Maya Sibul: Can you give us a breakdown of your role, your background, and your day-to-day operations?
Nic Basson: I’m the Chief Operations Officer at Old Street Digital. We're a London-based start-up cryptocurrency investment advisor, and our first fund is a Decentralised Finance (DeFi) stablecoin lending fund. My background is 15 years in traditional finance – primarily distribution, as a head of marketing, and, recently, I was the strategy and planning lead at a top-20 global asset manager.
I co-founded Old Street Digital with a former colleague of mine – now our CEO – and our Chief Investment Officer, who has a very impressive resume at blue-chip asset managers as an equity portfolio manager and CIO. We’re all crypto enthusiasts who have, in previous roles, been involved with the professional side of money management, but we saw a gap for the same institutional-class product in crypto and decided we were going to build it ourselves. It’s exciting creating an asset manager from scratch – and especially so in the world of crypto.
Maya: In your view, what is the single biggest factor stopping asset managers from integrating digital assets into their portfolios today? Is it a legal, fiduciary, or administrative issue – for example?
Nic: It's a blend of all those issues. This is a new space with nascent technology. All the frameworks, service provider offerings, and operational processes are still being – and need to be – built from the ground up. This phenomenon means that there's a real lack of choice, unfortunately; you have a few of the usual solution providers for asset management firms wanting to move in alongside some new crypto-native solution providers, but it is not a crowded space.
From a policy and legal perspective, we need stability and certainty, but we don't want the law to be made via enforcement – which is what we're currently seeing in the US. We want to see, frankly, more investment in legislation. It can be difficult to understand digital assets because they're a new asset class that can't easily be treated as another commodity – which is the way they are often viewed today. But from what we've seen from policymakers – certainly here in the UK – there's a desire to get the regulatory framework right because it could be a big opportunity for the financial services industry.
"Settlement in crypto is instant so any custodian needs to be able to support fast, high-frequency transactions intra-day, which can be a real challenge."
We’re not spoilt for choice on the fiduciary or custody side either. The security and custody elements of crypto are different to traditional assets; crypto is far more complex. There are multi-layers of security required for transaction approvals, and you can’t easily custody them within a ‘walled garden’ – to use hedge fund language – as you can with equity and fixed-income securities. Also, settlement in crypto is instant so any custodian needs to be able to support fast, high-frequency transactions intra-day, which can be a real challenge for traditional custodians.
On the fund administration side, we are using an administrator who is an expert in alternatives, and many of the systems have been retrofitted to accommodate crypto. It’s seldom a perfect solution; it’s adequate, and there’s certainly an opportunity to streamline the whole process.
Generally, though, you can get by with many of the same system providers as you would in traditional finance. These providers are doing their best to make their technology work for crypto, but in many areas, the perfect solutions just don’t yet exist. This is a space wide open for new providers, and we're seeing a lot of innovation. There is some good technology that has become available in the retail space, and it's coming up to institutional quality and standards.
Maya: Given the current state of market technology, are crypto funds the best vehicles for those looking to get exposure to digital assets?
Nic: The real crux of the question is that it comes down to the style of fund management. Speaking as an active institutional money manager: yes, we believe that there is an opportunity to apply the rigour of a fundamentally driven research process to the digital asset market.
But this is answering from an institution’s perspective, where you hire an advisor to manage part of your portfolio because you buy into their investment philosophy and see value in their expertise in the asset class.
"Crypto is a 24/7 market. It's not unusual to be transacting ‘outside of business hours’, and there are often huge volumes on Sundays."
Crypto is a 24/7 market. It's not unusual to be transacting ‘outside of business hours’, which you wouldn't usually do in traditional markets. For example, there are often huge volumes on Sundays. There is still a lot of information asymmetry and, added to the operational complexity, we think this lends itself to active management. Crypto funds are a good alternative for institutions that aren’t yet ready to hire dedicated teams to take direct or single-token positions and look after the security and custody concerns in-house.
Maya: Are there other, more viable, options? Do you see the potential for a new crypto vehicle structure coming to market any time soon?
Nic: I think so; the way we do things now is not the most efficient. There certainly is a path to improve, and a new vehicle structure might help with that. In our case, we operate with an existing fund structure that uses a well-proven KYC/AML onboarding and creation/redemption process on the client-facing side.
The back-end – where we deploy capital – is a world where we could benefit from tokenised funds or exposure. Strides are being made in that space with tokenised systematic index products, derivative ‘vaults’, and other novel innovation in financial products.
Much is waiting on regulatory approval and guidance. Some jurisdictions have the legal framework in place to recognise links in ownership between tokens and physical, tangible property – which is an important first step. The regulatory regime that these securities will fall within is important, too. Could we do it tomorrow as an industry? Absolutely. But will the regulatory space be ready for it? No, but I am optimistic.
Maya: Thinking about custody and storage-related pain points – such as how do you submit and store – are there any solutions available now that asset managers aren’t adopting? (Either because they aren’t aware, or because the technology isn’t up to fiduciary standard, or some other reason.)
Nic: Yes, there are a few options. The nature of crypto in general is that you have a private key for signing transactions that gives you authority over the assets and, in particular, the wallet that holds the assets. For these transactions, the current solutions are good at looking after that sensitive information, which is essential – given that transactions are irreversible. This is where the cryptography comes to the fore but it’s more technology than finance focused.
Some trading solutions give you an institutional-grade front-end to process transactions, but it still comes down to the security of that private key or series of private keys. Variables include how many blockchains you are transacting on or how you have divided your assets between different wallets – all of which are a critical part of risk management.
This is different to the way things work in traditional finance, due again to the irreversibility of transactions. Because of the near-instant finality, there's always the $5 wrench problem: the issue where you can have the best security in the world, but if there is a threat to someone physically, and if that person has the full private key, your security could still be compromised. So there remains a trade-off between safety and agility. When it comes to transacting, we need to make sure that the right people are online or physically in the same place to enable the biometric requirements for signing transactions.
"Crypto is shiny, new, and exciting. But the more layers of security you add, the slower you become in moving money."
Crypto is shiny, new, and exciting. But the more layers of security you add, the slower you become in moving money due to the number of approvals required and the need to coordinate people in different locations to move money between accounts and transact. The process can be onerous.
So, the technology solutions adopted by asset managers who are running crypto mandates often boils down to a trade-off between simpler transactions with added counterparty risk – like a centralised exchange or prime broker – or greater security on-chain with added transaction complexity.
Maya: To put it bluntly, is blockchain really where the investment industry is headed?
Nic: I believe so. As an industry we were waiting for the tech to reach this point – but this is a disruption to traditional finance, and it is foundational.
For example, if you are focusing on non-fungible tokens (NFTs), which are one of the most vilified innovations, there are plenty of real-world use cases – not just monkey JPGs that get press and hype. There is a lot of focus on the frivolous use of blockchain technology now, but the real question is: What can it do? What can it enable? What changes has it generated?
The industry needs to be thoughtful about where it allocates capital as new technologies are often created somewhat speculatively in the hope that they will be helpful – and then the use cases often follow later.
"There are revolutionary implications here for back and middle-office processes – which could enable huge cost savings for fund managers."
We now have key innovations such as transferable on-chain property rights, liquidity pools, and near-instant settlement on blockchain. There are revolutionary implications here for back and middle-office processes – which are being refined in real-time and could potentially enable huge cost savings for fund managers.
When we think about the investment opportunities around DeFi in particular – such as reduced intermediation costs and transparent contract terms – the benefits are clear. Early adopters are already using DeFi protocols for capital management (borrowing and lending) and investment. The best-in-class protocols have weathered the recent crypto downturn and continued to build a new product and move deeper into what was the exclusive preserve of traditional financial markets.
Fund Operator - news round-up 3/2/23
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