proof of reserves chainlinkTokenized Finance Is Inevitable Sergey Nazarov at Barclays Crypto & Blockchain Summit

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proof of reserves chainlink Exploring Special Purpose National Bank... Tokenized Finance Is Inevitable Sergey Nazarov at Barclays Crypto & Blockchain Summit
thank you welcome to the third annual Barclays crypto and blockchain Summit we have a great roster of speakers lined up over the next couple of days who will shed some light on where the industry stands following a admittedly tough 12 months for the sector so much has changed since our conference last year with quite a bit of speculative excess having left crypto I think at this point but what I see is an industry where despite the turmoil innovation has not really slowed down if anything of focus on utility infrastructure viable use cases has kind of emerged and and bubbled up were still Believers in the underlying you know blockchain technology continue to see it as transformative over a long period of time so our hope over the next couple of days is to focus on the pragmatic side of the industry on projects that have the highest probability over time to play an important role and and fulfilling the potential of the technology when it comes to actually changing the way we do things and there is no more fitting speaker with which to open our conference this morning than Sergey nazarov co-founder of chain link which is the most widely adopted web 3 Services platform facilitating trillions of dollars in transaction volume across key blockchain sectors such as defy Insurance gaming nfts and other major verticals its been a volatile time in the financial markets over the past few weeks Im excited to explore how blockchain technology may have a role in improving the systems and architecture underpinning our financial markets Sergey thank you so much for being here really appreciate it its uh its my pleasure thank you for having me great lets Jump Right In Here um first question for you Sergey in the wake of all the turmoil and financial markets the recent bank failures what are you seeing in terms of financial institutions exploring blockchain-based Solutions uh you know to regain user trust how do you see Capital markets benefiting from blockchains and smart contracts so I think theres theres three ways that Capital markets folks traditionally view smart contracts and blockchains One Way um the way that usually moves the slowest is the efficiency mode where they kind of say what efficiencies does this create you often hear questions about creating a golden record and the value you have a golden record and Reconciliation across counterparties becoming faster more efficient that type of thing this is this is the slowest mode of of blockchain adoption which which doesnt have a ton of um urgency to it because its its basically a cost and efficiency gain then you see um the second mode which it takes the form of custody uh most recently where basically their clients come to them and their clients say I would like to make money by custody in cryptocurrency I want to own cryptocurrency Im your client please help me do this and so this whole custody question comes uh comes into being and Banks and and various uh traditional financial markets custodians start implementing crypto custody Solutions and then the next stage of that is once that custody is enabled for their banking clients and their custody clients the next question will be what can I do with the assets that I custody with you can I get a rate of return on them can I put them into this D5 pool that D5 pool basically how do I get a return after after Ive gotten custody and the whole custody thing um I think is for different reasons for different institutional clients some of it is speculative in the short term some of it is a long-term uh focus on maybe Bitcoin or other other coins some of it is um just within the scope of basic diversification thats becoming a more common idea and this is one of the ideas that I think will gradually over time take a percentage of institutional capital and move it into the blockchain industry just as diversification thesis in that you should just you should be in multiple areas to some degree um so those are the two more traditional ones that the one that were seeing now with recent bank failures gives rise to a third one which I call the fast case for blockchain adoption so the previous two are the slow case and uh the one thats happening more now is the fast case and thats the one where theres a fundamental uh crisis of faith in a brand so theres uh theres banks that have existed for many years like Credit Suisse for example I think was uh started in the late 1800s something like 1870 1876 and that institution while it wasnt the most reliable jurisdiction for banking historically doesnt uh doesnt exist anymore which which is you know unfortunate but in addition to being unfortunate it starts to create this um psychological um crisis of faith for both retail and institutional clients and and so this is the thing that um blockchain technology fundamentally solves is it its a technology that can resolve this crisis of Faith by guaranteeing counterparty relationships and when I say guaranteeing I dont mean guaranteeing in the sense that theres a brand and the brand hasnt existed for over a hundred years and you can trust me Im regulated or Im really old as a brand or I have tens of billions of dollars as a brand like if if brands that have tens of billions of dollars are regulated and 100 plus years old dont continue to exist then being a brand of that kind doesnt have the same value anymore um similarly the the analogy I think about thats kind of most relatable to the most people is uh text messages so 10 15 years ago everyone would send text messages to each other unencrypted over SMS right over Telecom networks or they would use applications that run encrypted in social networks or whatever and then a crisis of Faith appeared where um people no longer trusted telecommunications companies because they were getting hacked and they no longer trusted social media platforms to hold their unencrypted messages and this is why at the top of why they used billion plus user applications like WhatsApp you have at the top of each message session the term end-to-end encrypted because what happened was you had these um Brands these entities which promised a certain user relationship and because they didnt deliver on that user relationship what what happened next was there was a crisis of faith and then Faith was restored through technology specifically encryption technology specifically end-to-end message encryption for text messages and I I think that the first two examples that I talked about is the way that banking has traditionally looked at blockchains its what is the efficiency gain and how do I make money from people that want to deal with this cryptocurrency Market once again thats the slow case the fast case is if theres a crisis of faith and then the question is how do you restore faith and my view my very strong view is that you would restore Faith through encryption Technologies which is what blockchains and oracles and smart contracts are theyre basically encryption technologies that apply ex very directly to the types of transactions and to the types of relationships that banks have with their clients and that clients have with each other through these institutions and I think its actually a net benefit to those institutions because itll make them better itll make the whole Global Financial system better itll make smaller local Emerging Market Financial systems better its actually a Big Boon to globalization uh because you dont need to suddenly you dont need to trust peoples local legal systems to transact or do foreign direct investment because the local legal system doesnt matter anymore the only thing that matters is that you have cryptographically guaranteed relationships which is once again what all this does so I think what Im starting to see with with the this this small spike in traditional Financial system issues is a very small window into into what the fast case begins to look like and my view is that the fast case due to various um monetary policy decisions and other other very um disconnected from reality decisions that the fast case will unfortunately um inevitably happen its its just a matter of when will it happen and uh most commonly this is expressed in uh in both some some kind of timeline and the concept of soft Landing versus hard Landing um so basically in that in in that terminology I think theres going to be a very very hard Landing but I dont know when uh because theres just so many variables in that equation um that is a great uh segue to my next question which was about tokenization uh its been gaining rapid interest across financial institutions dealing with traditional assets as bonds and commodities you know level set for us a little bit what is tokenization in this context and how can institutions you know securely bring those tokenized assets onto blockchains sure so so tokenization um obviously began with Bitcoin the first cryptocurrency which was the only thing that existed 10 plus years ago that I got into this industry and so tokenization um for me has always been cryptographically guaranteed ownership so so the reason that tokenization um is attractive for me is that you have user controlled ownership you have private key controlled ownership its not ownership that depends on a counterparty deciding whether to give you your assets its ownership that has to do with your ability individually to control your assets irrespective of anyone elses decisions and bank failures which are the common um counterparties for people to hold assets into well put assets into and hold them there um people losing faith in those in those containers makes direct control of assets more attractive now I dont think thats why its attractive to the capital markets industry but I I think thats the fundamental idea that that gave rise to bitcoin and then on top of that you had um censorship resistant currency and then you had uh store of value right so you had user control censorship resistance and store of value and the store of value thing is is what the capital markets focus on much more while while not focusing as much on the user control and the censorship resistance um so I I think that tokenization for the capital markets has begun with um various client interests and cryptocurrencies because thats the first thing that tokenization did was it created these kind of um artificial tokens these things that didnt exist before and basically banking clients came and said I would like to gain access to tokenization or or in banking terminology digital assets right I would like some digital assets please I would like some Bitcoin I would like some other digital asset and so that began this question of custody that banks are now tokenizing bonds uh Commodities um sometimes student equities and various other things I I think what that speaks to is two things firstly it speaks to um a general increase in demand for digital assets as a class as an asset class now its not completely clear to me what digital assets as an asset class means when you take traditional assets and you put it in there because I have to look at how that digital asset is built and whether it actually gives you any user control or whether it actually gives you any additional benefits about your ability to access it quicker and therefore reduce your counterparty risk maybe transfer it quicker move it around quicker get more information about the asset because its a digital asset for example digital assets can have various key pieces of information added to them so that the asset consistently becomes updated about whats going on with it um so I I think that the thing thats happening is a digital assets are becoming more of an asset class B um I think theres efficiencies to be gained from from tokenizing existing traditional things in in the financial system and see I think theres actually a dimension of cryptographic Truth guarantees um which is that third case right so if if if I have digital assets that I can transfer to you very quickly and that you can control and that you know are Beyond certain dimensions of risk then then maybe a digital asset formatted piece of value is more attractive to you as a counterparty than a traditional piece of value right no I I dont think that most banks are are thinking about it this way but I I think there is this um Third Dimension and this third dimension sounds crazy right and Ive been saying this this third dimension of of this uh of this industry for about maybe four or five years speaking about it pretty regularly and it sounds pretty crazy right because everyones like hey why do we need this risk management we we have all this wonderful trust in the system and now the trust isnt there as much I think its going to come back um and then theres probably going to be a bigger loss of trust because theres probably even more um stuff in the system that needs to shake out but but the point is that that third dimension of counterparty risk management through digital assets doesnt really um seem valuable until counterparty risk becomes more real as as it recently has so now when Im saying this now versus another previous talks that weve had now this seems to make sense and I think thats going to be the consistent Dynamic and I think the banks and institutions that create but digital asset capability and an ability to make and move digital assets across multiple chains and service client demand across multiple geographies in multiple formats four digital assets that their clients want will be well prepared for both market demand increase in digital assets as well as this kind of risk management scenario where if digital assets become viewed as a less risky form of asset container or a less risky form of asset ownership then the the institutions um and and the banks and all the folks that have the capacity to provide that might become very very attractive overnight similarly to how the internet made them very very attractive very quickly for doing various types of transactions um and and so that you know that thats what I think uh tokenization started as and thats where I think its going and now moving sort of from the traditional Finance Universe over to the more crypto focused uh sort of of Industry I wanted to ask a question about proof of Reserve so following the collapse of FTX proof reserves gained a lot of attention can you talk about you know what that is as a concept how it increases transparency and security for the end user sure so FTX uh for me was was actually a traditional financial institution that just didnt exist for for very long and apparently wasnt wasnt well run enough to continue to exist but it it wasnt something that was um really powered by cryptographic truth or blockchain technology it was it was a traditional financial institution that held and dealt in crypto assets exclusively and predominantly and so FDX has collapsed while it might seem like an indictment of the technology of blockchains and cryptographic systems it is not an indictment in that at all and and what proof of reserves is is proof of reserves is a very specific implementation of cryptographic Truth and cryptographic systems that would have completely solved FTX but it would have also solved multiple Bank collapses and other collapses basically by creating transparency so what proof of reserves does is it basically takes the balance sheet of of an institution or entity and it represents that balance sheet on chain and then representing that balance sheet on chain it proves that theres a certain level of assets and a certain configuration or mix of assets of certain types and so the reason the whole FTX happened was uh the FTX issue happened was because there was a bank run on FTX when people found out that a large percentage of fftxs balance sheet which was backing their deposits was not in U.S dollar stable coins or Bitcoins but it was in ftxs own token and so when people found that out they decided to rapidly rapidly withdraw which accelerated the bank run and just created more problems what proof of reserves would have done if it was implemented from the very beginning of ftxs Life is it would have cryptographically proven it would have pulled data from from ftxs back end and it would have proven to everybody that FTX is collateralized with dollars US dollar staple coins or Bitcoins or some combination and then if FTX decided to start changing that mix on the balance sheet and decided to start making 10 percent um of that ftt tokens instead of instead of the the other assets well everyone would have found out about that in seconds not in days or weeks and months or years but seconds and then there would have been a discussion with their user base and their user base would have said I dont want to use you if you if you make your deposits back by your own token and then FTX would have been faced with a choice and it would have it would either said okay users if you dont like this Im not going to do that Im going to make sure Im backed by Ether Bitcoin and dollars and so you dont need to worry and the users would have stayed or FTX would have made the decision I dont really care what you think you can leave user Im going to back myself with my own token and the users that want to stay can stay but in both of those cases because of the transparency of proof of Reserves you would have never had a bank run because there would have been no surprising news to to create a bank run of any kind and and so what proof of reserves really does is it uses cryptographic systems encryption to prove things that allow counterparties to do risk management in the case of proof of reserves its really risk management about the balance sheet that an institution is using proof of reserves is is is a very exciting thing something we launched into production over two years ago it was getting some adoption before FTX but after FTX uh adoption went absolutely vertical and theres other forms of proof of that were working on um proof of liability proof of solvency proof of all kinds of other aspects of financial um counterparties that also allow greater degrees of risk management and I think that these proof of uh things will basically eventually differentiate counterparties such that you would go with the counterparty where you knew they were solvent second by second by second instead of a counterparty that you had to wait for an annual audit by a person that could be gained or could be mismanaged like with Enron or someone else right and and so I think this is the the the the contribution that ftxs unfortunate failure has had to our industry is that proof of Reserve has now become the new minimum for how um Financial products and systems prove themselves and uh its its getting applied through chain link to many many different systems um including stable coins so many many stable coins and gold coins and real world asset coins are using proof of Reserves to on a block by block second by second basis prove that the assets that are backing the gold coin or the real world asset coin or the stable coin are are actually where theyre supposed to be so that you dont have to rely on on a one month audit or a one-year audit you know second by second that the assets backing the the token that you have exists and are of a certain value and are in a certain condition in in a place thats liquid and I and I think thatll also be an attractive features of those tokens um I mean there seems to be so much potential utility and benefit to a lot of the technology that youre youre talking about how do Capital markets secure you know securely connect to web3 in order to really you know leverage uh you know programmable Finance leverage technology get the most out of it so I I think as those three um categories of adoption accelerate whether its cost and efficiency servicing clients that want crypto Market access or restoring trust with uh existing users in the markets in general whichever three of those or maybe all three of those um youll youll actually as a as a multinational Bank be faced with the very simple problem of having to integrate with multiple chains so beyond even even creating a digital assets unit or creating digital asset products one of your most fundamental base problems will be the fragmentation in our industry and that multiple counterparties want to conduct transactions with you in multiple distinct environments so there is no one environment like the internet um there are multiple distinct private chains public chains semi-private chains that have uh permissioning and identity and all those things and so as a multinational Bank you will be looking at integrating and managing and interfacing with multiple chains once this really picks up every quarter every quarter youll have to integrate multiple chains and so the First Choice uh that that Banks and financial institutions have is how do I um even conduct transactions how do I efficiently conduct transactions in this multitude of different environments because the environments will vary based on geography and based of transaction type so you might have a derivatives chain in China thats completely different from a derivatives chain in Europe thats completely different from a derivatives chain in the U.S in terms of the technology that it uses and so thats actually the problem uh the chain link solves its called chain link for a reason um and the reason is that it can connect a bank system into all of those chains through one integration and then it can maintain those connections and it can secure those connections and as more chains appear for um Banks to transact in more places um you just have a greater and greater need for this basically so so the first uh the first challenge is how do I integrate with chains at all the the second challenge for banks will be privacy and this is the promise that certain private chains have made private Enterprise chains have made but traditionally historically so far have not delivered on and so the way that problem is solved with chain link is through zero knowledge proofs where you can prove something to a counterparty without revealing the data to them and so in addition to connectivity um the next stage will be privacy preservation confidentiality um and and thats something that uh chain link does through zero knowledge proofs and then and then the third problem once once you integrate with the chains where you want to do basic transactions and once youve met your privacy requirements in order to do those transactions the the next stage will be well wow theres all these Banks and all these competitors making decentralized Financial products or programmable Finance products um and theyre doing well my my banking competitors are doing well theyre making these programmable finance things theyre tokenizing these traditional assets and theres demand so the next challenge will be how do I as a bank build those things how do I make my own tokenized assets how do I make my own programmable Financial products how do I um accelerate my ability to compete in that market and in in that sense you would need to um choose an environment into which your assets would be issued which youd also want all the other Banks to be able to easily to connect to which chain link can also help with and then youd need a bunch of tools such as uh validated Market data automation functions and a whole bunch of other things to build those because if you actually look at defy D5 is a combination of Unchained State and Oracle networks on chain state is what blockchains make chain link uh makes Oracle networks and so thats the third uh third hurdle but you only really reach that hurdle as a bank when when youve decided you you want to really compete and make a programmable Financial products you dont want to just be a transactional counterparty because you want to participate in them so the first two are about participating and the final one is about creating the the programmable Finance uh products yourself um and what will the next stage of adoption be for smart contracts in the global economy you know where are we whats coming next and how does chain link kind of fit into the vision a lot of that is is actually quite hard to predict because it depends on certain macrodynamics that um are hard to predict basically so I I would say a I would say that um the crypto markets the public blockchain crypto markets defy in various tokens once they pass 200 billion dollars I was absolutely sure that this was a market that will never will not go away now theyve passed over a trillion dollars which is an extremely large Market even for the banking industry to take part in um Ergo why the clients come to them and say can you custody stuff for me from the public blockchain world because its a big enough market so the the market is already there its going to grow gradually no matter what because the the value of it makes sense and theres a gradual you know compounded annual growth rate for the crypto Market that I think has a has a very high floor I dont know what it is but its probably something like 20 to 50 a year in terms of the amount of people involved maybe not in terms of the total value in the system but in terms of the amount of users the amount of applications the amount of everyone doing things um I I think that the thing that really decides the rate of adoption is uh that crisis of faith that I mentioned and that crisis of Faith exists on a spectrum right um one end of the spectrum is people who are already very paranoid and already really committed and they they hold all their wealth and gold and crypto assets and theyre like the the worlds coming to an end and thats it and so the question there is how much more are they going to buy and how much more are they going to participate in the economy the crypto economy then you have people that are kind of in the middle who dont know if crypto is a scam or not a scam dont understand its value yet but I can definitely tell you that on the retail level retail bank failures um in my mind really really make the case for crypto very very strongly because your Alternatives after youve seen a retail banking failure is basically two things its by physical commodities or its get crypto and realistically in line with the diversification thesis I think its going to be some percentage in each what that percentage is is going to vary for for people in that middle and then there are people on on all the way on the other end of the spectrum that are completely uh convinced that traditional Financial systems can do no wrong and their trust assumptions are completely solid um I think some of the reasonable institutional issues are are going to make those folks wonder and I think what theyre going to get is theyre going to get digital asset formatted value so theyre not going to necessarily want us going to want to speculate on bitcoin or um some some other asset right just like they dont want to become a gold bug and go by by 20 of their portfolio in gold for the same reasoning right if you were to speculative and and just it doesnt doesnt sit with their their thesis um I think though when you come to them and you say heres um uh an asset youre used to but its formatted in this digital asset container that has less counterparty risk I mean these are pretty smart people in my experience and theyre going to say wow okay Ive been having counterparted risk problems Ive been having real concerns about my counterparties talk to me about how your digital asset has less counterparty risk um than my traditional Financial system asset can I move it faster do I have more control over it how how is my counterparty risk reduced and I think when they look at that in more detail theyre going to see something very attractive something very attractive from a risk management point of view which like I said in earlier in the conversation risk management doesnt get a lot of attention when everythings going well and everybodys printing money literally right literally printing money um but but when um you know as people put it in the in the financial industry When the tide goes out thats when risk management really starts to starts to be quite important um and so I think that digital assets have a large role to play here in in all three of those categories the people who are convinced that the that the traditional Financial system you cant meet their needs the people in the middle who um kind of dont know what crypto is and might consider it as a as a certain percentage of their portfolio to hedge risk and even institutional people that are convinced um that the trust assumptions of the financial system will always work I think all three of those groups uh will will get accelerated by their own unique crisis of faith basically um and I think that the global economy due to a number of factors uh both politically driven factors and um you know various other factors that Im not going to really go into here have has been driven into a state where um a hard Landing in my opinion is very very likely and that hard Landing is synonymous with the crisis of faith that I keep discussing in this in this conversation and I think the thing that someone should ask themselves is that that believes in a hard Landing I think they should ask themselves what technologies are going to help you get out of a hard Landing thats basically what Im saying in a very succinct form like if if theres a very hard Landing in the global economy and theres serious crisis of faith for all three of those groups um what technology restores faith in financial systems Financial products Financial relationships and I dont mean that it replaces Banks and institutions theres just like the internet posed companies with a choice do I participate in the internet or ignore the internet the companies that participated in the internet did great so I think a lot of existing systems and Banks and Brands can completely continue and even and even succeed great to create to a greater degree than they are today if theyre able to adapt to this new reality but but the fundamental question really is you know do you believe that there will be some kind of serious heart Landing and if so will there be a crisis of faith which I think is obvious those two things go together and then the question is how will faith in in the system be restored and and my very strong view once again is that um encryption Technologies like blockchains and smart contracts and Oracle Networks those are the things that are going to be used wholesale to restore faith in financial relationships and systems and counterparties in general um Sergey unfortunately were out of time always insightful talking to you thank you so much for for speaking with us today uh and uh looking forward to uh to another one of these uh hopefully next year when when the markets may come and you might see some of these uh Tailwinds that youve been describing kind of kick in thank you so much for being here great thank you for having me At the Barclays Crypto & Blockchain Summit, Chainlink Co-Founder Sergey Nazarov joined Barclays Senior Research Analyst Ramsey El-Assal for a fireside chat. They discussed the benefits of blockchain technology for financial institutions, the importance of Chainlink Proof of Reserve, and the future of financial markets.Watch last years Barclays fireside chat with Sergey Nazarov: Learn more about Chainlink: Website: Docs: Twitter: Chainlink Chainlink,