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PROFESSOR: So we're going to
talk about crypto exchanges
today, which very much relate
to blockchain technology.
But it's not directly
an application
of blockchain technology itself.
But it is so much a part of the
ecosystem of crypto finance,
with well over 90% and in some
cryptocurrencies 95% to 98%
percent of the actual
transactions happening
on crypto exchanges.
So I thought that no course in
blockchain technology and money
could really be complete without
talking about crypto exchanges.
But I want to just dare
say not to be looking
throughout these talk
today and even on Thursday
when we'll also be talking
about crypto exchanges
with some outside guests,
about, where are we lowering
the cost of verification?
Or where are we lowering
the networking costs?
This is about basically
the secondary markets
in this $200 billion ecosystem.
And the first crypto exchanges
came about actually in 2000,
late in 2010, I think it was.
But it may have been early
'11, because just when there
was one blockchain
application, bitcoin,
people wanted to move bitcoin.
It was like, well,
how can I do this?
I can do it with another
individual on a blockchain.
But there was even, how do I
find that other individual if I
want to sell it or exchange it?
And so there was a
business opportunity.
Mt.
Gox was one of the
first three or four.
I don't think it was
literally the first one.
But it was one of
the first handful
that started to take off.
We'll talk about Mt.
Gox that failed.
Dozens, if not hundreds
failed early on.
But they were trying to provide
a user experience to trade
initially just solely bitcoin.
Bitcoin versus fiat
was really what it was.
And it was providing
also a service
to people that were not as
technologically adept as some
of the MIT students.
So I was going to
ask again and by show
of hands, how many in the
room have ever owned a bit--
of cryptocurrency or something
like that just to-- all right.
So it's a third to a half.
But you'll see
it's going to be--
far fewer even in
this MIT community
have done that directly
on a blockchain, as well.
So is it Alin?
Anybody else?
So of the 30 hands that
went up, the other 29
basically have done it
through a crypto exchange.
So they provide a
service right there.
Now, there's a central irony
that Satoshi Nakamoto's
impetus, the motivation
that we've talked about
was how to do peer-to-peer
movement of value
on the internet without central
authorities, this failed
attempt throughout the '90s
that finally he or she solved
that riddle in 2008.
Here is a decentralized way to
move value around the internet.
And here, even at MIT,
the 30 or so of you
or the 40 of you that have
owned a crypto asset, but one
of you-- now, this is Sloan.
And it's not computer
science and AI class.
But I suspect even over in
the computer science class,
it would be less
than half actually
have gone and downloaded
the nodes, because there's
a convenience factor.
It's human nature.
And so that even
started in 2010.
So I wanted to talk a little
about crypto exchanges,
some of their challenges, and
some of the opportunities.
And it will set up also
for Thursday's discussion,
where we'll be talking about how
a crypto exchange might be used
for a payment solution
and how an entrepreneur,
like Jeff Sprecher really
has looked at and said, no.
This is where he can see value.
You will hear Thursday
somebody, who is true to his--
[LAUGHS]
--entrepreneurial
skills is trying
to find value in this whole
blockchain technology bitcoin
world and has chosen a kind of
a mixture of a payment solution
and a crypto exchange or both.
Well, this might not be tied in.
So I'll do it the
old-fashioned way.
So we're going to talk, of
course, the readings, crypto
exchanges, a little bit of
the public policy challenges,
and then my thoughts
on path forward.
Where do I see the crypto
exchange space moving forward
in time?
So Tom, you get to
answer another question.
How has--
[LAUGHS]
--crypto exchanges become
critical gateways for--
AUDIENCE: Yeah, I mean, so
obviously, the usability,
the interface [INAUDIBLE]
discuss about how many people
have downloaded digital wallets
and other versions of crypto
exchanges.
And this is still the--
PROFESSOR: Right.
So let's go to the
other side, because Alin
was the one hand that went up
that you've downloaded nodes.
Have you ever used
a crypto exchange,
if you're willing to share?
AUDIENCE: Well,
yeah, so I used--
PROFESSOR: So you've done both.
AUDIENCE: Yeah, I used Coinbase.
I bought some bitcoin.
And then, I transferred
some on my computer,
because I was doing
a research project.
And I thought I was
going to use it.
But [INAUDIBLE] ended up
deciding that it's too valuable
to sort of use it--
[LAUGHTER]
[INAUDIBLE]
PROFESSOR: Right.
Right.
So if it were 2018 now and you
were to transact in bitcoin,
would you prefer to use a crypto
exchange or the nodes that
you've--
just bitcoin?
AUDIENCE: I guess it depends
on the security goal.
So if I'm [INAUDIBLE],,
I'll use the node.
If I want to send money to
my mom, I'll use [INAUDIBLE]..
PROFESSOR: That's neat.
Your mom uses bitcoin.
AUDIENCE: No, but surprisingly
she's quite open to it.
PROFESSOR: She is
quite open to it.
OK.
So even somebody who
is computer literate
and has both the
nodes and the exchange
is saying depends
on how tired I am
and what my goals--
security's goals.
Maybe you didn't say tired.
But and anybody want to
hit the second question?
AUDIENCE: [INAUDIBLE] the amount
of time, the amount of disputes
that arise [INAUDIBLE]
resolve these things
[INAUDIBLE] that a regular
exchange could not [INAUDIBLE]
PROFESSOR: Which type
of disputes then?
AUDIENCE: Like, there was
money [INAUDIBLE] triple debits
from accounts or you know,
[INAUDIBLE] money not taken out
or too much and [INAUDIBLE].
PROFESSOR: Right.
And how do these
exchanges compare
to traditional exchanges?
So the New York Stock Exchange--
how does Coinbase compare
to New York Stock Exchange?
AUDIENCE: You must add it
to some kind of, like, user
ready to buy some
bitcoin beforehand.
And then, [INAUDIBLE].
PROFESSOR: So you're
saying they have reserves.
AUDIENCE: I mean, I don't
know if it's a reserve.
But like, we buy from Coinbase.
We don't buy from another user.
PROFESSOR: So Coinbase itself--
so one change difference--
and I'm going to highlight
three and see if we can get off
from this discussion.
One is the exchange
itself might be
on the other side of the
transaction from you.
Alexis called that that
they had a reserve.
Some might call
that market making.
I'm sorry.
AUDIENCE: Yeah, I [INAUDIBLE]
crypto exchange [INAUDIBLE]
as a broker.
So they face the customers
instead of facing [INAUDIBLE]..
PROFESSOR: Right.
So a corollary to what
Alexis says that they
might be a market maker--
remind me your first name again.
AUDIENCE: Zhongling
PROFESSOR: What?
AUDIENCE: Zhongling
PROFESSOR: Johnny-- is
that they take on brokerage
responsibilities--
in the world of finance
or on trading platforms,
trading platforms, by
and large, early on
did not allow the
public to transact.
The New York Stock Exchange,
when it started in the late
18th century by an arrangement
between members in the south
of Manhattan, you know,
near Wall Street--
the physical Wall
Street literally--
it was a membership society
or a membership club.
And you had to be a
member to transact.
Well, those
membership and clubs,
just like a golf club or a
tennis club, had a set of rules
well before governments
got involved.
And they would transact.
That became, well, what is now
known as intermediated access
that I don't think any of you
are members of the New York
Stock Exchange, are you?
I'm not either.
So we can't actually transact
with the New York Stock
Exchange.
But we can use an
app, like Robinhood
and ask them to transact with
the New York Stock Exchange
or Goldman Sachs or
Vanguard or you know, whom--
so that's called
intermediated access.
So two things we've
had is 1, is Coinbase
might be the other side.
2, there's-- they don't-- they
lack intermediated access.
Eric?
AUDIENCE: They don't store
the [INAUDIBLE] that's being
[INAUDIBLE].
PROFESSOR: Right.
AUDIENCE: --in the [INAUDIBLE].
The Coinbase actually
stores the currency.
PROFESSOR: Right.
So Eric says the
third big difference--
I mean, there are
other differences.
But the third big difference
is crypto exchanges
store the value.
The New York Stock Exchange
did not store the value.
Your value is
technically ultimately
on a ledger at the
Depository Trust Corp., DTCC.
And just like the payment
system has the central bank
and commercial banks,
securities ledgers
have a central ledger,
which is DTCC in the US
and in other countries, other
similar clearing organizations.
And underneath it
are the brokers
that hold things-- it's
called in street name.
But whatever it's called,
know that most exchanges,
traditional securities markets--
those are the three big
difference-- custody,
intermediated access, and who's
making markets against you.
Please.
AUDIENCE: Maybe
just a question I
have is when I
click the exchange,
every transaction is backed
by the [INAUDIBLE] right?
So [INAUDIBLE] if
I sell bitcoin,
I must have owned
the bitcoin before,
whereas in the relative
exchange you can just
issue trade without owning
[INAUDIBLE] or money,
just a promise.
So you can create
the [INAUDIBLE]..
PROFESSOR: Well,
so you're raising
a question of the
difference between cash
markets and derivative markets,
which exist and have existed
for a couple hundred years
so that in a cash market,
you're selling an
ownership right
and buying an ownership right
in a stock and bond or even
in bitcoin.
And then, in derivative
markets, you're
entering into a contract--
or sometimes people call them
contract for differences,
but a contract that's going
to relate to a price--
a pricing mechanism
from some of--
oracle it can be called.
In computer science,
they would call it
an oracle but in the
commodities market
by some index provider
or some pricing provider.
That's the difference is
between cash and derivatives.
But are you saying something
even in addition to that?
AUDIENCE: Yeah, because I
was going to get to the point
that [INAUDIBLE] launched
the bitcoin [INAUDIBLE]..
PROFESSOR: Right.
AUDIENCE: And I had
[INAUDIBLE] seems
to always be the derivative in
[INAUDIBLE] cash [INAUDIBLE]..
PROFESSOR: Right.
So I ask you all to
go as deep as you can
between now and Thursday,
because you'll have
the founder of ICE with us.
But ICE is a one-day futures
contract that literally you're
buying a derivative of bitcoin.
But it's a very unusual
futures contract,
because it has to be
100% collateralized.
So there's no margin.
There's no ability to have
leverage or debt or credit
extension.
And one day later, you
get delivered the bitcoin.
So one of the interesting
questions for Thursday
that you can press
Jeff and Kelly on
is, is this really a
derivatives contract?
Or is it a form
of a cash contract
that just starts as a
derivative, and 24 hours later
it becomes cash, because
it's 100% collateralized.
And it settles one day later--
very unusual future contract.
I'm not aware of any
other one-day future 100%
collateralized contract.
It feels to me that this is,
in essence, a cash contract
by another name for one
day that facilitates
being regulated by an official
regulator for derivatives.
That's for that one.
But I thought you were saying
one other thing is, can you
sell short bitcoin?
Has anybody-- Sean?
I don't know how, but
I have shorted bitcoin
before [INAUDIBLE].
PROFESSOR: Sean has
shorted ether bitcoin and--
AUDIENCE: Bitcoin cash.
PROFESSOR: Bitcoin cash.
So how did you do it?
AUDIENCE: Well, there
is-- it's not organized,
for instance [INAUDIBLE].
PROFESSOR: Shorting is selling
something you don't own
and taking the
opposite price risk--
in essence, winning
when a price goes down
and losing when a price goes up.
And it's existed for
hundreds of years.
It's not new.
But it's-- to short
something, in most markets,
you need to be able to
borrow the underlying.
To sell a stock
that you don't own,
there's a whole market
called stock borrow, where
ultimately-- and we
debated this one day.
And there are
experts in this room
that have worked in
stock borrow, where
you borrow the security.
And then, you sell it.
Or you sell it.
And within the two days
that you have to deliver it,
your broker borrows it for you.
So I'm assuming,
Sean, that when you
shorted bitcoin, what was
behind that app-- somebody
borrowed it.
AUDIENCE: Yeah,
[INAUDIBLE] borrowed it.
And I think the
market [INAUDIBLE]..
PROFESSOR: Right.
And so just to move to
the third question--
so three big differences-- and
we're going to dig into these--
custody, intermediated broke--
you know, basically, do
you have an intermediary?
Or are you direct?
And is the exchange
a market maker?
What are all the hacks and
manipulation and so forth?
Tell you about this state
of security at these
and the state of
market integrity.
AUDIENCE: It makes the crypto
exchange insecure and less
[INAUDIBLE] and
[INAUDIBLE] less customers
see the financial
institution or the mainstream
financial institution.
PROFESSOR: Right.
So in essence, that
regardless of where
you come out on pro-regulation
or anti-regulation or
pro-business or anti-business
or pro-bitcoin or anti,
it's a question of trust.
When you're losing a
lot of assets to theft--
and a hack is just another
word for stealing--
or you're losing money
to market manipulation,
then that tends
to have, you know,
lower trust in
these institutions.
I mean, we can debate
what to do about it.
I publicly have a point of view.
And I'm going to share
it with you as we
go through this class today.
But you don't need to share
the second part, which
is where I am on how to
address that to recognize
that the high level
of custody issues
and the high level of
market manipulation issues
probably is
associated with lower
trust in these institutions.
Even now, there's,
you know, 30 million
plus people that have
used crypto exchanges
and 30 or 40 people
in this class.
So there is a level of trust.
I'm just saying that
I think that's what's
really at the middle of this.
So let's have-- so we
had a bunch of readings.
I'll skip over that.
So crypto exchanges-- so this
is what a centralized exchange
does.
There's about 200 of them.
Probably in the history of
bitcoin, there's 100 to 200
that have already opened
and shut, you know.
So somewhere in the history,
there's been 300 or 400.
It's still pretty
darn decentralized
in terms of the number of them.
And I'll later say, I think one
of the things that will happen
is we'll see more consolidation.
There's just so many of them.
That's an unusual
market structure.
Markets usually coalesce around
some central pricing function.
You want to buy and sell your
apples hundreds of years ago.
You'd come into
the center market
if you wanted to get the
best price discovery.
AUDIENCE: Is there a
reason now, though,
because you have [INAUDIBLE]
in different areas alone.
So [INAUDIBLE] same
assets [INAUDIBLE]..
PROFESSOR: So the
question is, do we
have so many crypto exchanges
in part because of lots
of different regulation?
I think that contributes to it.
I would say yes.
But I don't think
that's the only reason.
Yeah.
AUDIENCE: I think another
reason might be [INAUDIBLE]..
PROFESSOR: So you're saying
traditional exchanges--
there was the--
especially for
physical goods, apples,
there was a locational advantage
of being in the central square.
I agree with that.
There was locational advantages
to be in New York or London.
Do you know in the 19th
century the Philadelphia Stock
Exchange was bigger than
the New York Stock Exchange
until about the 1840s or '50s?
Post-Civil War, New York took
off compared to Philadelphia,
but there is
locational advantages.
But in a digital age, there's
less locational advantages.
I agree with that.
I also think it's a very
early days in some regards.
It doesn't take much.
There's one software
provider that
provides the software for
over 100 crypto exchanges.
They're not the biggest ones,
because some of the biggest
ones write their own software.
But it's-- at least the
CEO that told me this,
who runs this software company
said that it was over 20%
and maybe 30% of the volume.
So half of the crypto
exchanges, of that,
a quarter of the volume,
all have the same software,
meaning the software
for the order book,
for the custody, solutions,
and things like that.
You, too, could start
a crypto exchange.
Please be compliant
with securities law
if you're going to
operate here in the US--
well, actually if you're going
to operate in any country,
but particularly in the US.
So it's not hard to start up.
That's one other thing.
It's not hard to start
up a crypto exchange
right now if you've got a
software provider that can
give you basically a package.
And you put a new name on it.
And off you're going.
But they're matching agents,
meaning they're matching buys
and sells.
They are also counterparties,
which we talked about.
And they're custodians.
Traditional exchanges
do the first.
But they tend not to do
the second and third.
Decentralized exchanges--
decentralized exchanges
are very small
part of the market.
We'll see some
numbers later that
estimate it's a little
less than one half
of 1% of the volume right
now in October of 2018.
But they're a computer algorithm
that allows you to trade peer
to peer without a centralized.
And there's a lot of variation
in the decentralized space.
And I'll take any
questions on it.
But it's an interesting
piece, where it's saying,
Kelly and I don't
really need Coinbase
to trade if there's
some application that
can find each of us.
And we can find each other.
Ross.
AUDIENCE: So it's really--
the decentralized exchange is--
I'm trying to understand what
you're saying correctly--
centralized but only for
the matching agent function.
PROFESSOR: Very good.
Correct.
AUDIENCE: Right.
And it just doesn't
have the other two,
because you can just trade--
PROFESSOR: Right.
AUDIENCE: --if you have a node.
PROFESSOR: So Ross has
raised-- are decentralized
really centralized for matching
and don't have the other two?
Let me answer it in reverse.
Decentralized exchanges do not
have any custody function--
no custody function,
though I could envision
that somehow they could set
up a decentralized escrow
function through some multisig.
You could technologically
even do that decentralized.
But what I know now is none of
them have a custody solution.
And none of them
are counterparties.
That is accurate.
It's not clear that all
of them are centralized.
There's one developer.
There's one set of
computer technologists.
But you can actually,
if you wish,
put that algorithm out and just
say, that was a fun project.
I'm a computer scientist at MIT.
And just put it out there.
And Kelly and I could
find each other.
But usually, there's an
economic model, where somebody
is trying to make some money.
And so then, there's some
centralization of the software.
And the SEC just brought their
first legal action last week
against a
decentralized exchange.
And it was, in essence, against
the software developers.
Now, there's the
First Amendment.
Don't get me wrong.
There is clearly a freedom
of speech and freedom
of expression in this country.
But you could be a
software developer
and still be complicit
in some crime.
And both the SEC and CFTC
have, in the past 12 months,
brought in legal actions
against software developers.
And it's interesting that
in the last week, the SEC--
they settled.
It was sort of a thing
where, EtherDelta
had put a decentralized
trading platform for--
what do you think the SEC
is most interested in?
What type of-- what's that--
AUDIENCE: ICOs.
PROFESSOR: --Catalina?
ICOs-- yeah, so it was
a decentralized platform
to trade Ethereum-based, more
specifically, ERC-20 tokens.
Decentralized-- Eilon and I
could trade our ERC-20 tokens.
But they said, no, no,
that's a Securities Exchange.
So and it's the first action
the Securities and Exchange
Commission has brought
against any crypto exchange.
Why they picked it
decentralized to be their first?
That's a story I don't know.
But they did.
So that's decentralized-- so
less than 1/2% of the volume,
but an interesting and
tough, you know, new area.
And it brings you
back to maybe Nakamoto
more vision decentralized.
So as I said,
responsible, just like
in this classroom for probably
95% percent of the bitcoin
and ether transactions--
who do you think the
biggest sellers are
in bitcoin around the globe?
AUDIENCE: Miners.
PROFESSOR: What's that?
AUDIENCE: Miners.
PROFESSOR: Miners--
right-- miners.
Who do you think the
biggest sellers of ether--
ETH is?
AUDIENCE: [INAUDIBLE]
PROFESSOR: Anybody?
AUDIENCE: ICOs.
PROFESSOR: What's that?
IC-- what'd you say?
AUDIENCE: ICOs.
PROFESSOR: ICOs,
yes, because ICOs--
80% of ICOs are
done on Ethereum.
And generally, in
the early days,
they were selling
a token for bitcoin
when Vitalik Buterin did his.
And he sold ETH for bitcoin.
But we've moved-- in
the last 12 months,
it's basically selling for ETH.
So then, you want to sell
it generally speaking.
I mean, they might keep some.
Over 30 million direct members--
and as we talked about, they
lack intermediated access
and as we'll see,
market integrity rules.
So this is, you know,
the market as it is.
The most important part of this
slide to me in this discussion
is not the volatility,
which we now.
And frankly,
actually, recently, we
haven't had much
volatility for six months.
But six months isn't enough
statistical relevance
to say what the next six
years or 60 years will be.
But 54% is bitcoin.
Ethereum is, what, 16%.
So between them, that's 70%.
So we already know in the US
and in many other jurisdictions
that 3/4 of the market
are not ICOs or not
what would be called securities,
even in the US, Canada,
and Taiwan, the three
jurisdictions that
follow something similar
to the Howey Test
that we've talked about.
3/4 of the market
is non-securities.
It's just a commodity,
a cash crypto.
So you'll hear debates about
initial coin offerings.
And what's a security?
And what's not a security?
Relevant-- relevant
and important debate,
but for 3/4 of the
market, it's not
particularly relevant as a legal
matter, as a regulatory matter.
Brodish.
AUDIENCE: I have a question.
So which bitcoins will become
a stable value crypto currency?
And what is the
relevance of an exchange?
If it is not an asset,
what is [INAUDIBLE]??
PROFESSOR: So is--
Brotish, is your
question that if there's
limited volatility, what's
the value of an exchange?
The value is still
is that some people
will want to sell that
asset or buy that asset.
Some people might-- if
it's a store of value,
I might still want to
sell that store of value
so that I can buy a
car or go to school
or pay for my medical bills.
You don't think that's as
exciting as a volatile asset.
Is that what you're
saying, Brodish?
AUDIENCE: Yeah.
PROFESSOR: Well, at
Goldman Sachs, for years,
it used to be that I was taught
volatility is our friend.
When you're an
investment banking
business and making markets, a
market maker likes volatility.
So you might be thinking
as a market maker
or as an investment banker.
But I still think that if
bitcoin or any of these
became very stable
stores of value,
people would still want
to trade in and out of it.
But you're saying it's
just less exciting.
For you or for the
market, you think?
AUDIENCE: For the
market, maybe--
I don't have any bitcoin.
PROFESSOR: Oh, OK.
I don't either.
So here are the top
crypto exchanges.
I caution-- this was
printed a week ago.
It's only accurate to say that
a web group, CryptoCompare, puts
out a monthly report.
And I grabbed the
October report.
But I would--
there's no confidence
that these numbers are accurate,
except for I can tell you
CryptoCompare has relationships
with about 140 exchanges.
And those 140 exchanges
give their information
to CryptoCompare.
But here are the big ones.
What do you take
from this slide when
you look at either the average
trade side, the trades in 24
hours, the volumes--
anything?
I mean, has anybody
traded on an exchange
that's not listed there,
if you're willing to say?
Eilon has, huh?
AUDIENCE: In Coinbase.
AUDIENCE: Coinbase.
AUDIENCE: Coinbase.
PROFESSOR: Coinbase isn't
listed in the top 14--
look at that-- for the month
of October by CryptoCompare.
Sabrina.
AUDIENCE: KuCoin.
PROFESSOR: What's that?
AUDIENCE: KuCoin.
PROFESSOR: True Coin?
AUDIENCE: KuCoin.
PROFESSOR: KuCoin.
Oh, KuCoin.
AUDIENCE: I used Poloniex.
PROFESSOR: Poloniex
which is definitely
smaller than this [INAUDIBLE].
AUDIENCE: I was just going
to say [INAUDIBLE] motivated
on selling [INAUDIBLE] is do
you know US-based exchanges?
PROFESSOR: So the US-based
exchanges aren't up there.
So we don't know if these
numbers are accurate.
They are what CryptoCompare
collects from 140 exchanges.
But it doesn't mean
they are accurate.
One way they can be
inaccurate is an exchange
can just outright lie.
And if there's no rule or law
against it, they can do that.
Another way they
can do it is they
can be honest about the
numbers, but inflate
the numbers through
something called wash trades.
Wash trades are banned in
the US under securities laws
and under Commodity Futures
Trading Commission laws.
A wash trade is when I buy
something and sell something
at the same time
basically to myself
or my affiliate or my colleague.
And if I have even--
if Alon and I are not
even legally affiliated, but
if I sell something to Alon
and he buys it, and we have
an agreement that we are just
pumping the volume for some
reason, that's a wash sale.
Why would somebody do
a wash sale between two
unaffiliated parties?
Come on.
Think devious.
Think like, you
know, a manipulator.
AUDIENCE: If you're
starting a coin,
you want to make
other people think
other people are using it.
PROFESSOR: Yeah, you wanted to
make sure somebody else thought
something was used.
What's the-- that's use--
another reason?
AUDIENCE: It will show
artificial liquidity
[INAUDIBLE].
PROFESSOR: So artificial
liquidity and one other thing
that you might show--
an artificial--
AUDIENCE: Price.
AUDIENCE: Price.
PROFESSOR: Price-- thank you.
So wash sales for a
long time in markets
was a good way for
manipulators to kind of, hey,
look at this liquidity.
Look at this price--
pricing signals.
So that's why in the US
Securities and Commodities
markets-- we say no.
It's one small core
thing that's not allowed.
But there's no
ban on wash sales,
though there's
academic literature.
There's some studies.
Some competitors, some exchanges
study other exchanges to say,
they have a lot of
wash sales over there.
So we don't know how real
these volume figures are.
The other thing that
I find interesting
is the average trade side--
$200 to $1,000, couple of
them a couple thousand.
I mean, these are not
large transactions.
Kelly.
AUDIENCE: So this isn't
really [INAUDIBLE] itself.
But some of the
articles that we read
compared exchanges to, say,
like Scottrade and Fidelity
and some other
platforms like that
for traditional securities.
So I wonder-- and it basically
was saying, like, look,
you know, I think Coinbase
or something has, like,
30 billion registered--
PROFESSOR: 20 million acount.
AUDIENCE: 20 million-- so
that's obviously pretty good.
I wonder how the other
metrics compare to--
PROFESSOR: So I went
around trying to find
a list of the membership.
And I couldn't
find it for others.
And maybe it's kind of--
it's a little harder
than pumping your numbers
through wash trading.
I mean, you could also
lie about your membership.
And even Coinbase's
20 million doesn't
mean they're active members.
AUDIENCE: True.
AUDIENCE: [INAUDIBLE] security
is [INAUDIBLE] Coinbase.
PROFESSOR: Coinbase--
so here is another way
to look at-- it is by legal
jurisdiction-- same database.
You're going to have eight or 10
slides that are same database.
Coinbase is in the US.
And this would say that it was
a little less than 140,000--
no, I can't quite see
where that line comes.
Maybe it's $100 million a day.
And this is just the
month of October.
So that's where--
Sean.
AUDIENCE: I was just curious.
Why is that the Chinese
crypto exchange [INAUDIBLE]
listed up there?
[INAUDIBLE] to me [INAUDIBLE]
actually quite vague.
PROFESSOR: It's listed
there in the Seychelles
at 300 [INAUDIBLE] I'm not sure
why it's not listed on this.
It's the same database.
It's not there.
Yeah, there it is-- number 5--
number 5.
So what would you
take around this
about the great financial
centers of the world?
Yes.
AUDIENCE: [INAUDIBLE] one
of the questions that I
got to see in the
previous slide was
if you sum up all the trades
that those [INAUDIBLE]
are claiming that they are
doing on a 24-hour basis,
isn't that a lot larger than the
capacity of the system itself?
I can't remember-- what?
It was like seven
transactions per second that--
PROFESSOR: All right.
So the question is, this looks
like a lot more volume that's
actually happening.
And I'm going to agree with you.
Why do you think
that's possible--
two reasons?
AUDIENCE: Because they're just
doing the exchanges internally.
So they're not actually
transacting on the blockchain,
because they [INAUDIBLE].
PROFESSOR: Right.
And remind me of
your first name.
AUDIENCE: Jack.
PROFESSOR: Jack-- so
Jack's point is, well,
maybe not all of this is
going to the blockchain.
It's happening on
a spreadsheet--
in some cases, an
Excel spreadsheet.
But I'm not aware of
anybody storing it even
on a blockchain within
the Coinbase or Kraken
or [INAUDIBLE] system.
Second reason?
AUDIENCE: Like, I
would say [INAUDIBLE]
because it's [INAUDIBLE]
the same second layer.
PROFESSOR: So it might be
using a second layer solution
or a lightning or second layer.
That's quite possible,
even though I'm not aware
if there's a lot of activity.
Third reason?
There's a lot of
currency crosses here.
This is not just bitcoin.
There's probably 2,000
to 3,000 different pairs
that get traded on any day--
bitcoin-ether, bitcoin-dollar,
bitcoin-tether.
You can bitcoin bitcoin cash,
but a lot of the crosses--
a cross in foreign currency
land is two currencies.
It's often called
a currency pair.
US dollar versus
euro or US dollar
versus yen, these
were currency pairs.
But now, if we can use
the same terminology here,
there's thousands of crosses or
pairs, so it's not all Bitcoin.
But the first reason's the
biggest one, what Jack said.
Not all of these exchanges
will settle to a blockchain
immediately.
In fact, it's costly,
even for them.
So they'll take some
price risk, and if they
have enough customers
and their market making
on the other side, they'll
take some price risk.
And they might settle to the
blockchain multiple times a day
but only settle when
there have exposure.
And I don't know, their
risk management might be,
I'll settle when I'm long 10
Bitcoin or short 10 Bitcoin,
but take some price exposure.
That risk management,
in essence,
Coinbase or Cracken
or Gemini or Huobi
are basically saying, I'll
take some price exposure
and only settle to the
ultimate settlement
finality, the
blockchain, several times
a day which, of course, takes
10 to 60 minutes as well.
So that's happened here.
Good observation.
Yes, Isabel.
AUDIENCE: [INAUDIBLE] talks
a alot about how they key
digital wallets off of the
network for added security.
So do other exchanges
not do that?
PROFESSOR: So Isabel has
raised that Coinbase promotes
that they have a secure custody
solution, and part of it
is keeping your Bitcoin
off of the network.
The term is keeping
it in cold wallets
instead of a hot wallet.
Anybody know what
a hot wallet is?
Eric?
AUDIENCE: Software-based wallet.
PROFESSOR: Software-based wallet
that's connected, currently
connected, as opposed
to a wallet that's
disconnected and not signed up.
Let me hold that
question, because I've
got a slide on that, but yes,
the answer is others also
have cold storage.
Mt.
Gox five years ago didn't
have much cold storage,
but what other
observation here about
the great financial
centers of the world?
James?
AUDIENCE: They're
all tax havens.
PROFESSOR: They're
all tax havens.
Malta, Binance,
and OKX, now again,
whether the Binance and
OKX numbers are legit.
You're Hong Kong, right?
Yeah?
You're Hong Kong.
Biggest tax haven of China.
Yeah, the British
Virgin Islands,
Seychelles, it's kind of--
so there's some regulatory
arbitrage going on.
And these are the countries
where they're registered,
not necessarily the country
of the real operations.
Some are-- Huobi is one
that started in the People's
Republic, but in Beijing, but
they registered elsewhere.
AUDIENCE: [INAUDIBLE]
PROFESSOR: You mean
you don't know them?
Does anybody want to say?
Priya?
AUDIENCE: Islands of
the South Pacific right?
French Polynesia or something.
PROFESSOR: There you go.
I'm surprised that
you haven't learned
about this financial center.
OK.
James is this going to
tell us more about it
and how much it costs to go
on Expedia during sip week.
I think Sloan should
benefit from a true trip.
OK.
So this is a different
way to measure it.
This is not on volume.
I'm going to take a second.
This is just number
of major exchanges,
and there's the eight
big ones in the US,
starting with the biggest--
Coinbase, Bittrex, Poloniex,
that we talked about,
Cracken, Gemini, Itbit.
Those are the ones
that are US-based,
that some of you in
the US might have.
I think on this chart, if
you don't find your exchange
on this chart, I would be--
all right, all right,
maybe, because it
might have already failed,
whatever exchange you have.
But Eric, who are
you looking for?
AUDIENCE: [INAUDIBLE]
PROFESSOR: All right.
These slides will
all be on Canvas.
I'm sorry, Joe,
you had a question?
AUDIENCE: [INAUDIBLE]
2 So what all of the
exchanges did very early on--
this is starting right
in late '10 and in '11--
they set up an account
structure literally
on Excel spreadsheets,
but an account
structure for all
of their customers.
And let's say that you're buying
Bitcoin, and Kelly is selling.
Maybe I could do that
transaction between you
and Kelly right on--
this is going to be called
the Gensler Exchange--
right on the Gensler Exchange.
So I don't need to move that
to the blockchain, because--
oh, one really important thing.
What happens when
you open an account?
I'm sorry.
It's a good question,
and now I realize
I skipped over something.
What happens when you open an
account at a crypto exchange?
Alin.
AUDIENCE: KYC and AML.
GARY GENSLER: You
might do KYC and AML,
but that's not what
we're looking for.
AUDIENCE: Would you
be issued a key pair?
GARY GENSLER: What's that?
AUDIENCE: Would you
be issude a key pair?
GARY GENSLER: What you--
you might be, but
actually what I'm looking
for is what happens to your--
I have Bitcoin, and I open an
account, or I have US dollars
and I open an account.
I sign a user
agreement with them
that they're going to store
any of my crypto in their name.
Coinbase, Kraken,
Huobi-- they are not
storing it in Alpha's name.
I don't know if you
have an account,
but I'm just using you.
If Alpha has an account,
he signs a user agreement.
He says, when I buy
Bitcoin, it's in a--
at best, it's on this Excel--
well, it's probably better
than an Excel spreadsheet,
but it's in their
database in Alpha's name.
But on the Bitcoin
blockchain, it's
in a bunch of Bitcoin addresses
that Coinbase controls
or Kraken controls.
AUDIENCE: [INAUDIBLE]
GARY GENSLER: It has a name
tag on a separate ledger.
You have some legal rights
against Kraken or Gemini.
I mean, you do.
I mean--
AUDIENCE: Yeah, but after,
I mean, is it centralized?
GARY GENSLER: Correct.
That's correct.
And so because both
of you, Kelly and you,
have signed some
agreement, they're
moving Bitcoin to Kelly
and Bitcoin to you--
or if you put US dollars in
and you're buying Bitcoin.
But it's because the market, the
customers want it that way too.
So decentralized exchanges--
again, based on CryptoCompare,
these are the top five
in October by volume.
But these are not the
five you read about most.
The article that you
read talked about others.
So I don't have a deep
confidence in these,
but these are the numbers
that CryptoCompare
could pull together.
And you can see, they're
much smaller numbers.
In aggregate, in
the crypto database,
it's only 0.4% of the volume.
AUDIENCE: [INAUDIBLE]
Robinhood, it
said that they waived the fees.
In terms of competition, I
didn't understand the business
model--
how they're making revenue.
GARY GENSLER: So how many
of you have Robinhood
app on your phones?
Yeah, about 10 of you.
Do you pay any fees for
securities transactions?
Remind me your name.
AUDIENCE: Erin.
GARY GENSLER: Erin.
No.
Anybody pay any
fees to Robinhood?
No.
Isn't that kind of neat?
AUDIENCE: I do.
GARY GENSLER: Whoa, you do.
You pay some fees?
AUDIENCE: They sell your float.
They sell your flow.
They sell your data.
[INAUDIBLE]
GARY GENSLER: OK,
and your name is?
AUDIENCE: Isaac.
GARY GENSLER: Isaac, right.
So Isaac's got it.
They sell your data,
and they sell your flow.
What was the third
thing you said?
AUDIENCE: Float.
I don't know exactly how their
custody of brokerage works,
but I know that there's
an advantage to actually
having the securities at
their brokerage [INAUDIBLE]..
GARY GENSLER: OK, all right.
So three things--
your data, your flow,
and what Isaac called float,
but I would call that they have
the securities system to lend--
stock borrow or stock lend.
And those are the three ways.
How does Facebook make money?
They have your data.
So we live in a time where
platforms sell your data
and use your data to
sell advertisement.
AUDIENCE: I was going
to say, with Robinhood,
you can also pay a premium
that's tiered to be [INAUDIBLE]
margin.
So instead of paying
interest in the margin,
you play a flat fee.
And then they also
advance your settlements
instead of taking three days.
They'll do it immediately.
GARY GENSLER: All right.
So there's a premium
service where you maybe
could get further.
They sell your flow.
What that means is there are
parties that will pay brokerage
houses payment for order flow.
Vanguard does it as well.
It's not-- Fidelity
probably does.
I'm not certain.
But many big brokerage firms,
when we all work with them--
and my account at Vanguard,
I have zero commissions,
but I know they're
selling my order flow.
AUDIENCE: But who would
be interested in the data?
GARY GENSLER: So who would
be interested in the data--
or who is interested
in the flow?
AUDIENCE: So Facebook,
I understand,
would be marketing companies,
so they were targeting,
but in this case, is it
federal agencies or--
GARY GENSLER: OK, no.
Who is interested in the
data or the actual order
flow of financial transactions?
Tom?
AUDIENCE: Hedge funds,
trading entities.
GARY GENSLER: Hedge funds.
What type of trading entities?
AUDIENCE:
High-frequency traders.
GARY GENSLER:
High-frequency traders.
So I believe that Robinhood
side contracts with initially,
I think, three and then five
high-frequency trading shops.
And I've been told a
number of those names.
I don't know if they're public,
so I'm not going to repeat them
on the camera, but big--
a couple of them--
US-based, high-frequency
trading shops.
Why would a high-frequency
trading shop pay for it?
Daniel?
AUDIENCE: Go ahead.
I had a question.
GARY GENSLER: Why would
a high-frequency trading
shop pay for it?
AUDIENCE: [INAUDIBLE]
GARY GENSLER: So they
think there's some value.
Isaac?
AUDIENCE: Or you can front run.
GARY GENSLER: Yeah, you
can-- right, right, right.
So anybody who's read, you
know, some of the books
on high-frequency trading--
you can front run, but
there's also value--
to answer Rahim's
question-- there's
value in the order
flow, because if you
can see that the
market's leaning
just a little bit this way
even for a few seconds,
you can optimize your algorithms
and make money off of that.
And the US equity markets--
well over 60% of the US equity
markets are trading with
high-frequency
trading right now--
any daily volume.
In the commodity markets
when I was at the CFDC,
some contracts we thought
it could be as much as 90%.
The S&P 500 Futures contract
or the interest rates contracts
vary significantly.
And they provide a service.
There's a market-making function
those high-frequency traders
do, and mostly,
they do it legally.
But there's a value
to that order flow.
And so payment for order
flow is a very critical part
of financial markets all
the way around the globe
in any highly-liquid currency
market, bond markets, equity
markets, and, yes, Bitcoin.
So Robinhood-- Erin, do
you trade Bitcoin on there
or do you trade regular equity?
AUDIENCE: Yeah, I actually
don't use it that much,
but it's on my phone.
GARY GENSLER: It's on
your phone, all right.
But the one or two times you
used it, you had zero fee,
because some trading
house in Chicago
has a contract with
Robinhood to do that.
And Jeff Sprecher, who
you'll meet Thursday,
will tell you Robinhood,
with five million accounts
now, that's a real threat
to the brokerage model.
Why would people mostly of your
generation-- or Millennials,
because you're not--
some of you're Gen
Xers, I think, but--
I'm a Baby Boomer.
I know where I am.
But Millennials, you get
so many services for free.
Robinhood saw an
opportunity, and they've
all of a sudden got
five million customers.
But that's how they--
it's a very good question.
And so moving a little
along just to give you--
So these are the main things
from this CryptoCompare
just in October to
give you a sense.
Two thirds of the volume they
measure, spot in one third
is derivatives.
And we're not talking about the
Chicago Mercantile Exchange.
$$$
The biggest derivatives
exchange actually in crypto
is BitMax that has
a perpetual Bitcoin
swap and a perpetual Eth
that has no settlement date.
Highly-leveraged-- you can put
1% margin down and 99% borrow.
And every 10 hours,
it reprices, but it's
a perpetual rolling
10-hour future.
And that's why it's
called a perpetual--
Ross, I saw you look quizzical.
It's made perpetual, because
it's rolling 10-hour pricing
settlements.
But you don't
settle at 10 hours.
You have to either
post more margin
or receive profit
every 10 hours.
AUDIENCE: Why isn't
it a 10-hour future?
GARY GENSLER: What's that?
AUDIENCE: Why isn't it
just a 10-hour future?
GARY GENSLER: Because at 10-hour
future might not have you
or may continue in the contract,
so they created a perpetual
rolling--
AUDIENCE: If I don't post,
I'm out 10 hours later.
GARY GENSLER: That's correct.
AUDIENCE: [INAUDIBLE]
GARY GENSLER: BitMax is
the largest in this volume.
They say they don't operate in
the US, because if they did,
it would definitely have
to register its commodity
futures trading commission.
But whether they
operate in the US
or not is probably for some
other people to figure out.
Crypto to crypto
versus Fiat to crypto--
70% of the volume is on
crypto to crypto exchanges.
Again, we don't
know if the volume
figures are accurate, but
just based on these figures.
So the ecosystem is still
2/3 crypto to crypto
rather than switching
out to some other--
Decentralized-- we
already talk about this.
Really important innovation.
I think we're going to see
more about decentralized,
but right now we're
still at the early days.
Bitcoin versus Fiat-- this
is just the month of October,
but 50% was versus US
dollar, 21% yen, Korea--
who's from Korea here?
Anybody, do we have anybody?
So tell us a little
bit about that figure.
Why 16% Korea?
Your views.
I know there's no
readings on it.
AUDIENCE: I am not
actually sure why.
But there were a lot
of articles about how
there are some people who just
put all the money that they
have invested over your lifetime
to cryptocurrency [INAUDIBLE]..
They didn't have any future
like making money by working.
I don't know like [INAUDIBLE].
So [INAUDIBLE].
PROFESSOR: Any other views?
Are you--
AUDIENCE: I think
psychologically
a lot of the speculators thought
that this was a very even thing
to just sort of speculating
on the stock market,
where you needed to have some
fundamental technical skill
sets.
Whereas, this is
just a very pure--
PROFESSOR: Pure.
AUDIENCE: --even keel.
Not here, but, you know,
just that you didn't require
any specific skill sets.
PROFESSOR: That's
just pure, up or down.
AUDIENCE: Getting
around capital controls.
PROFESSOR: Getting around
curious to us capital controls?
Yeah.
There's a kimchi premium
even that Bitcoin
sells for a little bit more.
And that's what it's called.
I didn't make that term up.
There's a little
bit of a premium.
And there's some
academic studies
on how that widens and narrows
sometimes depending upon what
the government's doing.
It's measured in
single digit percent.
But you might pay
3% or 4% premium.
Sometimes it's 1.5% premium.
But there's a premium
on the Korean exchanges.
But three years ago, what cross
do you think was the largest,
over 50% just three years ago?
It's not even on
that chart right now.
Tom?
AUDIENCE: Rem NB.
PROFESSOR: Rem NB.
In 2015 and 2016, over half
the market was Rem NB Bitcoin.
Kind of got the attention
from the Chinese central bank.
By 2017, that all changed.
And the US dollar thing then
kind of took that space.
And a lot of folks
that gets really
US dollar to tether to
Bitcoin or other ways.
This fluctuates.
These numbers aren't stable.
There's some months that
yen is the biggest number.
We talked about the country's
wonderful financial centers.
And then KYC, an
interesting statistic.
Now, this is about 140
exchanges that Crypto Compare
has in their database.
And they say only
half of them, 47%,
observe strict
know your customer.
1/4 partial and 28%
absolutely none, zero.
No.
That's just sort of the
state of play of crypto.
I hope none of those 28%
are operating in the US.
But they might be.
So what are the
policy challenges?
One is the markets are
readily susceptible to fraud
and manipulation.
Any market-- it's human nature.
I don't think we're going to
take the human out of human.
It's going to look for
angles, look for ways to make
opportunities, even
the best meaning folks.
If you hold the assets in
custody and you might make
the markets, because you're
not settling to the blockchain,
even for short whiles
, this market model,
this business model is
to make markets maybe.
There's inherent
conflicts of interest.
There's conflicts of interest
in pretty much all of finance.
But then we try to manage.
We either manage
conflicts of interest
by certain rules about
transparency or certain
prohibitions about,
in the custody world,
banks hold custody as well.
But we prohibit them
from using your assets
unless you permission
them to use your assets,
and things like that.
So what we try to
use usually is build
some system of transparency and
affirmative responsibilities
or prohibitive actions, those
three buckets, transparency,
some affirmative
responsibilities,
and prohibited actions
around conflicts.
But this space has the
conflicts without much
of those three
things, transparency,
either obligations or
prohibitive actions.
So inevitably, I think
it's human nature.
You're going to have some
kind of games going on.
The custodial arrangements we
talked about, big challenge.
We're going to see a
little bit more about that.
Complying with anti-money
laundering, KYC,
and implementing tax reporting.
In the US, at least,
in the US, brokers
have to report to the
government when you buy and sell
something.
This was not true
30 and 50 years ago.
But we've come to
a place where I
think it was in the last 15
to 20 years, laws changed.
Ross, maybe you know
on your legal work.
But laws change where brokerage
houses have to report.
And those reports go into the US
government and other countries.
So the brokers say James
sold this many shares of this
and had a basis of that.
And there's more tax compliance.
Here, there's no broker.
So it's hard to
attach something.
And some of the exchanges
are rather slow when
the IRS comes knocking.
Coinbase and the IRS
had a little kerfluffle,
I'd call it, when the IRS
asked for data on their then 13
million customers.
And they settled,
because the IRS
was bringing an
action against them
when they wouldn't give
them any information.
And they settled and gave them
information on their 10,000
or 20,000 most active accounts.
But for a while, right
now, the coin basis
can act like they're
Swiss bank accounts.
Is anybody from Switzerland?
All right, then I can say it.
But, you know, for decades--
wait.
Who?
AUDIENCE: [INAUDIBLE]
But I lived there.
PROFESSOR: You live there?
Well, what did for
decades, maybe centuries,
Swiss bank accounts
been known for?
AUDIENCE: Secrecy.
PROFESSOR: Secrecy.
Secrecy.
That was their-- they had a lot
of other good things going on.
But that was one of their
marketing points, secrecy.
It's a little harder now.
But it's still relative to a
German bank or a French bank,
probably a little bit
more secret, right?
AUDIENCE: Yes, it's less.
A lot because of US
pressure [INAUDIBLE]..
PROFESSOR: Right.
Right.
AUDIENCE: Still more secret than
some of European [INAUDIBLE]..
PROFESSOR: Yeah.
But crypto exchanges are
still thinking, oh, well,
how can we give up secrecy?
Because competitively, other
exchanges aren't doing it.
So I think Coinbase was
trying to be good citizens,
but also not give everything
to the IRS the IRS wanted.
There's a big question
of what's a security?
What's a commodity?
What's a derivative?
And in every legal
jurisdiction around the globe,
securities exchanges are
regulated pretty much
in every jurisdiction.
So what is a security
and what's not a security
does relate to what's currently
regulated under current law.
I've testified in
the US Congress.
And I'd say regardless of that,
if it's even just a commodity,
like Bitcoin under US law
is considered a commodity,
you probably want these
exchanges regulated.
And if it's a derivative,
in most jurisdictions,
it also is regulated.
So the first and the
third in that list,
securities and derivatives,
exchanges are regulated.
In most jurisdictions, commodity
exchanges are not, but not all.
So the definitional thing
also relates to what comes in.
So in the US, there are
a number of exchanges
that will, I would predict
in the next 18 months,
register with the Securities
and Exchange Commission
as broker-dealers under
regulation alternative trading
system Reg ATS.
But I think that they will only
do it if they're category one.
They have a bunch of
initial coin tokens
that are so clearly
securities, they register.
But what if you're only
trading Bitcoin, only trading
Bitcoin and Eth and so forth?
Those might say, I don't want
to have all those added costs.
So question for Thursday is,
why did the Intercontinental
Exchange create
a one day future,
which appears to be like it was
like walking into and saying,
I want a regulated exchange?
As a business
proposition, that's
what it feels like to me.
That that was part
of that decision set.
But you can ask on Thursday.
Tracking beneficial ownership.
We've tracked beneficial
ownership in the securities
markets for a long time,
from the first joint stock
companies.
Because you track
beneficial ownership
to ensure that somebody
gets their dividends.
And if they're voting once a
year on the board of directors
and things like that.
But somewhere in the
last 30 or 40 years,
law enforcement agencies
said that's a good way
to track against money
laundering and track
against other things.
So layered on top
of securities laws,
law enforcement agencies
around the globe
said, we want to
know who owns what.
For the prior 50
to 100 years, it
was just securities law
that cared about tracking
beneficial ownership.
But there's some
international treaty--
I can't remember
the name of it--
that says all securities
regulators have
to do something
extra and make sure
that there's transfer agents.
And there's this whole
regime of keeping
ledgers of who owns what.
In addition to this
anti-money laundering stuff,
securities laws have this
embedded in most jurisdictions,
This is a tough
one for this space,
not only because it comes
from a libertarian basis.
But it's also a tough
one just technologically,
just the technical solutions.
The crypto exchanges,
half of them
have what Crypto Compare says
is strict anti-money laundering.
But 1/4 don't have any,
which means they're not
tracking beneficial ownership.
I think that will
slowly get ramped up.
But if you see a lot of
registered exchanges leaving
one country for another,
they're probably
going to a place that
has lower regulation.
Oh, and how do you remediate
a noncompliant exchange?
There's a bunch of
exchanges here in the US
that will register.
Securities and
Exchange Commission
can do, look, we're
not going to fine you.
We're not going to give
you penalties for the past.
Can you just come
into compliance
in the next 12 to 18 months?
That's probably what's
going to happen.
But like the Ether
Delta situation
just last week, they
come to some settlement.
They say, you've been violating
the law for the last X
number of months.
But how do you come
into compliance?
And so that will be
an interesting sort
of what level of regulatory
forbearance will there be?
I think that at
some point in time,
there will be fines
and penalties.
But I think in the US context,
they'll bring a half a dozen,
or eight, or 10 into regulation.
And then they'll bring
down a heavier footprint,
bring down the hammer, if
you wish, in 2019 or 2020.
I don't think that's
going to be in 2018.
Kelly?
AUDIENCE: So maybe this is
a question for Thursday,
but what is the thought on
the side of the exchanges?
Do you think that there
will be a huge cost to them
to come into compliance?
Or do they think that
they're going to lose members
or maybe even it would increase
because it's [INAUDIBLE]??
PROFESSOR: So a
very good question.
What does being compliant with
some broad public policy norms
do?
And I think there's probably
different business models.
If you're an incumbent,
like NASDAQ--
and there was a
brief article when
Adena Friedman who
runs NASDAQ said
she wanted to be in this space.
If you're NASDAQ, if
you're CME, if you're
Deutsche Borse in
Germany, if you're ICE,
you really already know
how to be compliant.
It's probably advantageous
to be registered
and for all those
startups to be registered.
In some ways, it creates
a barrier to entry.
But you want to do it.
If you're a startup, you
could go one of two paths.
So Gemini here in the US and
Coinbase, at least publicly,
are saying we want
to be compliant.
How do we get there?
Coinbase may be,
because now they're
almost like an incumbent.
And so they might want to keep
the next round of startups out.
But I think around
the globe, there's
no doubt that it
would raise costs.
The question is whether it would
either secure your market share
or flush out some competitors.
I would contend that
it would increase
the overall size of the market.
Because more people
would be interested.
But some fear that it
would shrink the market.
Because if you had known
beneficial ownership,
if you tracked
beneficial ownership
for 100% of this market, some
worry the market would shrink.
That's from a
commercial concept.
Meaning, if you're tracking
beneficial ownership.
Question Riham?
AUDIENCE: [INAUDIBLE] the whole
essence of Bitcoin, all of this
is deregulation, being away from
the government, and transaction
between individuals
without having
regulations, this
more libertarian
view of exchanges [INAUDIBLE].
PROFESSOR: So the
nature of your question
is, isn't Bitcoin and crypto
about some off the rails,
libertarian, pro
libertarian, peer to peer?
I think it's genesis.
Eric, you want to answer?
AUDIENCE: [INAUDIBLE]
there's common theme
in the reading
about Coinbase where
[INAUDIBLE] the fact
that more and more people
with that libertarian
point of view
are constantly reminded
[INAUDIBLE] that it's
kind of betraying that ideal.
But you don't have
to believe me.
I mean, he's trying to make
a business out of this.
So being compliant
with that is actually
trying to broaden
the base of customers
and make the business more
profitable and growth.
PROFESSOR: I think that to
go from a $200 billion market
to $2 trillion or
$10 trillion, it's
got to come inside the
public policy envelope.
I just don't see particularly,
lowering the risk
of manipulation and fraud.
Then you're going to have a
broader societal acceptance.
And investor protection matters.
But there are others on
the other side of that.
These are on the numbers.
I'm not going to stay on it.
But this is just
to say one thing
Crypto Compare does is
average daily visitors
versus their volume.
Coinbase's average
daily visitors
is you can see that
a highest read chart
compared to their volume.
They probably have
legitimate use.
The two, ZB and EXX,
almost have no visitors.
And they report a lot of volume.
So it's just an interesting
statistic to sort of say--
and it might well be that
Binance's volume statistics
are accurate.
They're just a crypto
to crypto exchange.
But they also, their ratio
of visitors to volume
is very different than Coinbase.
Just to give you a little flavor
for the craziness out there.
Investor protection.
I sort of said investor
protection is critical.
We're going to talk about
this in a week or so
about initial coin offerings.
But it's further than
consumer protection.
And importantly,
because we address.
We know.
We are honest.
We're earnest about it.
We say, yes, there are
conflicts of interest.
How can we address
conflicts of interest?
You don't ban
conflicts of interest.
But you sort of say, is
there ways to manage it?
How do we promote
market integrity
through transparency and
rules of anti-manipulation?
So it's kind of those, you
know, the realities of humanity.
And we say, well, how can we
sort of put some traffic lights
and speed limits in the system
to give people confidence
that drive the roads?
And by the way, Rahim,
I can't tell you,
because I wasn't there around
the debates in the nineteen
teens and the 1920s.
But you can be
assured there were
debates in whether to put
the first traffic light out.
Literally, you know?
Whether to put the
first crosswalks.
And do traffic
lights and crosswalks
restrict the use of automobiles?
Absolutely.
Absolutely.
But think about this.
Did they promote the
sales of automobiles?
And I would contend
they also promoted
the sales of automobiles.
That simple regulatory
intervention
meant that people could
feel a little bit more safe
having their neighbors drive.
Because most people
didn't drive.
But having their
neighbors come down
pass there walking on the
street, the pedestrians.
Pedestrians felt safer.
So I think it's a bit of both.
All right, I might be
disclosing my point of view.
I think investor protection
bolsters investor confidence
in capital markets.
And that everybody benefits.
But you've got to get
the balance right.
And I'd respect if
half of you say,
no, it should be less
regulation, and have said more.
I'm disclosing more
where I am and at least
the logic behind it.
You know what the Howey Test is.
We'll come back
to this in a week
when we do initial
coin offerings.
In the center of
crypto exchanges,
it's an important issue as to
which crypto exchanges have
an ICO token.
Then they've got to kind
of do a little bit more.
Hacks.
These are the biggest
hacks I could find.
These are reported hacks.
Who knows what's
not been reported?
Coincheck and Mount Gox
each about a half a billion.
A couple of 50 to 100, 200.
And here's a bunch of
tiny ones that I've put.
I mean, they'll be on Canvas.
But there's a
bunch of basically,
steal somebody else's coins,
because they're [INAUDIBLE]..
Earlier question, cold storage.
This again, thanks to the
friends at Crypto Compare.
Isabella, that was your
question earlier, right?
So I can't really tell
you why BitFlyer only
has 80% in cold storage.
And some of these others,
like Bit for Nexus 96% or 97%.
But I think that if you have
a high volume and high flow,
you could maybe keep
more in cold storage.
Or if your model is more about
custody than transactions,
you could have more
in cold storage.
You do need something, you
know, probably connected
to give your customer
base liquidity.
And somewhat depends
how long it takes
you to move something from
cold storage to hot storage.
AUDIENCE: [INAUDIBLE]
PROFESSOR: What's that?
AUDIENCE: At least they used
their own capital [INAUDIBLE]??
PROFESSOR: So they self-insure.
And Gemini announced
that they just
signed a contract with Aion
one of the world's largest
insurance companies, to
insure against loss of that
which they're having custody.
But don't confuse it
for 100% insurance.
The insurance companies
are charging significantly,
somewhere around 1.5% a quarter.
So there's some
crypto exchanges,
which will allow you to
pay for the insurance.
And Gemini says they've
signed a contract with Aion.
And I can't quite tell whether
that's just because Gemini is
going to pay for the insurance.
Or they're going
to allow you to pay
for the insurance in
that custody solution.
Let's see what else.
Oh, we're almost wrapping.
So here's what I think.
Custody, I think
the custody duties
either have to be
fixed or spun off.
I think from a public
policy perspective,
they're better spun off.
And that's because there's
such an inherent conflict.
I think if you're
holding somebody's funds
and also transacting, it's just
too sweet a honeypot not just
to be stolen, but for
the operator to say,
I want to use it in my own--
lend it, borrow it,
transact around it.
But that's my thought.
Fix it or spin it off
would be the custody.
Illicit activity, I think we're
going to have to get to a place
where if not 100%, close to
100% are actually complying.
And if 1/4 of them aren't
even doing AML and KYC,
there's still a lot of--
there's some road ahead here.
I know it might not fit, Rahim,
with the libertarian soul
of the genesis of all this.
I won't say you
maybe personally.
I think that's going to
be the path for our--
if we're still two
and three years
from now 1/4 of the
market not doing it.
I think that the
market integrity
piece is the toughest one.
And it's maybe where
my own personal views
shouldn't cloud my judgment.
My own personal views is
we need market integrity,
anti-manipulation, no front
running, things like that.
But realistically,
it's probably going
to be done by
individual exchanges
or self-regulatory
organizations.
Gemini and others
in the UK, there's
some self-regulatory
organizations.
I don't think that's sufficient.
It's a step really in
the right direction.
But I think somewhere,
if this gets bigger,
it needs to be the official
sector putting some traffic
lights and stop signs in.
Registration and remediation.
First, to determine whether
you have to register
and then comply.
And that's a multiple
month or year period.
In Japan, they started
registering in late 2017.
They started with
16 and another 16.
Some had to shut down in Japan.
South Korea is registering.
Now, some of those
registration regimes
are really just about
custody and Bank Secrecy Act.
They're not going as far
as I would like to go,
which is into market integrity.
But I think you're going to
see a bunch more jurisdictions,
registration, remediation,
some closing, and the like.
Margin and fee compression,
I think that's inevitable,
whether it comes from the Robin
Hoods or the Intercontinental
Exchange.
But the juice is
so much right now.
I mean, some of these
are charging 1% to 3%.
You all transact.
You know your fee
structures better.
But I think there'll be
margin and fee compression.
And I think there'll
be some consolidation.
There's not enough room
here for 200 plus exchanges.
So those are my predictions.
And I think the
decentralized exchanges,
once they have
enhanced customer UI,
there will be more adoption.
But right now, not that easy
to use for most regular people,
the non-computer scientists.
Two questions and then
we might have to wrap.
AUDIENCE: Is there
any indication
that crypto exchanges
are profitable?
PROFESSOR: Crypto
exchanges, profitability,
they're enormously profitable.
Coinbase did a venture round
at an $8 billion valuation.
One crypto exchange just
sold itself for $400 million.
And Coincheck that
lost the half a billion
of Nam, the 27-year-old
who ran that in Japan
did not declare bankruptcy.
Because he had already
made over a half
a billion dollars in
the previous 12 months.
They are enormously profitable.
