Last month, the exclusive “accredited investor” club cracked open its doors to the public. But don’t celebrate yet. Chances are you still didn’t receive an invitation to join. Members in this exclusive club can legally invest in certain private offerings, like hedge funds and start‐up companies. Until the SEC’s recent revision, entry was limited to people who earn at least $200,000 a year ($300,000 with a spouse) or have a net worth of at least $1 million. About 13% of U.S. households qualified under those rules.
The new SEC rule lowers that high threshold a bit, but only for people who hold certain securities licenses or work at private funds. So unless you are comparatively well‐to‐do or part of this group of financial industry insiders, most private securities offerings are still off limits to you.
Even this modest loosening of the restrictions has come under fire. House Financial Services Chairwoman Maxine Waters urges the Biden administration to rescind the revised definition.
SEC commissioners Allison Herren Lee and Caroline Crenshaw suggest the wealth thresholds be indexed to inflation to ensure that the club remains limited.
The Biden administration should not heed these calls. Narrowing the accredited investor definition may be good news for the wealthy few because it concentrates investment opportunities in the hands of those who are already advantaged. Breaking down society’s wealth divides requires removing such barriers to opportunities for investors and entrepreneurs to make financial gains.
Broadening access to private offerings, rather than further restricting it, is a better solution.
In 2019, for example, registered offerings raised $1.2 trillion, while Regulation D offerings raised $1.5 trillion (of the $2.7 trillion total raised by exempt offerings).
The SEC reasons that less well‐to‐do investors are protected by limiting riskier investments to the financially sophisticated and those who can absorb losses.
But being wealthy is no proxy for financial sophistication. The wealth test clearly misses the mark.
This line drawing lumps the elderly with substantial retirement savings and lottery winners with windfall profits in with people whose earnings depend on some financial know‐how. It also excludes those who don’t have a substantial nest egg but have a great deal of general investment knowledge or have experience with the industry in which they seek to invest.
SEC Commissioner Hester Peirce has observed that the this limitation on investors “offends the principles of personal liberty, which allow people both to earn and spend money as they see fit.”
For investors, the accredited investor definition makes it harder to get rich unless you already are rich. It takes about 11 years for a company to go public today, meaning that it is likely past its high growth phase by the time most people can invest in it. There are also fewer public companies today than there were 20 years ago. So people have fewer choices in the public markets and those choices may offer lower potential returns.
Private offerings also provide different opportunities than those in the public markets, including diversification options and the ability to support a compelling idea or local entrepreneur. And for investors and entrepreneurs alike, the accredited investor definition deprives many communities of capital needed to grow.
Accredited investors aren’t representative of the U.S. population: white families, on the whole, are considerably wealthier than others, and wealth is concentrated on the U.S. coasts. Would‐be entrepreneurs in less‐wealthy communities are thus limited in their ability to turn to those they know best in building their businesses.
Instead, 74% of aspiring entrepreneurs cite networks and connections as barriers to accessing capital, and too few can rely on angel investors, who tend to invest in nearby businesses. That’s why the SEC recognized that minority‐owned businesses, in particular, may benefit from increased access to accredited investors. Where proportionally more minority‐owned businesses have closed in 2020 due to the pandemic, expanded access to capital is even more crucial.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
VCs, LPs and governments need to change their ways if they want to create and fund businesses that will make the world a better place. Here’s how they can do that.
When a Pulitzer Prize-winning journalist turns their attention to you in the New Yorker, you must have done something terribly right — or wrong. Back in November, a bunch of VCs found themselves in this situation. The writer, Charles Duhigg, chastised them for not only neglecting their oversight responsibilities on startup boards, but also for chasing the wrong kind of company: the mythical unicorn.
From WeWork to Uber, it turns out that quite a few of these $1bn-plus businesses are in fact full of hot air.
Investors should stop hunting these mythical creatures and search for another one instead: enter the “green zebra”.
How the zebra got its green stripes
The zebra model — a term coined by the now-international collective Zebras Unite in 2017 — is thought to be a more solid, more founder-driven alternative to building a unicorn.
These are companies that, instead of seeking to blitz-scale their way to market dominance, fuelled by multiple venture capital fundraising rounds, prioritise profitability. Zebras also tend to be focused on equitable ownership and building sustainable businesses, and they seek to create a positive social impact, for example by providing solutions for underserved markets or prioritising employee happiness.
I believe the next generation of companies following this model will not only operate on zebra principles, but environmental, social and corporate governance (ESG) ones. They will be green zebras, and green in the widest sense of the word: more inclusive, ethical, thoughtful and sustainable. They will raise capital by showing that commercial opportunity goes hand in hand with sustainability and impact — and the current cleantech boom is only the tip of the iceberg here.
But what if we wanted to see a whole generation of these green zebra companies, which work on responsible and sustainable solutions to big problems? What in the structure of venture financing would have to change?
How VC can nurture more green zebras
Here are three suggestions:
1. VCs need to embrace ESG principles themselves
How are you going to properly support a portfolio company that is driven by ESG principles if you’re not putting them into practice yourself? At the moment, the number of funds that explicitly apply these criteria is extremely small. But there is increasing pressure from founders (of zebras and beyond), employees and consumers to do so. The forerunners — such as Antler, 500 Startups and Balderton, which have come out with explicit ESG initiatives already — will also be the ones that green zebras gravitate towards, and stick with. These initiatives are a good start in signalling that a firm is about more than just quickly maximising returns for stakeholders.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
EVENTS ON Wall Street have become so strange that Netflix is said to be planning a show to immortalise them. But what should be the plot? One story is of an anti-establishment movement causing chaos in high finance, just as it has in politics. Another is how volatile shares, strutting online traders and cash-crunches at brokerage firms signal that a toppy market is poised to crash. Both gloss over what is really going on. Information technology is being used to make trading free, shift information flows and catalyse new business models, transforming how markets work (see article). And, despite the clamour of recent weeks, this promises to bring big long-term benefits.
Don’t expect screenwriters to dwell on that, obviously. Their focus will be the 8m followers of WallStreetBets, an investment forum on Reddit, who have invented a new financial adventurism: call it swarm trading. Together, they bid up the prices of some obscure firms in late January. This triggered vast losses at hedge funds that had bet on share prices falling (see Buttonwood). And it led to a cash squeeze at online brokers which must post collateral if volatility rises. Since January 28th the most prominent, Robinhood, has raised $3.4bn to shore itself up.
The swarm seems to have moved on. This week the price of some favoured shares sank and silver leapt. Meanwhile, in many markets the normal rules of play have been suspended. Almost 300 “SPACS” listed last year, raising over $80bn and allowing firms to float without the hassle of an initial public offering (IPO). Tesla has become America’s fifth most valuable firm. Bitcoin, having gone from the fringe to the mainstream, has a total value of $680bn. Trading volumes for shares are at their highest in at least a decade and those for some derivatives are off the charts.
Part of the reason for this is that government bail-outs have put a floor under risky debt. Banks have so much spare cash—JPMorgan Chase’s pile has risen by $580bn in the pandemic—that they are turning depositors away. Instead of using the lockdown to learn Mandarin and discover Tolstoy, some people have used their stimulus cheques to daytrade. Although the whiff of mania is alarming, you can find reasons to support today’s prices. When interest rates are so low, other assets look relatively attractive. Compared with the real yield on five-year Treasuries, shares are cheaper than before the crash of 2000.
Yet the excitement also reflects a fundamental shift in finance. In recent decades trading costs for shares have collapsed to roughly zero. The first to benefit were quantitative funds and big asset managers such as BlackRock. Now retail investors are included, which is why they accounted for a quarter of all trading in January. Meanwhile, information flows, the lifeblood of markets, are being disaggregated. News about firms and the economy used to come from reports and meetings governed by insider-trading and market-manipulation laws. Now a vast pool of instant data from scraping websites, tracking industrial sensors and monitoring social-media chatter is available to those with a screen and the time to spare. Last, new business models are passing Wall Street by. SPACS are a Silicon Valley rebellion against the cost and rigidity of IPOs. Robinhood, a tech platform from California, executes trades through Citadel, a broker in Chicago. In return for free trading, users’ trades are directed to brokers who, as on Facebook, pay to harvest the data from them.
Far from being a passing fad, the disruption of markets will intensify. Computers can aggregate baskets of illiquid assets and deploy algorithms to price similar but not identical assets, expanding the universe of assets that can be traded easily. A sharply rising proportion of bonds is being traded through liquid exchange-traded funds, intermediated by a new breed of marketmakers, such as Jane Street. Contenders such as Zillow are trying to make housing sales quick and cheap, and in time commercial-property and private-equity stakes may follow.
On paper this digitisation holds huge promise. More people will be able to gain access to markets cheaply, participate directly in the ownership of a broader range of assets and vote over how they are run. The cost of capital for today’s illiquid assets will fall. It will be easier to match your exposure to your appetite for risk.
But financial progress is often chaotic. First time around, innovations can cause crises, as the structured-credit boom did in 2007-09. The capacity of social media to spread misinformation and contagion is a worry.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
The trading frenzy surrounding the video-game retailer is a prism for a range of epochal issues.
Libertarianism vs Paternalism
This is an eternal debate. Freedom means the freedom to mess things up. But governments have a responsibility to citizens, and companies have a responsibility to clients, to reduce the risks that the actions of some will harm others. Driving is the most popular analogy. Paternalism demands that manufacturers fit cars with seat-belts, but libertarianism permits people to take the risk of not wearing them.
There is a line to be drawn. Within markets, it is best to set a few simple rules, enforce them, and leave everyone as free as possible. That way the invisible hand can work its magic. But if the invisible hand really thinks that GameStop is worth $25 billion, something has gone wrong. The Securities and Exchange Commission is considering what to do, and there is plainly a regulatory issue here. Meanwhile, the decision by Robinhood Markets Inc., the main broker used by the Redditors, not to accept trades in GameStop on Thursday has already prompted class-action lawsuits from clients. For arguments against paternalism, look at the comments below the piece by my colleague Conor Sen arguing that Robinhood did the right thing.
As day traders are the Davids in this drama, up against hedge-fund Goliaths, their supporters in Congress include progressive Democrats such as Representative Alexandria Ocasio-Cortez, and Senator Elizabeth Warren. The politics will be unpredictable. But a few points seem clear:
Regulators must respond with equity. Any suggestion that they are defending hedge funds against retail investors would be disastrous. Anything that clamps down on retail trading will have to be balanced by a serious attempt to stamp out “naked shorts” — the practice of selling a stock you don’t have, which led to the imbroglio at GameStop;
The issue of whether Robinhood and others really engaged in “gamification” — making trading more like a game, and helping to get people addicted to it — needs to be addressed. I think they have a case to answer.
The need to protect people from losing money they cannot afford to lose should remain paramount. Redditors complain it would be unfair to stop them from taking risks that are allowed for hedge funds. There’s a good reason for this, though. Hedge funds are restricted to wealthy people who can afford losses, while others deserve more protection. I am sure that opinion will make me unpopular.
There is no libertarian objection to stopping behavior that endangers others. Libertarians can agree that nobody should be allowed to drive a car when drunk. Distorted markets, and particularly asset bubbles, lead to malinvestment and wasted capital, and ultimately to lost jobs. The Federal Reserve is adamant that it cannot and should not attempt to identify and deflate bubbles before they grow too big. Incidents like this suggest that they need to be more active.
What was intended to be one of the week’s biggest stories disappeared in the vortex of excitement caused by the sub-redditors. Laurence Fink, chief executive officer of BlackRock Inc., the world’s largest fund manager, released the startlingly assertive letter he had sent to the CEOs of every company in which his firm invests. His demands notably included:
Given how central the energy transition will be to every company’s growth prospects, we are asking companies to disclose a plan for how their business model will be compatible with a net zero economy – that is, one where global warming is limited to well below 2ºC, consistent with a global aspiration of net zero greenhouse gas emissions by 2050. We are asking you to disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors.
BlackRock is trying to come up with a more palatable model for shareholder capitalism, which can guide the economy and society to better long-term outcomes, even if they don’t bring immediate returns. Viewed cynically, this is a public relations effort to make Wall Street look more virtuous; less cynically, it is an attempt to live up to the demands of stewardship.
Not only do BlackRock and other big fund managers need to provide a pension for their clients in retirement, the argument goes; they also need to ensure that they have a world with a breathable atmosphere in which to retire.
The truth lies between these poles and includes a realization by Fink and others that capitalism is widely seen to be failing, and that they need to do what they can to reform it from within, before having reforms imposed on them.
The Redditors — or at least some of them — also plainly believe that they are part of a democratization of finance that will allow them to help make capitalism fairer. Rather than leave this process to big fund managers using “ESG” investing, their idea is to force a more “just” outcome.
That includes, in the case of some of the companies they are now buying, the notion that it is unfair to starve them of capital. This is in part a well-intentioned attempt to rescue some companies; it sounds much like governments’ old practice of saving lame ducks and picking winners, rather than letting the market ensure that capital doesn’t go where it cannot be well used.
Share ownership is now largely a business for institutional managers using other people’s money, who don’t have the incentives that direct owners would. The new breed of retail investors hope to reform capitalism by returning to direct ownership and breaking the hold of what they see as the corrupt institutions that now control the market. Many seem to delight in the label “anarcho-capitalist.”
The common thread is, of course, an acceptance that the current model isn’t working. I’m far from convinced that either the BlackRock or the WallStreetBets model is the answer. But the debate over what the new model of capitalism should look like, which should have happened at least a decade ago, can be delayed no longer.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
The Paris Agreement (2016) is explicit in highlighting the importance of climate technologies for a sustainable future, stating in Article 10, that: “Parties share a long-term vision on the importance of fully realizing technology development and transfer in order to improve resilience to climate change and to reduce greenhouse gas emissions.” Providing its full-hearted support, it makes a strong case for further action: “Accelerating, encouraging and enabling innovation is critical for an effective, long-term global response to climate change and promoting economic growth and sustainable development.”
Outlined below are seven suggested steps towards achieving this goal:
1) Recognizing that the digital and green transitions are closely intertwined
Given that, digital innovations are increasingly indispensable as key enablers for the economy’s green transition, while the greening of digital technologies is a critical success factor for digital transformation. Therefore, investments need to keep up the pace with the transition to a digital and green economy.
2) Addressing the investment gap for green tech
The investment trends in clean climate technologies have been lagging. In fact, US venture capital funding for climate technologies, after experiencing strong growth in the early aughts, has declined since 2011. Astonishingly, Silicon Valley has become green tech’s Death Valley, as almost all of the 150 renewable energy startups founded there, over the past decade, have shut down. In fact, a mere 2.5% - 6% of US venture capital funding goes into the financing of climate technologies (UNFCC Report, 2018).
The main reason for the tepid investment is that there is limited commercial profitability and lukewarm demand from investors to finance these highly innovative climate-tech start-ups in need of long-term patient capital. Clean tech companies’ positive externalities are not rewarded by the market, as investors prefer mature technologies to early-stage ones. The market failure in financing climate technology companies can be attributed to five prevalent factors, including green tech’s: (i) high-risk profile; (ii) capital intensive nature; (iii) patient capital demand; (iv) lack of collateral (intellectual property intensive); and (v) high-opportunity costs attributed to the high-profitability and shorter returns of competing technology investments. Based on these factors, there exists a counter-cyclical trend of underinvestment in green tech, which represents a key barrier for highly innovative green tech startups and SMEs to incubate and scale-up their businesses. Therefore, it is critical to reverse this under-investment promoting innovations that foster both a digital and green transition.
3) Getting innovations out of the lab into the market
Besides the critical financing gap facing green tech companies, another significant challenge lies in getting these innovations out of the lab and into the market. A greater concerted effort is needed to provide just-in-time technical advice to improve the commercialization of green startups. Too often, it takes too long for key technological innovations to not only reach high levels of maturity in terms of their technology development (a.k.a. high technology readiness levels), but also their optimal market and investment readiness.
Innovators often require hands-on support in terms of venture building, business planning, finance, marketing, and commercialization. Many times, highly innovative technologies do not reach markets—not because of technology bottlenecks—but due to the significant challenges that innovators face in terms of building a successful venture. Therefore, it is critical to enhance the required support to innovators through dedicated startup accelerator and venture building programs.
Key remaining issues to move forward the twin transition to a green and digital transformation
In climate change, a key and oft-overlooked factor, is the need to develop and adopt digital innovations that enable collective action among the different stakeholders, including industry, small business owners, startups, local governments and citizens. The decentralized nature of blockchain technologies, lend themselves to being adopted and appropriated by people and institutions, flexibly and suitably fitting their specific needs.
In fact, the nature of blockchain technology takes us back to the origin of the Internet, which was intended to be a highly democratic, decentralized and open system that empowered citizens to not only consume information, knowledge and data, but to produce, own and share their individual localized content. The local appropriation of Blockchain technology remains to be fully unleashed and holds great potential in this regard.
Following, are the key remaining issues to simultaneously move forward a green and digital transformation:
How can digital innovations be leveragedto overcome the tragedy of the commonsand provide incentives to all stakeholders to reduce their carbon footprint and consider the overall societal impact of their actions?
What policy andfinancial instruments need to be leveraged and/or developedto better support breakthrough innovations (at incubation and scale-up) that stand at the intersection of the digital and green transition?
How can we overcome the dilemma posed by the most game changing innovations, which are unable to raise the necessary finance due to being considered too risky, too innovative, too uncertain, or too complex for investors?
How can we better leverage green digital finance through the adoption of fintech innovations (i.e. green bonds and alternative finance mechanisms)?
How can UN agencies, the European Commission, national governments and the private sector further strengthen their collaboration to support a green innovation ecosystemand improve financing for green technology startups and SMEs?
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
Monzo founder Tom Blomfield is departing the U.K. challenger bank entirely at the end of the month, staff were informed earlier today.
Blomfield held the role of CEO until May last year when he assumed the newly created title of president and resigned from the Monzo board. However, having been given the time and space to consider his long-term future at the bank he helped create six years ago, and with a refreshed executive team now in place, he says it is time to “hand over the baton”.
In a brief but candid telephone interview, Blomfield also revealed that, as well as being unhappy during the last couple of years as CEO when the company scaled well beyond a “scrappy startup”, the pandemic and subsequent lockdowns exacerbated pressures placed on his own mental well-being. “I’m very happy to talk about what’s gone on with me, because I don’t think people do it enough”, he says.
“I stopped enjoying my role probably about two years ago… as we grew from a scrappy startup that was iterating and building stuff people really love, into a really important U.K. bank. I’m not saying that one is better than the other, just that the things I enjoy in life is working with small groups of passionate people to start and grow stuff from scratch, and create something customers love. And I think that’s a really valuable skill but also taking on a bank that’s three, four, five million customers and turning it into a 10 or 20 million customer bank and getting to profitability and IPOing it, I think those are huge exciting challenges, just honestly not ones that I found that I was interested in or particularly good at”.
In early 2019 after realising he was “doing too much and not enjoying it,” Blomfield began talking to Monzo investor Eileen Burbidge of Passion Capital, and Monzo Chair Gary Hoffman, about changing roles and how he needed more help. Then, he says, “COVID just exacerbated things,” a period when Monzo also had to cut staff, shutter its Las Vegas office and raise bridge funding in a highly publicised down round.
Meanwhile, Blomfield describes his resignation as a Monzo employee as “bitter-sweet,” and is keen to praise what the Monzo team has already achieved, including since his much-reduced involvement. “I think the team has done phenomenally well over the last year or so in really difficult circumstances,” he says. In particular, he cites Monzo’s new CEO TS Anil as doing a “phenomenal” job, while describing Sujata Bhatia, who joined as COO last year, as “an absolute machine, a real operator”.
To that end, Monzo now has almost 5 million customers, up from 1.3 million in 2019. Monzo’s total weekly revenue is now 30% higher than pre-pandemic, helped no doubt by over 100,000 paid subscribers across Monzo Plus and Premium in the last five months (sources tell me the company surpassed £2 million in weekly revenue in December for the first time in its history). Albeit at a lower valuation, the challenger bank also raised £125 million from new and existing investors during the pandemic.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
While bitcoin offers the possibility of removing third parties and making transactions peer-to-peer, the reality is that most cryptocurrency today is bought and stored using third party exchanges. These platforms typically act as combined brokers and custodians—executing orders on behalf of customers, and storing their funds in commingled omnibus custodial accounts.
Over the last decade, the liquidity flowing into cryptocurrency has been captured by various different exchange-custodians, creating a landscape of fragmented liquidity that is difficult for traders to navigate. At the same time, the growth-focused mindset of early exchanges has led to poor standards of security and regulatory compliance, creating billions of dollars worth of losses from hacks and security breaches. This insecurity has deterred large investors and institutional players from entering the market, further exacerbating the liquidity problem. Even cautious smaller investors are often unwilling to be exposed to such high levels of counterparty risk, especially with an asset class that has irreversible transactions, where theft of private keys leads to permanent loss.
To improve this insecure and illiquid trading environment, the cryptocurrency ecosystem is beginning to mirror the institutions of traditional finance, with independent brokers, exchanges, and qualified custodians working together to provide secure custody and trading.
Under the Investment Advisers Act of 1940, this custodial setup is a legal necessity for institutions with $150 million or more in assets. But it can also be beneficial to individual investors that want to mitigate counterparty risk. And in the bigger picture, this traditional division between custodians and brokers can help solve the broader liquidity, security, and user-experience issues that are preventing the market from scaling.
"Protection of customer funds is paramount. Without trust, high quality service and real-time access to funds the crypto sector will fail to expand past the current market cap and attract further adoption." —coinpass
By focusing solely on safeguarding private keys, specialised custodians can offer all the same assurances as traditional finance. Investors can avoid the complexity of setting up their own crypto wallets, and renegotiate the tradeoff between security and accessibility that typically accompanies the decision between storing crypto assets in hot or cold wallets, or on an exchange.
Crypto assets held with a trusted custodian can be both secure and accessible, with private keys stored in segregated accounts that are backed by insurance coverage, bank-grade security, full regulatory compliance, and governance controls over managed assets. These protections shield investors from the risks and complexity of the crypto market, creating the ideal starting point to make the most of the latest crypto asset innovations.
Safeguarding cryptoassets - the evolving ecosystem
Instead of needing to visit different venues to access the financial services of trading, investment, and lending, each with their own specific onboarding requirements, investors using the services of a cryptocurrency custodian can easily access these different services from a single secure wallet.
Through decentralised finance (DeFi), brokers and exchanges can now access liquidity on decentralised platforms to better service their clients offering them more opportunities than ever to participate in the ecosystem and 'sweat assets' to maximise returns. This might be through lending, staking, borrowing, securing the network, or conducting complex trades with new financial instruments. Equally, brokers become best placed to introduce their clients to custodians featured in their network as part of their risk management strategy.
By offering investors the opportunity to tap into this ecosystem and generate an income without increasing security risks, crypto custodians move beyond basic safekeeping to become a one-stop shop for cryptocurrency services—a financial browser so to speak that partners with defi protocols and exchanges to offer secure, direct access to the same diverse range of liquidity, lending and leverage services as prime brokers offer hedge funds in the world of traditional finance.
Diversification with DeFi and staking
The rapid evolution of the cryptocurrency market has created more opportunities than ever for portfolio diversification, with smart contracts not just replicating the functions of traditional finance on the blockchain, but supercharging them—giving investors unique opportunities to take advantage of crypto assets.
The rise of Proof-of-Stake, which is expected to come to Ethereum later this year, is now giving investors the opportunity to be rewarded by setting aside assets to be "staked" or "delegated" in order to help secure the network.
From an investment perspective, income generated from staking is akin to earning interest on fiat in a bank account. But with staking, returns are typically far more lucrative. Ethereum 2.0 is expected to offer staking rewards up to 15%, and smaller chains like Cosmos are already offering 8%. This opportunity to earn a yield by staking has led to comparisons between Proof-of-Stake cryptocurrencies, and traditional assets like treasury bonds, which typically occupy a valuable position in an investment portfolio by offsetting risk.
Individuals choosing to stake independently, however, take on the risk of incurring network penalties known as slashing.
The economic model of Proof-of-Stake relies on a carrot and stick system, where honest validators that follow the rules of the network are rewarded, and misbehaving or lazy validators are penalised with a loss of tokens.
While some bad actors might break the rules deliberately, slashing penalties are equally likely to be incurred due to technical errors stemming from a non-professional supported staking set up.
With an independent custodian and exchange partnering to offer dedicated staking services and custody, investors can remove the risk of slashing by outsourcing the responsibility for following the staking procedure correctly. Instead, stakers can focus on getting the best rates by choosing between different staking service providers offered through the exchange-custodian partnership.
Aside from staking, custodians can also offer crypto investors secure access to the open-source system of smart contracts known as DeFi. This new form of financial plumbing gives traders access to shared liquidity pools, borrowing and lending protocols, innovative derivatives, and decentralised peer-to-peer token exchanges—providing more potential than ever to maximise returns, minimise risk, and implement sophisticated trading and investment strategies.
Regulated exchange + Insured crypto custodian
As visionaries like Ethereum founder Vitalik Buterin have suggested, the ideal form of crypto custody infrastructure would let users securely tap into decentralised protocols and exchanges from a centralised fiat gateway. Hence, what the browser is to the Internet and what the bank is to traditional finance is what the custodial wallet then becomes to the blockchain, and to the future of finance - an unbundled set of services accessed via an aggregator platform such as a wallet where users secure their keys in their wallets, and then use them to manage their assets.
With such a setup, an investor might sign into their custodial wallet to get full access to centralised or decentralised exchanges and protocols providing services spanning trading, lending, borrowing, staking, and liquidity—just like a prime broker might offer hedge funds bundled services in the world of traditional finance.
This secure access to financial innovation can be made possible through partnerships.
Independent custodians would remain responsible for safeguarding crypto assets with the same institutional-grade security mechanisms as traditional financial institutions, including segregated accounts and insurance coverage. These custodians could evolve to become ‘smart custody platforms’ or programmable custodians where endorsement APIs could effectively let end users move faster on opportunities in the market by enabling them to self-create controls or rules without needing to wait on the custodian to approve their business logic. They would also provide the technical infrastructure and support needed to integrate with staking services, DeFi protocols, and regulated fiat-to-crypto trading, through open APIs.
Exchanges meanwhile, can forge their own relationships with regulated banking partners to offer the seamless transfer of fiat into the system, and move beyond simple trading services by offering direct access to DeFi and staking—underpinned by the infrastructure of the custodian.
In light of these potential benefits, crypto custodian Trustology is exploring a partnership with soon-to-be regulated cryptocurrency exchange and client, coinpass.com.Trustology's custodial infrastructure secures crypto assets with biometrics, multi-sig, top-tier encryption, walled gardens, and allow or whitelists as commonly referred to. Funds are covered by a range of insurance plans, and customer support is available around the clock. With advanced integrations, crypto asset holders are able to directly tap into the latest income opportunities—including staking on Ethereum 2.0—in a safe, secure, and regulatory compliant manner, and securely access the DeFi economy from a web browser or mobile app via MetaMask integration or API integration. Trustology continues to focus on building out solutions within its infrastructure that best deliver on best execution for clients and meet with institutional regulatory requirements around segregation of duties. Their goal is to lead with a flexible custodial platform that can easily integrate with the right services, protocols and partners to deliver on what's best and needed for its clients to reduce custody risk and overall transaction costs. They are currently exploring best practice in facilitating settlement and clearing, enhancing the treasury management workflow and incorporating more payment on ramp platforms such as coinpass.
Meanwhile, coinpass is forming the ideal entrance point into the world of DeFi—letting users swap pounds or euros for crypto with regulated banking partners, and then dive straight into the innovation of decentralised protocols. Their vision - a digital finance platform integrating banking, crypto and defi services for retail and institutional clients across multiple user interfaces. Having recently launched their mobile app trading platform, they are now turning their focus on banking DeFi services.
Together, this combined exchange-custodian partnership could bridge the gap between the institutions of traditional finance, and the burgeoning cryptocurrency ecosystem—preserving the security and compliance benefits of the traditional broker and exchange duo, while also delivering access to the new opportunities provided by digital assets.
This article appears as a featured article in NCFA's digital magazine, Fintech Confidential (Issue 3 Dec 2020). Click to read the latest thought leadership, insights and trends about Fintech in Canada:
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The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. 
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. 
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Monzo founder Tom Blomfield is departing the U.K. challenger bank entirely at the end of the month, staff were informed earlier today.
