioned and plus some new ones, because there are so many things going on right now in the markets that I think really make everything that you just discussed kind of illustrate the importance of all that. One other thing that I wanted to ask you about was, in the early days, as you mentioned, you got that New York State trust company charter, and you received it in May 2015, but you started the process of trying to getting it in 2012. I think I once heard you say it was May 2012. So, can you describe what it was like working in the bitcoin industry at that time and compare it to the bitcoin industry right now?
Oh, well, I don’t know. It’s like we were wandering in the desert, it felt like, in some sense. You know, you go back to 2012, there wasn’t even Ethereum. So, we really were believing that this could fundamentally alter the financial system in a profound way from very, very early days when, you know, it was really, in some sense, a bit crackpottery to believe that, and you know, catching things early is really exciting because you can see how things evolve, and I mean, it really evolved a lot.
I mean, it was very early community, a very, I would say, cyberpunk-y. It was really not hugely financially literate in a sophisticated sense. It was really much more about being technologically literate, and there are so many exciting things when you’re that early to see something evolve into what it is now, and it’s gone through a number of different stages, you know, from really the absolute cutting edge, like, kind of cyberpunks and hard libertarians and you know, people who are really deeply into cryptography, into decentralization.
It was such a new field back then, and I’m not a technologist, so I definitely enjoyed talking with them, but I was completely out of my depth because I don’t know those things on a native basis. I remember, you know, after about five clicks, you would be through all of the information about Bitcoin when you first started. You had, like, the white paper, you had, like, you know, three websites, and you had, like, one chat board, and that was about it.
And to now get to the point where the torrent of interest and the many, many different types of communities that are evolving so rapidly, you can’t even keep up with it. I mean, it’s bewildering almost, and that’s awesome to see, because the reason we got involved so early was because we thought it could get this big, and that wasn’t obvious, but it was something we really believed had the potential.
Yeah, and you know, I was just trying to think back. I think the price around then was…am I right that it was either in the single digits or the low double digits?
That sounds definitely right. I think it was probably somewhere around ten or twenty dollars when we started wanting to work on the trust. It was really kind of surprising how much the price started to move in very unusual ways, and the technology itself was less of a focus, and so, you went through a number of these stages where it would be about the technology or be about Bitcoin.
And so, at that time, it really was still a lot about Bitcoin starting to move up, and so, when we were applying for the trust, a lot of people were like, well, why are you so focused on this Bitcoin thing, you know? It seems like it’s just for money launderers or for, you know, the dark web, and you know, we kept trying to point out that, actually, the technology and Bitcoin, while they might be separate, are allowing the same thing, which is more financial freedom and more financial access and that they’re going to play a common part together.
And it just wasn’t so obvious for people who were familiar with financial markets that Bitcoin could make sense. Then people who were really familiar with technology said, oh, yes, I understand Bitcoin, but you know, I don’t understand how the plumbing works and why this technology could be so fundamental. That’s what we’ve actually bridged at Paxos for so long, is, on one sense, traditional markets and the problems they have and what this technology can solve, versus the insurgent nature of bitcoin, which we also believed in, in terms of how it can really fundamentally alter a lot of the financial services market, as well. So, there’s so much to go on between both of them.
Yeah. Yeah. Something that’s really interesting is I’m pretty sure that right around that time that you started that process of trying to get the trust charter is right around when Brian Armstrong of Coinbase was starting his Y Combinator program, and so it’s just interesting. So, Paxos and Coinbase I think kind of got their start roughly around the same time.
And yeah, and I think what’s also so fascinating is that, you know, with your traditional financial services background, you know, Goldman and everything, that you saw the potential and could see where this was going at a time when I just feel like a lot of people with your background really did not, because I feel like 2012 era was when you started seeing more of the entrepreneurs, like the Wences Casareses of the world, kind of start to get into it, although, yeah, he did actually convince some people on Wall Street. Okay, so, yeah, it was…
And I would also say, like, what really fascinated us was because I had spent so long as an investor, and you know, there’s lots of different ways to invest, but one of the fundamental ways we invested was being contrarians, which is, you know, non-consensus ways of looking at problems and what could be very huge optionality out of them.
So, we looked for that a number of different times in our career, and I think we caught some of them. Some of them, we were wrong on, but you’re never going to be right on all of those, but we caught a number of them investing in exchanges in clearing corps when they’re really trading below the value of the buildings that they were housed in. You know, I mean, and then they suddenly are trading at 15 times revenue, this huge opportunity.
We were short subprime, mortgages, and commercial real estate mortgages. Then there were long distressed mortgages coming out of the crisis. We had a number of other positions. Those are some of the more notable ones, and then coming across Bitcoin at three or four cents and like, kind of, you know, really having fun with it and looking at the technology, but constantly trying to think of what is the problem? And what is the best way to potentially have real upside in that problem being solved?
And you know, I think that’s what really kind of lent us to understanding this opportunity, but also why it was actually important for us to be in financial services in order to see that. You know, if we hadn’t gone through the crisis, if we hadn’t seen the problem in the plumbing of the system, if we hadn’t understood all of those things, I think it would’ve been really hard for us to get it.
And because we lived there, which is still different than more people on Wall Street, living in those types of areas in the markets, it made us really understand, I think, on a native basis, what the problem was and why this will be able to solve it, and have conviction around it to continue to hold it and not just be like, oh, it’s hit 200. It’s time to sell, or it’s hit, you know, 1,000. It’s time to sell, because, otherwise, you would I think, from our backgrounds at least.
Right. Right. No, for sure. I feel like the more trader-y type of people tend to not have that conviction and want to sell when they think the price is high. So, one other thing that I wanted to ask about, just because you do have such a long history in this space, and I feel like, you know, during that time, you were kind of gathering all these different elements that have now come together to form what we think of as Paxos, which, obviously, probably is most well known for its relationship with PayPal.
But before that, you had…which, obviously, you still do, but it’s definitely one of the smaller exchanges, and so, were there times when you…and obviously, you know, I think we discussed this the last time you were on my other show, Unconfirmed, where we were talking about how, in 2015, when you did get the trust charter, I recognized that that was significant, but I sort of still didn’t understand exactly how it was going to be used, you know?
Like, I couldn’t really see where things were going or what was going to be created, and so I kind of want to hear about your journey over that seven-year time period where you were building Paxos, and maybe, you know, you tried certain things, and did you kind of always know where you were going to end up, which, right now, is I think you’re kind of more in this B2B play, or earlier, you know, were you trying other things, and then did you feel like you tried to pivot?
Well, I think there are a number of components to that. When you’re in the early adopter stage, which I think is a clear way of describing where the market was five or six or seven years ago, and real early adopter, I mean, like, you know, no adopter stage, right, at that point, and you know what I mean? You could tell the whole community, like, you know, in one Reddit room or one email thread.
And so, when you’re in that stage, you kind of need to have the AOL strategy, I describe it as, which is you need to do everything from soup to nuts, from the front end all the way to the back end. It’s a small world, and you know, the only way you can capture value is by doing a lot of different things, because your customers need all those things done, but there’s nowhere else for them to go get it, and that AOL strategy makes a lot of sense.
If you were going to end up on a mainstream adoption point, the AOL strategy starts to make less and less sense, and it becomes much more about specialization over time and enabling a wider swath of users and businesses, B2B, B2B2C, and it’s not just around having the entire stack yourself. Because we had this belief that this technology could fundamentally change financial services, we thought about what types of strategies, what types of businesses can be very valuable and very important when you get to a more mature state, and what should we start to build in order for that to happen?
Now, I would never imagined it was going to take what, in some sense, seems like a short period of time, but in some sense, feels like a long period of time, which is seven, eight, nine years, whatever it is, to get to this, you know, really fantastic moment that the space is having now. I thought it would’ve happened maybe three years ago where we’d get to something that looked more like this, and I guess things always take longer than you think, and then they happen faster than you thought.
I think that’s the saying, and so that happened for us. When we built the business, it was always with the intention of let’s be for many different types of institutions that want to eventually come in on a turnkey basis and be able to access crypto, be able to access tokenized assets, because I still believe that this is about a lot more than Bitcoin. Its hugely important element is Bitcoin, but just the power of re-platforming the financial system onto a blockchain is beyond transformative across the board in so many different ways.
And we can talk about that, and building that, in the early days, definitely felt like we were wandering, in some sense, through the desert, because we weren’t building a B2C platform, and that was mainly who the earliest adopters were, and then it was mainly for traders trading with those early adopter retails, and that’s still very much still almost retail in some sense, and here we are not building a retail platform.
But I think that, over the horizon viewpoint of where things were going to go is what is really paying off for us right now because we’ve made sure we kept our business, I think, a lot more focused on that infrastructural layer. The point of itBit, our exchange, was this is for institutions to be able to use who are holding their assets and want it to be a safe liquidity pool and want it to be a safe place to be able to execute, but of course, that only has so much utility if you don’t have lots of retail players in there.
Now, you can go acquire those retail players, or could go acquire businesses that have retail players, and so that’s the point here, is add firms like PayPal, add firms like Revolut, and a whole number of other firms where they want to power their end user experiences and have a safe, reliable, compliant, turnkey solution, and you can’t get that anywhere else because it wasn’t an obvious thing to build when you’re in the early adopter stages.
Yeah. It’s interesting also because I could imagine…and you tell me if I’m wrong, but it sort of seems like when you’re trying to make that type of sales pitch, what happens is that maybe getting the first kind of big client would take awhile, but that, once that happens, then there would be kind of like a flood of them. Do you know what I mean? It’s just like whoever wants to be first…like, nobody wants to be first, but then once somebody goes, everybody’s like, oh, we all have to catch up. So, am I right that that’s kind of how those conversations went?
Well, there’s some elements of, you know, these firms just really coming into a space that they have to be careful about, that, you know, has a little bit of a risk to it. People fear the reputational risk, or they fear just doing something new, fear being first, lots of regulation.
And so, all of those things, certainly, I think held back this mainstream phase a little bit more than we would’ve thought, and so, I think all of those are contributing factors, and not just them coming to Paxos, but to them coming into the pace in general. So really playing that through, with our strategy of we’re going to focus on creating turnkey solutions for these types of businesses, banks, brokers, payment companies, technology firms, remittance companies, I think that’s now really clear that that was the right way to approach things, but you know, it felt, again, like, hey, why didn’t you just go out and acquire millions of retail customers?
You know, and that is just the nature of shifting from early adopter to mainstream, having the right moment in time, and we were able to get there because we had the right investors. I think we had the right vision. You know, all of us really believed in where this was going to go over time, even when it was not obvious.
Yeah, it is so similar to your initial contrarian bets in the traditional financial services space in the markets where you could kind of see that something was going to happen, but you just needed to wait long enough for it to happen.
Which I know that can be a challenge.
But obviously, it paid off for you.
You know, in investing, there’s a saying, there’s no difference between early and being wrong, and that’s because, you know, you have to be able to have the position. You have to be able to continue to make it, and there are so many firms in crypto and in general where that time was too hard, or maybe they focused too much on just the blockchain technology, private blockchains being such a huge fad for a moment in time, and not that it’s gone away, but there was a huge moment where everyone was just about it’s only about private blockchains, about private blockchains, not public blockchains. You know, you could get really deterred and pull away. So, lots of chapters in this book, when you kind of drill in, it kind of looks smooth when you zoom out, but it definitely has been a wild ride.
Yeah. Yeah. You’ve kind of actually straddled the two trends pretty well, especially given that one of them hasn’t really panned out in the same way that, you know, the hype kind of seemed to indicate it would back in 2015 / 2016.
So, you know, speaking of the PayPal relationship, I did ask on Twitter what I should ask you, and a number of people wanted to know this. So, PayPal empowers corporations to provide a crypto experience for their customers so they can buy and hold crypto. It also does enable your customers, the firms, to send and receive crypto, and so I know, obviously, you don’t represent PayPal, but can you give us insight into why PayPal users cannot withdraw the crypto that they purchase there directly to their own wallets or to other crypto addresses?
Well, you know, I think there are a couple components to this. The first is I think everyone should appreciate PayPal coming to this space is probably the biggest thing that’s happened to this space, you know, notwithstanding Elon Musk and Tesla creating some huge hoopla around it. At the end of the day, that’s 300 million consumers that PayPal either has enabled or will plan to enable.
They’re rolling this out over time, including the international and Venmo, and so there’s a lot that PayPal is doing here, and just getting that into place was a big deal for them. They’ve never allowed the possibility of owning something, aside from dollars, holding something aside from dollars in their app. So, this is a big deal, and I think them making the commitment, which is very big to the crypto space and decentralized finance space, is just an important moment for all of us.
And if you go and read their two-page press release, they’ve laid out what are some, you know, really expansive goals that they want to achieve over the next 12 to 24 months. Now, you know, I don’t think that I can tell you exactly what their plans are, but I would say that this was just the first step. You know, this is “let’s get going.” You can’t launch everything on day one, and so they have a lot more plans, and you know, when those actually come out, we’ll see, but I don’t think was as far as they want to go. This was how do we get going and launch something as fast as we can and build on that?
So, if you approach it from that perspective, I think it looks less like, you know, you’re buying crypto, but you don’t really own it, to it’s more like I now have access to crypto in a way I never did before. There’s going to be a lot more coming down the pike, and that’s going to be really great, you know, if you’re a PayPal customer, and of course, PayPal and Paxos, we’re sitting here trying our best to make sure they have as much functionality as they want to be able to offer to their customers. I think you’re going to see a lot more exciting things from them in pretty short order.
So, my theory around why people can’t send the crypto directly to their own wallet or other crypto addresses is because, when you’re switching from a service that runs on the traditional financial rails where you can, like, claw back funds if you need to, and then you’re moving to a system where you cannot claw back funds if you need to, that this creates an opportunity for fraudsters, and so they maybe need to kind of like up their fraud protection? Is that a good theory?
Well, I think this is an important component, and by the way, we saw this with the rules out of Treasury. They’re thinking about different ways of being able to track movements of funds to non-customer wallets in blockchain and in crypto. So, there is, you know, clearly, like, a compliance component to making sure that you understand what’s going on when funds leave your platform, whether it’s Paxos or Coinbase or PayPal, but again, I think I would really focus on, wow, this is a huge effort for PayPal to get to where they’re at, and this is about, you know, adding in functionality over time.
So, are you working with PayPal on adding those functionalities?
Well, I can’t really speak for PayPal here, but I would say that we’re clearly excited to be an infrastructure provider for them, and as they continue to roll out more services, I think we’re going to be there within them in a lot of ways. I know that people really want, you know, as much as they can possibly have today, but sometimes, you got to be patient, and I think you’ll see some really good things out of what Paxos is doing and what PayPal’s going to do in the next 12 months.
And I also noticed in the PayPal queue for earning call, that CEO Daniel Schulman said that PayPal will be creating a new business unit dedicated to crypto. I wondered, what does that mean for Paxos’ partnership with PayPal?
Well, firstly, I think that gets to the point we were just making before, which is they’re putting a lot of resources behind this. They have a group that’s just focused on it. We work with them all the time. It’s great to see them now have more dedicated resources in that way, and you know, at the end of the day, Paxos is an infrastructure provider. We’re not going to be the only infrastructure that PayPal relies on. I think it’d be probably nutty if they only used Paxos, you know, given the size that they are.
It would just make sense that they’re going to do things themselves. They’re going to use other providers, but on the other hand, there are just a number of things that we can uniquely enable, and not just now, but over what they want to do over the next several years, and so we’re going to be there I think, like, as a really important partner for them, and we’re excited to be that best possible partner for them and others, too. You know what I mean?
There are just so many players now who are saying, wow, PayPal blazed a path. They’re doing it. Why can’t we do it? A lot of people are saying, oh, man, you know, look what’s going on. We have to get off our hands and get in the game, and they’re just trying to figure out a way to do it, and here we are, as Paxos, purely dedicated to that. We’re not going to compete with anybody. We’re here to help you. We’re here to do it fast. We’re here to do it in the most trustworthy way that you could possibly want, and you know, we’re really thankful for the partnership we’ve had with PayPal so far.
And shortly before recording this show, you were the final speaker at the Bitcoin For Corporations event held by Microstrategy, and your parting message to the audience was that bitcoin, as a reserve asset for corporations, would be a trend in the future or pretty much has arrived, and they should not be the last to get in, but to be early. I was curious, you know, it’s only been a few days, but what kind of interest has Paxos seen since that event?
Yeah, I mean, I think it’s another exciting moment here in Bitcoin. It’s an interesting new chapter, and sometimes they’re unpredictable. I wouldn’t have imagined that late 2020 and early 2021 was going to be about corporate Treasury adoption of crypto. Honestly, I would’ve never imagined that.
On the other hand, it’s very exciting to see, because, like I was mentioning at that conference, Microstrategy, which was so exciting to be a part of because it’s opening up all kinds of new vistas here, you know, people are seeing this as a reserve asset and a monetary network, and in some ways, it’s like gold was before we went off the gold standard I think, and that’s what digital gold allows, is now a capacity to hold something where, you know, you can participate in a monetary network in the future, and so you get involved.
You own some now. It’s still a small market cap overall versus where it can be. There are lots of tailwinds. They’re not going to stop printing money anytime soon. We have another $1.9 trillion stimulus bill coming through. I was looking at the amount of government spending as a percentage of GDP. We’re at just about where we were during World War II, and that’s crazy, right? This is where we were at in World War II. I mean, COVID’s a real crisis, but this is not World War II crisis.
And so, we’re printing money and spending it at a pace we’ve never, ever seen before, and with that type of tailwind, unfortunate as it might be for the value of the dollar, it’s very fortunate for the value of bitcoin and its emergence as a monetary network that can be used in the future as a means to connect everybody on a global basis, and you know, it’s exciting to see corporations want to be a part of that because that really is mainstream adoption. I mean, that is as mainstream as it gets.
And then, I mean, this, obviously, is just a few days after that event, but also with the Tesla news, did that create any extra spike?
Well, it’s definitely created even more interest. I mean, you know, you have Microstrategy, which was almost like a revival, in some ways, around, like, how fantastic bitcoin and the Bitcoin monetary network can be for society on a broad basis. I think Steven Ross did an awesome job of explaining that when he was talking with Michael Saylor.
But, also, now you have Elon Musk, you know, the richest man in the world. He has a huge platform. You know, he’s put some real dollars behind it. A billion and a half dollars is not a small amount, and clearly, he’s thought about this. It’s a public company, and that I think starts to really open up this possibility for a lot of other companies. You know, someone’s got to go first. People need error cover. People need someone to be able to point to and say, someone else can do it. Why can’t we do it?
And Musk has been the first in a lot of things, from, you know, electric cars to trying to go to Mars, and so why wouldn’t it make sense for him to be on the first to own what could be really the new monetary asset? And I think everyone’s going to look at that and say, well, you know, he’s been really prescient. You know, we should take a really hard look at this, and that’s definitely what we’re seeing.
All right. So, in a moment, we’re going to talk about all kinds of other current events that involve this technology, such as them GameStop-Robinhood situation, but first, a quick word from the sponsors who make this show possible.
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Okay, back to my conversation with Charles Cascarilla. So let’s also talk about some other current affairs that touch on all these issues we’ve been discussing. How would you characterize the main issue that occurred with the GameStop / Robinhood situation?
Well, you know, I think this is a really important warning sign for all of us in financial markets. I wrote a blog post about this, and my point is Lehman Brothers, GameStop, and the next financial crisis all have something in common, which is that if we’re relying, and continue to rely, on the infrastructure we have, it’s inevitable that you’re going to see more of this. The real problem is, in financial markets, we built them 50 years ago because we were switching from paper to electronic.
And you know, there were a lot of good reasons why you had to get out of paper and get onto electronic. But, you gave up something when you did it. So, when you’re paper, you’re sitting here having to settle trades, giving a paper certificate, and getting dollars for it. You’re actually moving the real asset. That certificate is the ownership of IBM, and if I give it to you, Laura, your own the IBM shares, that’s a bearer asset, and when you you try to electronify that, it’s not easy to do.
You know, it’s really hard to use the right technology 50 years ago to make sure that there’s an electronic certificate that’s moving from myself directly to you specifically, and so they put everything into a giant pool. This is what people don’t really understand. Is that, actually, all the shares of all stocks in the country sit in a giant pool at the DTC, and it’s actually held in a street name called CD&Co.
No one’s even heard of it, but they hold all of the stocks in the entire US. Are basically sitting there, unless you withdraw them into your name, which some, you know, people do. You have certain preppers and conspiracy theorists that are like, I want to own my own stock, and rightfully so. What happened with Lehman Brothers is that you can’t let someone fail, because everything is, in a sense, mutually owned together, and so everything becomes too big to fail because it’s all sitting in a giant pool.
And so, 50 years ago, that made sense because you needed to solve this problem of paper to create more liquidity, because they were having to shut the stock market every Wednesday and limit hours. You just couldn’t keep up with the amount of trading. So they’re like, okay, let’s start DTC and put everything in a big pool account. The problem is 50 years have gone by, and we’ve completely outgrown that mode of doing things. It’s running on COBOL mainframes from the ‘70s.
You know, it’s taking two days to settle, which doesn’t make any sense. You know, you can order toilet paper to your house faster than you can settle a share of stock. It doesn’t make out. Why does that make sense? So, all of these things are a real problem, and you know, you basically get something like GameStop, and it really underscores it. I mean, we haven’t even had a real crisis in assets and the plumbing came unglued again. Imagine, you know, we almost had it with COVID.
We almost had it with GameStop where things almost locked up, and if we don’t re-architect the system in the right way, we’re going to have this again. It’s shocking that we’re using, like, the equivalent of Latin, you know, COBOL mainframes, to manage things when we could now be using technology like blockchain, and you could be actually tracking each share moving through the system and know the end owner at all times, and that gets back to what does a blockchain does: it says who owns what when.
So, that’s the backdrop to, like, this GameStop issue, and so, what happened is you have 140% of the share short, and everyone’s like, well, why did that happen? And they think, oh, maybe it’s the Reddit army, or maybe it’s hedge funds, or maybe it’s the broker-dealers. Who’s the problem here? And actually, the problem was the infrastructure, because everything’s sitting in a pooled account. You can’t tell where the shares are.
So, I’ll give an example really simple here. So, I buy a share. I take that share, and I lend it to you. You take that share that you’ve borrowed from me, and you sell it, and then someone else buys it, and then they can lend it out again, and the same share keeps getting lent out again and again, and there’s nothing nefarious, per se, happening, except for the fact that we don’t have a way of being able to track the shares that keep moving through the system, and so now you end up with 140% of the shares short.
And then the next problem is you’re settling in two days. Why are you settling in two days? I mean, it doesn’t make sense, but you are, and so, between the day you trade the share and the day you settle, well, someone guarantees it, and all trades are actually guaranteed by the DTC. Now, they’ve never used this guarantee fund in 50 years. They didn’t use it in the ’87 crash. They didn’t use it during the Asian crisis or the dot com bubble or when Lehman Brothers failed.
It’s never been used before, but what they do is they make huge capital calls right at the moment when everyone needs their own capital. So, they normally have $7 billion dollars of capital in the fund. I can tell you, I know three brokers, including Robinhood, where there’s over 7 billion dollars of capital calls that were made just from three brokers. I mean, there are tens of billions of dollars, most likely, of capital calls that were being made right at the moment when all those brokers need money.
So, they’re actually drawing in all this capital and making more systemic risk because it’s too big to fail, and so, why do you have a too-big-to-fail intermediary in the middle? Well, because 50 years ago, we decided that was the best way we could do things, and it was, but now it isn’t. You could be moving the shares around in near real time, maybe same day, you could start at, and that would really collapse all of the risk of your fear that someone would fail and so you need a guarantee.
And so, taking from T+0 to T+2 to settle is a big problem, and then here’s another nuance which people won’t believe. On the day of settlement, all the shares and all the cash go in. They only come out at the end of the day. In between, there’s a lien on it from the DTC. So you have a guarantee that’s happening for two days, and then, on settlement day, we have all this cash and shares that are trapped.
Crazy that you would do this and really an anachronism that it’s still done this way, and so you could imagine how GameStop is just a small example of how this could unravel. Too much shares are short because the technology is old and can’t track it. It takes a long time for there to be settlement. It takes a long time for there to be a trade guarantee. You have a too-big-to-fail intermediary in the middle, and suddenly, like, things really just become…the plumbing just gums it all up.
Yeah. I think, just from a pure narrative perspective, what I also love about this story about how all of this kind of nasty and outdated underbelly of finance got exposed was it was from a really crass and vulgar sub-Reddit where some of the people had, you know, names like DeepF***ingValue and YouTube personalities, like the name RoaringKitty, and then, on the other hand, you know, a lot of it was driven by anger at a firm that came out with a little note about why GameStop stock would go, and it was like a famed short seller, and so when you put all that together, you just see how this house of cards tipped over just from all that. Like, to me, it’s just kind of…
But it was kindling, you know, just there. Dry kindling.
Yeah, it’s crazy.
And it’s because, like, the plumbing just doesn’t exist, and there is a much better way to do this, and you could have a system where, actually, you free up capital and have more safety and more fairness. You would know where all the shares are that are short. You can track everything. You can, you know, shrink settlement times, and that could open up access and allow there to be a lot more people participating in the markets. So I think, in some sense, it feels mundane. Oh, wow, it’s the plumbing? You know, that doesn’t sound like somebody that you want to turn into a bad guy.
The plumbing’s the bad guy? But it really, in this case, is, you know, somebody that’s actually holding back the whole financial system, because everywhere you go, whether it’s payments, equities, corporate bonds, the whole thing is all 19th century sewer systems, you know, like in New York City, and like, it just looks fine, and a storm comes, and this doesn’t even have to be a bad one. This is just like, you know, a simple summer thunderstorm and the streets started to flood. You know, just wait if we had another superstorm come through.
It’s really funny you made that analogy because I wrote my grad school master’s thesis on that issue.
On sewer systems? That’s amazing.
Well, yeah, kind of. It’s like it was about, you know, environmental, et cetera, et cetera, but anyway…
Okay, so, Paxos has built something that kind of maybe could be, you know, the beginnings of the kind of solution that you were describing. In the fall of 2019, you announced that Paxos had received a no-action letter from the SEC to settle stock trades on a blockchain-based platform in near real time, and that is something that really could threaten the dominance of DTC, as you mentioned. So, can you describe for me what your private, permissioned blockchain that Paxos settlement service looks like and what problems it solves and whether it could actually resolve the issues we saw with Robinhood and GameStop?
Yes. So, we’re really proud. We have a no-action letter from the SEC to settle tokenized equities. We’re the only firm that has that. Now, the no-action letter limits us in terms of number of stocks and amount of volume. So, we’re doing it in, you know, a handful of stocks and a certain amount of volume. I think we’ve done 1.7 million trades now since last February when we started, we got approved to being…
And what is the number of institutions on it?
So, right now, it’s SocGen, Credit Suisse, and Instinet Nomura. We have another participant that’ll be joining shortly and another one that signed on. So we have, you know, another couple that are coming on, and then we have some more that are really engaging with us, and certainly, the GameStop news has accelerated interest in how people can move settlement and how they can really remove these impediments to their business.
This is now a real focus because it’s become, in some sense, an existential issue for many firms, and that’s good because you want to address this when you can, not when you have to, and you know, and when you have to, being a crisis, it’ll be a real problem. So, now is a good moment. You know, times are still good. It’s not going to be a different type of issue, like if you had a Lehman Brothers again, and so, we’ve started with those firms. This is really working well. We’re applying for a clearing agency registration license, which is a fairly rarified piece of infrastructure.
There are two that are really functioning right now, the DTC and the Options Clearing Corp., the OCC. We would be the third. We would be the second one that’s settling equities trades with the DTC and ourselves, being those two. This would allow us to really start to do unlimited volume in a whole variety, almost unlimited QSIPs here, and so we’ve been working on this application now for years, believe it or not. So, I think we’re very close to being able to submit it and go through public comment and get approved.
Hopefully…you know, we’re optimistic in the middle part of this year. Certainly, I think the latest news I think underscores the need for this, and so we’re really excited to get this thing going. Believe it or not, only 10 brokers are 80% of the US equities market. So I know it’s like, you know, you think the equities market seems like it’s a lot of players, but actually, it starts to really narrow down in terms of who is actually trading with who. You know, one broker trading with a broker, 80% is 10 brokers.
So, I think we can be at five, six eight when we launch, which gets us most of the way there, and we’ll continue to add more, and what the advantage of this is you can settle on any time frame you want. You can know exactly how many shares are short. You can track it where it’s moving. You can be in a position where you have much lower expenses. We cut 70% of the expenses out. Since you’re settling, potentially, on the same day that you do the trade, you’d actually be able to release capital while being safer, because most of the capital is tied up because you’re afraid someone might fail over two days from when you do the trade now.
Imagine if you’re actually settling on the same day. This is like, you know, a real big improvement, and potentially, you could even do intraday. Like, every couple hours, you could settle up all the trades. Really make a big, big difference in terms of allowing there to be more access, allowing there to be more safety and fairness in the markets, and there’ll be transparency for the regulators to see what risks are building up every single day in real time, whereas, right now, you don’t have that. Instead, you have a too-big-to-fail intermediary that’s facing every single trade in the market, and that’s how the DTC operates.
So, we’re really excited about what we have. This is modern technology, using blockchain, tokenizing shares, and I think the key shift is going from paper to digital allowed you to create more liquidity. Going from digital to token allows you to keep that liquidity, but to also have chain of ownership so you really know who’s owning the shares at all times, and that actually creates safer and fairer markets.
And you know, famously, a lot of blockchains have issues with throughput when you compare them to legacy systems. So, for the Paxos Settlement Service, what is the current number of transactions per second it can handle?
So, this is a good point, and there are a couple of components to this. Clearly, blockchains can’t handle, in real time, so what I would call real-time growth settlement. Every time there’s a trade, you settle. Blockchains could not handle that level of volume. It’s just very, very hard to do because you’re potentially trading in microseconds, and then you have to settle and re-settle, and that’d be cumbersome to do. You don’t need to settle that fast, even if you want to trade that quickly, and so you can set up a system where you’re settling every couple hours.
So, the trades come through. You’re batching them. You could net the trades down, and then you settle it out, and then you continue on for, you know, the next period, and you could pick whatever settlement time period you want, and that actually is something a blockchain can do very reliably. That does not stress them. Now, you could not put that on a public blockchain, also, to be clear, initially. I think you’d have trouble because regulators want to make sure they understand who’s securing the network, and that’s harder to understand in a public blockchain at the moment.
People are becoming more and more comfortable with it, but also, the throughput on Ethereum, for instance, is 17 transactions per second. That wouldn’t be able to handle even batched settlements in the equities markets, because you have about 120 million settlements a day. On the other hand, being able to do 120 settlements at the end of a trading day over, let’s say, the course of 30 minutes or 45 minutes is really not that complicated. Maybe 20 years ago it was or 30 years ago it was.
That was probably a confounding problem 30 years ago, but now it’s not. You know, the advances in hardware and the advances in software mean that you can actually manage that type of volume relatively in a straightforward way. So I think, you know, you have to think about what exact problem do you want to solve? Do you want real-time growth settlement? The technology for blockchain is not going to do that right now. Maybe it will in the future. If you want to be able to settle at the end of the day or in batches and be able to handle even all the amount of settlements in the market, that is completely achievable with today’s technology.
Okay, yeah, batching maybe, at the end of the day, would still introduce some of the risk that we were discussing with Robinhood and GameStop, but if you did it multiple times throughout the day, it could mitigate that, and one other thing, so, just so I understand, with all the companies whose stocks then trade on the Paxos Settlement Service, all the shares are now digitized and only tradable there, and then, so, now the entire…like, all the shares for that company then are transparent, and the trading in all of them is transparent, and so, if any of them were to become the new darling of Wall Street bets, then we wouldn’t see the same kind of issues that we saw with GameStop. Is that the theory?
So, there are two components to what you said, just to unpack it a little bit. Even if you settled, by the way, at the end of the day of T+0, you would still be fairly safe versus intraday batches, because what happens is you see the risks building up all day long. You could have limits, and you could say, oh, okay, you hit a limit and you need to pay down the level of risk that you have, and so you’d have transparency on all of your counter-party risks in real time.
And that means if something got out of whack, you don’t have to wait until of the day. You could do it earlier. So, even if you said normal processes end of day, during exceptional times, you’d be able to address it earlier. So, I think that that’s the component here, creating flexibility so that you can reduce risk when it’s appropriate. You don’t have to necessarily force it at all times.
Then the next component is we’re backward compatible. We have a full DTC participant account, and we hopefully…you know, knock on wood here, receive our clearing agency license. It’s a mandate that we are backward compatible into the DTC, and so, that means that when shares trade, if the two participants are Paxos customers, the shares will settle at Paxos. If one of them is, it can settle at the DTC, and if none of them are, it would definitely settle at the DTC. So that means that shares can move over into the Paxos environment and get tokenized, and if they need to go back into the old environment, they can.
So, there is some moment of time where we’re backward compatible into the old environment, and it doesn’t create a requirement that every single person switch over to Paxos, but I suspect what’ll happen is you’re going to get a certain amount that come through, and then you hit a tipping point, and that’s when you start to get all kinds of additional benefits around tracking every single share at all times, because if it goes back into the old environment, you can’t track it. You can only track stuff that stays on Paxos.
Oh, wow. Okay, that’s really interesting. Yeah, so, maybe you’re right. There might be kind of like a musky period where it’s sort of in and out, you know, kind of somewhat transparent and somewhat not transparent, and then, at a certain point, there probably would be a tipping point when, yeah, it’s just obviously superior and everybody moves that way.
And the advantage to that is, you know, we wanted to make it backward compatible so that it made it really easy for participants. Ultimately, you have to think about how you get people to adopt this and you get them to adopt it because it costs less.
You know, it’s solving operational problems. It’s safer. It’s fairer. It allows them to mobilize their assets in a different way, but also, part of that is how do we solve your operational problems? Means we can’t create new operational problems. So, you know, if you have two places that don’t talk to each other, that would be a real difficulty, and so we’re deliberately set up where that wouldn’t be the case, and that just means that benefits will scale over time.
You know, we’re not going to port the whole market over tomorrow, but if your broker spent all of their time in the Paxos environment, you would be able to track all the shares. You know, so, if someone said I’m going to spend…I only want to settle on Paxos, you could only trade equities or settlements on Paxos, you’d be able to see that. So this comes down to partly, like, you know, how do you want to get the benefits and when?
All right, and for the SEC clearing agency registration, when you get that, that’s the registration that will enable you to move on from stocks to other types of assets?
It would allow us to move on from stocks in the no-action letter so that we can then operate, you know, really, in all stocks and in unrestricted volume, but also, by the way, it can allow us to do a lot more than stocks. Bonds, et cetera, other things. So, there’s so much opportunity here because, you know, the stock market alone is $45 or $50 trillion dollars of assets. You know, the single largest asset class in the world is US equities.
You can imagine getting to the point where that’s tokenized is a huge step forward in basically re-platforming the financial system and creating a much safer and much more dynamic way of being able to allow companies to raise capital and for participants to be active in the equity markets.
I mean, it’s a huge deal to get that to go because then it becomes a lot easier to get subsequent asset classes. Most participants will already be on if you got the US equities market to go. That’s part of our point, of let’s do the US equities markets because it’s very liquid: it needs it, it’s a big problem, and it’ll then be the product journey to get the whole rest of the asset class moving on this journey, too.
So, you know, part of your journey to tokenize other assets has started with a tokenized gold product that you guys offer, and I was wondering, you know, why was that one of your choices for a different type of real-world asset that you would offer, and how do you plan to move on from securities and from the one gold offering?
Yeah, so, we’re really excited about where the gold product is. It’s grown a lot in the last year. It’s gone from maybe $15 million of tokenized gold to about $130 million dollars of tokenized gold, and so it’s growing quite a bit. You know, goal was a very logical asset to start to tokenize, firstly, because it is a bearer asset, but you can’t own it in a bearer asset way in the digital world.
People have been owning gold by owning an ETF for a future, and so, this is a problem. How do you get bearer assets that are physical to operate like bearer assets in a digital way and not just be, you know, an account-based asset, but be a token-based asset? And so, in the case of gold, first of all, it’s been money before. People want to be able to use it like money in many places. It’s still the foremost value, even though bitcoin is clearly showing so much promise, and there’s $10 trillion dollars of gold in the world, and gold is mainly traded around and moved. It’s not consumed.
So, you know, you wouldn’t want to go do iron ore. You know, you basically pull iron ore out of the ground, and then you consume it. So, there’s not as much need to tokenize it as it would be for something that’s highly tradable. US equities is an example. Gold is an example. I think we’re going to definitely do other types of assets. Silver, platinum, and palladium are logical other ones to do. They trade not nearly as much as gold, and you know, there’s a lot of other things to add besides equities.
There are bonds. There are private company shares, which is something we’ll be doing shortly, and you know, you kind of go on from there. Real estate, collectibles, but there’s an adoption curve, in my mind, around how assets become tokenized, and I think that adoption curve is driven by what are the benefits that you get by being tokenized, and so, there’s really kind of three-ish benefits as I think about it.
One is it just saves you money, and it might save you capital. It might save you expenses, and you know, in some way, it’s saving you money by going from what is either a digital account-based asset or a physical asset into a tokenized asset. The other benefit you get is liquidity, and liquidity means that you’ve now made the asset easier to move around and trade. That can be a significant benefit because, a lot of times, you know, you’re at frictional costs when you’re trying to move assets around, and then the last benefit is access. When you create a digitized version of the asset on a public blockchain, it’s open access.
I mean, you have to have the right controls in place from a compliance perspective, but it’s open access. You can really create an ability for someone to have assets that they couldn’t before. You know, example being dollars. An example could be gold. Now, some people get scared about open access because they think, oh my god, it’s going to go to money launderers and you know, terrorists. Now, of course, there is some risk with that, but on the other hand, you also get the capacity to create universal ability to access financial assets, which is really hard for people.
There are so many people who don’t have bank accounts or don’t have ability to access and participate in the financial system, and so access is a really key thing, and maybe you’d say the fourth thing is it allows there to be more innovation because you can now program assets and change them around and do different things with them. That’s the advantage of basically going tokenized, and so, if that’s the benefit, you want to think about which assets get the most benefits from going this route, and that’s where you want to start.
So, obviously, crypto is a new asset class, and that’s pulling people in. It’s pulled dollars in, and you needed to have dollars in there because it helps to create all kinds of operational savings to have money moving 24 hours, 7 days a week, 365 days a year. There are lower expenses. You have freed up capital because the money is moving fast. You don’t have it just sitting there moving slowly through the banking system over many days, and then you have an ability to program it and create more accessibility.
You know, people can hold dollars without a bank account. That’s a huge benefit. Cash is a logical thing to get pulled in. It got pulled in by crypto, but it’s going to be now used in buying goods and services and eventually, for wholesale asset settlements. So, you know, dollar’s the next thing, and then you say, oh, gold can make sense, and equities can make sense. When you get to, like, real estate, that’s probably a little bit later, in my opinion.
And quickly, before we move to stablecoins, which, you know, you were just mentioning, I did want to ask earlier, when you said collectibles, did you mean physical collectibles, and if so, what? Like, art or coins or stamps? I didn’t even know what you meant.
It could be any of those. There are examples of cars, art. I know of a number of projects that are working on art.
And digital or physical art?
Physical art, and so, let me give you an example of one that could be interesting. Is, well, there’s a lot of museums that are having trouble and tough times now. Well, what they could do is sell some of their collection, maybe pieces of it, to people who could own some of it, but the museum continues to be the depository. They hold it. People can go see it, but you can now raise money where you could sell fractions of pieces of art. Like, that’s one example of something that you could do with art.
Another one could be that you just use it for whole pieces of artwork. You know, you want to trade fractions of it or whole pieces. You know, how do you make sure you track the prominence of artwork? It’s an enormous problem, and it’s an enormous asset class, and so art is an example. We’ve seen people trying to do collectible cars. I think there’s really no end to the way you could use the blockchain to track who owns what when.
But what you need to do is, you know, figure out some of the operational logistical hurdles to it and have it make sense to do it at what time, and so you’re going to see more of it. Real estate is another example. People’s houses. Imagine if you could track the mortgage title moving through the house. You never have to use title insurance again. You kind of go on and on. Like, there are so many exciting things to do. There are 600 trillion dollars of assets in the world. Where do you…like, how do you start, and with a problem that big, there’s going to be lots of nuance when you get into individual assets in individual countries.
Yeah, I could imagine custody would be a big question for things like physical art and stuff, but okay…
Let’s move onto the stablecoin question because, you know, you did talk about, obviously, how stablecoins have become a big part of the crypto ecosystem, but you know, I just wondered, I know it is one of your business lines. You have your own stablecoin, and you also provide the backend for other providers to have their own stablecoins. How do the different stablecoin providers compete with each other?
Well, they’re ultimately competing on a number of different propositions. One is what is a utility of this coin? You know, what can I do with it? Can I go buy things with it on different exchanges? Can I go make a loan? Can I borrow on it? Can I just hold my money in it? Is it available in lots of different types of wallets? So, there are some that are much more widely usable than others. USDC, Tether, PAX, BUSD, Rcoins.
You know, I think we have three of the top five dollar stablecoins, and you know, they’re very accessible and very usable, and that distinguishes it from some smaller stablecoins where they might not be available on lots of different wallets or on lots of different exchanges. So, that’s one thing that distinguishes. The next thing is, well, what’s the regulatory oversight, and I think, particularly for Paxos, we have a primary regulator, which is the New York Department of Financial Services, that oversees our stablecoins, and that’s different from anyone else’s.
So Tether has no regulator. USDC doesn’t have a primary regulator. They have money transmission licenses, but they don’t have a primary regulator that oversees it. We actually have both, our trust company has a primary regulator and our products have a primary regulator. That’s exactly what, if you looked at what FATF guidance, the FATF, or you look at Treasury guidance and others, they really talk about you should have a primary regulator that oversees it, because, otherwise, you open yourself up to all kinds of possible misuse of it.
So, we’re I think really trying to always make sure in everything we do at Paxos, that we’re looking at what the regulators are saying, making sure that we’re following best practice, because we’re not just trying to hamstring ourselves. We’re this because, ultimately, how do you get to mainstream adoption? You’re never going to get to mainstream adoption without a primary regulator overseeing the coin. You know, banks aren’t going to accept it. I don’t think corporations are going to accept it. They’re going to want to use something that they can trust, and part of that trust is having someone else who’s overseeing it.
That’s what you always have in financial services, because you can get to issues where an issuer, without a primary regulator overseeing it, could very well be faking the assets that are backing the token, and of course, you can use auditors and other people to help, but some are unaudited and unregulated, and that can start to create systemic risks, and maybe consumers wouldn’t realize it, or less sophisticated users wouldn’t realize it, and that’s what we’re proud of, how we separate ourselves from others.
And so, it sounds like you’re talking about Tether primarily, which is unregulated, and what was the other…
Unbacked. Unregulated and unbacked.
Oh, or unaudited, rather. We don’t know if it’s unbacked. There are a lot of allegations about that, although, now, recently, there’s news that a loan that Tether gave out to Bitfinex has now been paid back. So, however…
Well, that’s what I was going to say, is we do know it’s unbacked, actually. So they actually said we’re unbacked, meaning they said…
Or that it was for a period.
We have a loan…yes, and they have bitcoin and other things. Like, if you look at the terms and service, it doesn’t say it’s backed just by dollars sitting in a bank account. You know, if you look at, like, the Bahamian banks, they have, like, maybe 700 million dollars in all the Bahamian banks, but the primary Tether bank is supposedly in the Bahamas. Where is the 25 billion dollars sitting? Everyone would like to know the answer to that. No one knows, but they have said that they’re not fully backed one-for-one with dollars, and you know, that may be fine, but that means it’s not a dollar stablecoin.
Right. Right, although I did have Gregory Pepin, I think was his name, the Deputy CEO at Deltec, who said that that 700-million-dollar figure for the Bahamian banks was some portion of the assets, like just the Bahamian dollar reserves or something like that, and that US dollar reserves should not be counted in that. I think that was his…I’m going to have to link to this in the show notes because I don’t remember the exact specifics, but he did have an explanation.
But something that was interesting was you discussed this with Frank Chaparro on The Scoop podcast back in September 2019, and you were talking about Tether, and at that time, you said this is the best it’s ever going to be for them because it’s unregulated and institutions won’t touch it, and hello, at that time, Tether was about $3.5 billion, and now it’s ballooned to $28.5 billion. So, do you believe that now it is the best it will ever be for Tether, and just in general, you know, how do you think this whole thing with the kind of regulated / unregulated stablecoins is going to play out?
Well, I’d say maybe 2 or 3 things here. First, yes, I still think this is the best it’s ever going to be, and what I meant by that is it’s never going to get used outside of the crypto ecosystem, right? So it’s never going to get mainstream adoption, and so maybe it grows to 50 billion dollars, but it’s only going to happen because people in the crypto space are using it, not because…you know, I call tell you, maybe I’m wrong here, but I would be shocked if Tesla or Microstrategy goes, oh, I’m going to start using Tether to move dollars around, but I don’t think that it’ll be shocking for Tesla or Microstrategy to move tokenized dollars around.
They’re just not going to move Tether dollars around. When you think about there are 60 trillion dollars of M2 in the world, you know, is Tether going to be the number one dollar stablecoin in a world where you get to huge amounts of tokenized dollars? No shot. It’s impossible. You know, it’s unbacked. They’ve already told us. You know, I mean, we’ll see what happens with the New York Attorney General. I just think it’s very unlikely that it could be unregulated, unbacked, and unaudited. We can throw an extra on there.
Yeah, I don’t think we know enough to say whether or not it’s unbacked, but clearly…
I thought that they went on a podcast and clearly said, you know, yes, and in terms of service, it may not be backed. If you go on the Tether website, it says it’s not fully backed.
Yeah, well, or that it holds a mix of other assets, including bitcoin.
Well, that’s not being dollar backed. So, maybe we could say it more precise and say it’s not fully US dollar backed. You know, there’s other assets that are backing it. I mean, that’s a big deal. You know, it’s supposed to be a dollar stablecoin. You know, you’re really not then. You’re a security, actually. You’re a security when you start to have other assets in there that aren’t short-term US dollars in there. I know, because we spent a lot of time examining this. We’ll see, obviously, what happens here over time, but you know, I think they’re whistling past the graveyard.
Yeah, I mean, it could be a security…yeah, no, it is interesting to see how this is going to play out, and also, I think something that fascinated me, too, about this is that, you know, a huge percentage of Tether usage comes from Asia. So, in the end, it may be fine for Tether, but yeah, here in the US, things maybe go in a different direction. All right, so, I have so many questions about regulation. Obviously, we talked about how Paxos initiated the process to obtain that New York trust charter, even before the BitLicense existed. If it had existed at that time that you started that process, would you opt for that instead? Like, you know, what do you think of kind of going the trust charter route versus bit license?
Well, for us, it’s just crucial to have been a trust company, and that’s why we did it in the very beginning. We thought about getting a money transmission license, and there were conversations about what a BitLicense might look like, and for us, getting the trust license made all the sense in the world because we wanted to be infrastructure. It’d be very hard to be infrastructure if you just have a BitLicense. It’d be very hard to have a primary regulator that oversees the tokens that we’ve issued, our gold tokens, our dollar tokens, additional tokens that we launch in the future without having the trust.
And so, to me, it’s a lynchpin of our strategy. You know, getting it meant that we were going to operate a little more slowly than firms that were just using money transmission licenses or the BitLicense because they could operate in other states in a much different way than we could as a trust, but again, it kind of goes back to our strategy of if you want to be the early adopter winner, or do you want to be the mainstream adoption winner?
Do you want to be infrastructure for the B2B and the B2B2C players when, you know, this goes into being about billions of users, or do you want to get to scale at 40 or 50 million users. We just tried to have that long-term viewpoint from the very beginning, and you know, it really was an over the horizon viewpoint, like our conversation earlier, but it’s one that I think is really clearly bearing fruit now and has put us in a different place with all of these firms that are now coming in and looking for turnkey solutions.
Yeah, we’ll see how this plays out over the long term because, obviously, I mean, if we go back to that comparison point about how Coinbase started around the same time, and it has gone that route with the money transmission licenses and I just think, in general, operating from California versus New York, which has had these pretty onerous regulations. You know, Coinbase now, in January, they did 117 billion dollars of volume. ItBit, you know, saw a little over 2 billion. So, you know, I understand that now you’re going after a different route, but Coinbase clearly has been successful. They’re going to IPO. It’s going to be…well, it looks to be a successful IPO.
No, it’s going to be huge. Absolutely. I think Coinbase, it’s been fantastic. I mean, they have, you know, huge retail user base. So, in that way, it’s where I’d say the money transmission licensing route makes a lot of sense, because, you know, you can acquire the retail consumers, and for them, it’s about the service that you’re offering, and then when you look at institutions, they’re expecting just a different level of oversight, and so that meant that, in the early adopter phase, you’re going to be moving slower, but in the mainstream phase, you’re in a different position, and so it’s not bad or good. It’s just a different thing.
Right. Well, so, your firm has been so buttoned-up when it comes to compliance and regulation, and so it seems like you have a pretty pragmatic approach to it, and yet I do imagine that you maybe have thoughts about how regulation in the US could be improved, particularly since you do operate in other jurisdictions. So, what would be on your regulatory wish list for US regulators, and we can talk both federal and state level?
Well, you know, they kind of interplay together. There’s just an alphabet soup of different regulators, you know, kind of across the board. The Treasury and different departments within the Treasury, and then the OCC and FinCEN…that’s part of Treasury. CFTC, SEC. You know, you look at all the different state regulators. It’s almost bewildering in some sense.
I think there are some simple things that could be done, which is states coming up with a way of being able to create reciprocity if you hit certain benchmarks with other states. Right now, the only why to get explicit reciprocity is, essentially, you have FDIC insurance. That’s the most green line way of getting, so to speak, full reciprocity across states or having federal oversight, and of course, that would be becoming either a federal bank or a federal trust. I think, you know, it’s important for there to be some competition amongst regulators because you can be innovative then.
You know, we want competition in the markets. We want competition everywhere, and you want to be able to have different places where people can try different things. So, I think that’s valuable, but on the other hand, you know, you can have too much competition, and then you don’t get reciprocity, and it becomes really hard to move around. So, I don’t think you should have one regulator, but I also don’t think that having a lack of reciprocity works, either. That’ll be one easy way to solve things.
Now, of course, there’s also something I didn’t mention, which is the Federal Reserve is also another regulator. So the Fed, the OCC, the SEC, the CFTC. Now, they’re doing different things, but even the IRS is a regulator, and so where does this come into play? It gets a little confusing. The IRS says bitcoin is property. Treasury and FinCEN is saying this is a monetary instrument. You know, how you’re being treated for tax reasons is different from how you’re being treated for regulatory reasons. That is a problem.
I think there needs to be some way of creating some clear understanding of what an asset is amongst these different regulators, and sometimes it might blur the line, but like, for instance, bitcoin doesn’t feel like we’re blurring the line here. There should be a common way, but there isn’t, and so there has to be a common way of saying let’s look at an asset class or look at a token. Let’s have some of these federal regulators come together who might be overseeing it. Is it a security? Is it a derivative? Is it property, and being able to have a common viewpoint.
That would actually really promote, without having to make any kind of adjustments to all the different regulatory umbrellas. That would actually have a really clear way of getting entrepreneurs an understanding.
Then the last thing I would say is regulation tends to be one size fits all, and that is really difficult because businesses aren’t one size fits all. If you have to carry the burdens of being a fully regulated entity, but say you only have a million or 2 million dollars in revenues, you’re not really taking a risk-based approach to what applies. When can you be in a sandbox? When can you have a period of time to get up to speed? You know, we’ll give you a grace period of one year, two years, or a revenue threshold when you need to get to someplace. This could really help entrepreneurs a lot, and that’s not necessarily good for Paxos because we’ve already done all this, but I think it’s good public policy, which is how do we allow there to be more innovation and more competition?
You know, I think that’s what you need, and so you have to make it so it’s possible for people to be entrepreneurs and not get tied down in oversight that makes sense if you’re a large company, but doesn’t make sense if you have almost no customers and you’re trying to get a product out into the market. I think those three things, state oversight, clear understanding of where an asset sits, and you know, some types of sandbox and grace periods can make a huge, huge difference for financial services. We’ve seen it in other areas.
And one other thing I was so curious about was, in the US, what percentage of your operating cost do you estimate you spend on compliance?
Oh, well, that’s a good question. I don’t know the answer to that off the top of my head. You know, we were looking at this a couple months ago, but it’s very, very significant. Now, some of those are fixed costs, so it changed over time. As we scale, you know, those costs can scale, but I can tell you we’ve spent tens of millions of dollars getting ourselves into the position that we are right from a regulatory perspective.
That’s an enormous amount of capital. You know, you look at just creating the trust company. Millions and millions and millions of dollars of capital. You can’t be a startup who’s, you know, raised a seed round of 1.2 million dollars and say I’m going to go become a trust company. It’s just not going to work. Now, there’s a reason why, you know, you probably don’t need to be a trust company, but could you operate in a sandbox to be able to do things?
Could you have a grace period to be able to offer certain things? You know, maybe there’s a minimum amount of revenues that could give you a chance to explore product market fit. I think that would be really huge for, you know, breaking open competition in financial services, which is going to be good for everybody, and it doesn’t mean you don’t need regulation, but it’s when do you need it?
All right, so, I’ve kept you long enough, but last quick…well, we’ll see whether or not it’s a quick question. You’ve applied to be a trust bank nationally, and in December, Paxos also raised its Series C fundraising round of 142 million dollars, and so I just wondered, you know, what was next for Paxos?
Well, look, we’re going to keep pushing our regulatory stack to be able to handle more assets and to be able to handle them in broader ways. Having the trust on a national basis does create explicit federal preemptions. So, you know, you can operate in all the states in a really clear way. That’s valuable. It also gives you potential access directly to the Federal Reserve, where you can now hold dollars and bonds directly with them. That will be important for us. I’m getting a clearing agency registration from the SEC, as I mentioned before, as another big approval.
And we’re doing a bunch of these outside of the United States, as well. So, you know, you’re going to have to keep building on a regulatory stack. There’s no kind of sitting on your laurels because, as this becomes more and more mainstream, it needs to be able to operate in different ways than maybe where you did, you know, five years ago or even where you did today. We’re constantly looking down the field at other things that we can do to be able to expand the geographies we’re in, the assets that we’re in, and the way those assets are being used.
All right, well, this has been super fun. Where can people learn more about you and Paxos?
Paxos.com is a great place to start. Also your podcasts.
All right. Perfect. Well, thank you so much for coming on Unchained.
Thanks for having me.
Thanks so much for joining us today. To learn more about Charles and Paxos, check out the show notes for this episode. Don’t forget, you can now watch video recordings of the shows on the Unchained YouTube channel. Go to YouTube.com/c/UnchainedPodcast and subscribe today. Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Daniel Nuss, Dan Edlebeck, Shashank, and the team at CLK Transcription. Thanks for listening.