Greengage looking to be first merchant bank for the digital finance sector
Why would a banker be interested in Decentralised Finance (DeFi)?
As SEC Chairman Gary Gensler put it in 2018: “With increased competition and innovation in the financial system, DLT (Distributed Ledger Technology) – both permissionless and permissioned – offers a catalyst for change by incumbents or an opportunity for entrepreneurial start-ups, potentially lowering costs, risks and economic rents in the financial sector which represents 7.5 per cent of the US economy.”
The opportunities that DLT – and by consequence DeFi – can bring for financial markets is not something that banks can just sweep under the rug or dismiss as trivial. While we should be clear that Greengage has nothing to do with DeFi today, we are watching the space closely. DeFi is still in its early stages – and so is our engagement with it – but we know that its consequences will be significant.
Greengage is the first fully-integrated financial services group bridging traditional fiat currency banking and trading with the emerging digital asset and cryptocurrency sector.
We plan (when regulated) to become the first merchant bank for the digital finance sector.
Greengage intends to serve two significant underserved client sectors: the first is cryptoasset companies and the second is the UK and Gibraltar SME market. In the long-term, Greengage intends to expand its product offering to include the structuring of digital debt.
We located our headquarters in Gibraltar, reflecting the growth of the jurisdiction as a thriving crypto-hub and a great place to invest, do business and grow. At the recent Crypto Gibraltar conference we gave a keynote speech addressing the topic of DeFi versus Centralised Finance (CeFi) and looked at how these two worlds are going to collide.
CeFi stands for Centralised Finance and commonly refers to cryptocurrency exchanges that are not decentralised. However, the concept can extend further to include financial services in general that are controlled by a single entity. While such a system allows for clear decision-making and enables easier regulation, it does have drawbacks.
The concentrated power that makes identifying responsibility and thus regulation simpler also creates a single point of failure and the in-built monopoly on control of the service often excludes users from deciding how that service runs or evolves.
Liquidity and the pricing of risk
Banking is a clear example of CeFi. It is one of the oldest professions and, alongside money, has its roots in the oldest civilisations. To radically simplify its role in today’s economy, banking and the broader suite of financial services deliver two core things: liquidity and the pricing of risk.
DeFi, on the other hand, is a financial service where control is distributed across its network of users. DeFi’s core aims align with those of public blockchains, particularly being permissionless and trustless. This means users don’t require authorisation to use the service and they don’t have to trust a central body to provide that service. There is no single point of failure so the service can continue to operate even if a node or many nodes go down. Nevertheless, this distribution of power complicates decision-making and raises questions of responsibility, making regulation harder to implement. Evidently, the advantages of DeFi are the disadvantages of CeFi and vice versa.
Ethereum is the premier protocol for DeFi and hosts the vast majority of DeFi services. The two most popular types are decentralised exchanges (DEXs) like Uniswap and lending platforms such as AAVE.
DEXs can use an order book similar to centralised exchanges, though they more often use liquidity pools to determine asset pricing via automated market makers. Lending platforms offer various types of loans though almost all are over-collateralised.
Most DeFi platforms require the user to connect their crypto wallet to use the service and are thus non-custodial. This is generally safer than trusting an exchange to hold your private keys. Nonetheless, DeFi does come with security issues, mainly around smart contract exploits in addition to fraud or theft by developers.
With financial services as lucrative as they are today, why add DeFi into the mix? As a challenger bank, Greengage has four main interests linked to DeFi:
1. Reducing frictional costs, particularly for complicated products such as securities and derivatives
2. The returns – are these sustainable once various factors have been priced in?
3. Can we safely engage with DeFi to offer better returns to our future customers than the near-zero percent interest rates on deposits from high street banks?
4. Some financial services houses have started to engage with DeFi, primarily via venture capital or owning their own balance sheet. How are they doing this when DeFi remains unregulated and will there be repercussions?
So, what are the challenges and direction of travel? Wharton at the University of Pennsylvania has put out an excellent paper on the definitions of DeFi but relatively little material is available otherwise in terms of practical guidance using this base layer of terminology. Greengage is engaging in debates and educational activities with various groups to explore how we could potentially engage with DeFI in specific areas in more detail.
Can we place our own Greengage funds into DeFi, for example, exposing our balance sheet to risk, and what would be the regulatory risk weighting applied to such assets? If we do place them, would we get regulatory consent and what proportion of a balance sheet exposure would be sensible?
The DeFi space is still nascent and lacking in a set of standards which might allow closer cooperation between different entities, increasing interoperability. Yet there is no doubt that DeFi is here to stay and its ramifications will be felt in the world of centralised finance. It’s time for bankers to start paying attention.
Sean Kiernan is the CEO of Greengage, which intends to become the Next Generation Merchant Bank.
The press launch of Greengage’s upcoming analysis and report on the state of the UK blockchain industry will take place on 3rd November at 10am. Register here.