The Top Five Innovations from the Great Crypto Sandbox
Welcome to the Great Crypto Sandbox
The cryptocurrency market is sketchy, scammy, flawed, unregulated, volatile, empowers bad actors and generally has been an evil carnival for the past two years.
That being said, it is the greatest sandbox for financial market innovation to have ever existed. Never before has there been a single, interoperable playground for teams with new ideas to compete for global capital. Your application can near-instantly be rewarded with hundreds of millions of dollars of asset deposits, or be destroyed and left for dead in a single afternoon.
The Market is Ruthlessly Competitive
The crypto market is ruthlessly competitive, which accelerates innovation. There are almost no barriers to entry (unlike traditional finance, where there are understandably large regulatory hurdles, paired with deeply-entrenched hundred-year-old incumbents). In crypto, new competitors can literally just copy your code and “go”. If another competitor appears to be marginally better, there are no frictions in the system that keeps users from transferring funds out of projects instantly. As a result, applications are forced to invest heavily in marketing and building loyal global communities, because users are not captive and moats are weak and small.
The cost of this sandbox is high. The Silicon Valley ethos of “move fast and break things,” when applied directly to money and investments, has resulted in billions and billions of dollars of assets lost, stolen, or held by bankrupt companies. Crypto users can be separated from their funds dozens of different ways — through bad custody practices, accidental transfer errors, smart contract hacks, or one of the many well-honed malicious tactics mastered by country-level hackers. Play carefully here, the sandbox is dangerous.
The Technology and Innovations are the Value
The common argument “crypto assets have no value, it’s fake internet money” misses the forest for the trees. The technology and innovations are the value. And these ideas will make their way into the existing capital and payment market regimes, because many of them (though not all of them) are better.
The grey-haired wall street veteran (no offense intended, I have some grey hairs) has an instinctive distaste for the cryptocurrency market. But, everyone that has worked with operations, and middle or back office teams, will admit there is a problem with existing payment and capital market infrastructures.
The current system evolved piecemeal from one built to store gold and paper certificates. Before crypto, digital innovations were built off that archaic foundation. The build-up of structural friction across the system as a result is offensive. Crypto offers a clean, digital-first, break.
The biggest winners of the next five-to-ten years of financial market innovation will be those that find out how to bring the innovations into traditional financial products, investment communities, and markets. And that will be hard. As in actually hard (not launch some token and flip it to retail in six months hard).
Integrations, navigating through regulations (and lobbying regulators to change regulations where needed), developing user protections, competing with entrenched market infrastructures, and breaking into the Club of Wall Street are all tough things. They would be hard to break into even in a supportive fundraising environment. But it is worth it to try — capital and payment markets are absolutely massive and the system needs a refresh.
The Top Five
Below is a top five list of innovations in payments and capital markets from the cryptocurrency market. Like all innovations there are good and bad aspects to each. For brevity’s sake I’ll give a cursory overview of each with links to resources that explain them in greater depth.
Crypto, for better or for worse, gives users the option to completely unlock money or assets from third party banks or custodians. Anyone can custody (through private keys) an infinite amount of money or assets themselves with a single little USB device (or software wallet). Users have the option to send funds or assets where ever they would like. They miss out on core protections (general money or asset safeguards, central clearing, SIPC/FDIC insurance) but gain autonomy, user power and choice.
Stablecoins like Circle’s USDC, Tether’s USDT, and now Pay Pay’s PYUSD (among other fiat-backed versions) hold reserves held in traditional bank accounts, money markets, short-term treasuries, etc. But unlike holding money in a bank account, you can use any application or interface you’d like. You can send payments to anyone, anywhere within seconds, 24/7/365 globally. In the process you can bypass many of the frictions, delays, and predatory fees that occur across different types of payments both internationally and domestically.
Perpetual futures (futures that never expire) first launched on BitMex in 2016 as a hedging tool for bitcoin miners. Ever since then they have dominated crypto futures, with a 98%-2% market share lead over traditional expiring futures. Unlike traditional futures where the future converges to spot or index price upon maturity, perpetual futures maintain alignment with underlying spot or index prices through a funding rate mechanism, with micropayments between the long and short sides.
When using decentralized exchanges, you do not trade through a company, but through code on a running blockchain which matches buyers and sellers. If the company developing the decentralized exchange went bankrupt, the exchange would still work. The code lives on a blockchain and the blockchain itself cannot go bankrupt, meaning the decentralized exchange is forever. On the market making side, any market participant can easily deposit funds into pools to provide liquidity for these exchanges and capture trading fees.
With decentralized lending applications you are also interacting purely with code. There is an automatic, coded margining system. After depositing assets into a smart contract, users can borrow against those assets. The major decentralized lending applications operated without issue through the 2022-2023 market while crypto lending companies were entirely wiped out (BlockFi, Genesis, Celsius, Voyager Digital). Rates to lend or borrow are both better in crypto than with traditional stock brokers. Taking 50% of a user’s asset lending profits, as seen in stock lending programs through E*Trade or Interactive Brokers, would be uncompetitive in crypto. Same with charging a hefty 13% to borrow on margin.
Conclusion
These and many other crypto innovations have promise. But, there is significant work left to do. Crypto is currently stuck in “PvP” zero-sum world where high-net-worths and small-to-medium sized crypto funds trade in circles.
Fintech innovators should build products that attract real size and volume from traditional finance behemoths. In order to do that, start-ups will have to better acquaint themselves with the complex, regulated markets of traditional finance. BlackRock’s requirements are different from Johnny Crypto’s.
Traditional finance firms are risk-averse, follow laws, and need to know that there are no edge cases where their assets disappear. Building products that work for them may mean making compromises with design decisions, meeting regulators halfway, and prioritizing integration into the existing financial system where required.
Even with that approach, it will still be extremely difficult for fintech start-ups to gather critical mass in the face of powerful incumbents. But for those that do, what will be the reward? A better, more competitive financial system, freer from the curses of costly frictions, captive users, and archaic infrastructures.