‘How blockchain can replatform the financial system’: Paxos’ Charles Cascarilla
- With the versatility of blockchain and the security of physical asset backing, stablecoins are on the rise as an important digital asset.
- Trust is key to the long term success of stablecoins; infrastructure must be built on regulation and oversight.
The following was produced by Tearsheet Studios. We worked with crypto brokerage Paxos to create a podcast series about the mainstreaming of crypto, the genesis of Paxos, the rise of stablecoins, and crypto’s energy and environmental impact.
The mainstreaming of crypto means the mainstreaming of blockchain technology as well. Through blockchain, it is now possible to hold all assets -- within and outside the cryptocurrency market -- safely and decentralized. Stablecoins are an attractive digital asset, because they promise to pave the way for a new and improved movement of money.
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The following excerpts were edited for clarity.
Charles Cascarilla, Paxos: There's a shift that's happening around: how can you hold assets in token form or on the blockchain that aren't just crypto assets? Bitcoin and Ethereum are crypto assets; a stablecoin asset is something that represents a specific thing that isn't natively on the blockchain. So for instance a dollar, or a euro. It could be any type of shift of an asset onto a blockchain. But when most people talk about stablecoins, they’re talking about taking a fiat currency and putting it into a blockchain form to move around. An example would be taking a dollar and creating a tokenized version of that dollar.
It's relevant, because you're taking dollars, and you're enabling them to move 24 hours a day, seven days a week, instantaneously. Anyone can have access, as long as they're on that blockchain. And that's allowing there to be many more levels of innovation, and it's freeing up capital and costs that are tied to moving all these different types of money around. That's a huge shift. That's why it's relevant. The way the world works today, every single dollar sits in a bank somewhere, and all those dollars sit at the New York Fed in Manhattan; you can't have a digital dollar and not have it be in an account.
An advantage to a stablecoin is you now have a dollar that can move around just like a physical dollar does, person to person, without an intermediary account. That's very relevant. And it's happening because the crypto ecosystem, which is about $1.4 trillion to $1.5 trillion in value, needs money, cash, US dollars in this case, to move at the speed of crypto, which is 24 hours, seven days a week, happening globally in instantaneous movements. So it’s very cumbersome if you were waiting for a bank wire to go international for three days, and it has lots of costs -- or you could move it instantaneously on a blockchain. I think that's why stablecoins came into existence, and have now grown to be about $100 billion.
Stablecoins are shifting things in ways that aren’t possible with the key cryptocurrencies. Stablecoins are on the rise because while they offer the same versatility as cryptocurrencies, their tethering to physical assets makes them far less volatile.
Charles Cascarilla: There may be $60 trillion of money in the world, so not a huge amount has been turned over into a tokenized form, but it's growing very, very quickly. In the case of Paxos, we have about $12 billion that we have tokenized. We started this year at about a little over $2 billion, we started last year at $250 million. So it can give you some sense of the unbelievably rapid growth that's happening because of the need in the crypto ecosystem. And so the stablecoin shift is an important one, because that starts to change how the whole financial system works, because the financial system is tied to the money movement of dollars -- that's essentially the blood in the circulatory system of how our financial system works. And getting that shift to happen is really just still beginning.
And now what happens over time is that you go from just being about crypto trading, which is where it's primarily used today, to starting to be about goods and services; you can now start to pay for goods and services in a tokenized dollar. Through tokenized dollars, you can start to have real big wholesale movements of money, like how the banks move money, through tokenized dollars. And that's going to save huge amounts of costs for all of those institutions. That's the promise of what a stablecoin can do.
With the rise of stablecoins, the blockchain environment is no longer only about holding or trading crypto. As instant-transfer tokenized dollars, stablecoins pave the way for mainstreaming crypto with everyday use cases for wallets, from monthly subscriptions to the morning coffee.
Charles Cascarilla: Historically, it's just been buy crypto, sell crypto, be able to hold some money. That was an important first step. But what you need to now go from is that early adopter community, just like you went from an early adopter community to mainstream who is now capable of buying crypto and who's participating, you need to do that for tokenized dollars as well. So you want to go from the early adopter community to mainstream, and that shift will be about enabling real world payments. For instance, you could go into Starbucks and use a stablecoin, or checkout and use a stablecoin. Any of those ways of being able to trade for goods and services, not just trade for crypto with your tokenized dollars, will be an important shift. We're seeing it now: Visa is doing certain things, there'll be other payment companies that are doing things, and I think pretty significant ones. You've seen the news that Diem (which was formerly Libra, which was started by Facebook), was about trying to be able to create a concept of money being able to move anywhere. And then you'll get it, I think, into the larger banking and corporate banking system. And what becomes very important in that shift from crypto to mainstream is the trustworthiness of how you've tokenized the dollars.
As stablecoins step into the arena of real world payments, stablecoin providers have to think of themselves much like traditional financial institutions. They must be able to ensure the same level of stability and reliability needed for customers to place their trust in them.
Charles Cascarilla: This is very important and this is where Paxos is different: we have the only tokenized dollars that have been created where they are overseen by a primary regulator, which is the New York Department of Financial Services; they are issued from our Trust Company, which is a banking institution; all the assets are held fully bankruptcy remote, fully segregated; they're all held in a transparent reserve system of just T-bills; FDIC insured bank accounts; and overnight repo that's over collateralized with treasuries -- extremely safe, you can liquidate it immediately. And so you need to have that level of confidence that if something happened to Paxos, the money is there. If something happens to the market, there's no interest rate risk, there's no credit risk in the assets that we’re holding; your money will be there no matter what. Those are really important differentiations.
And you don't have to take our word for it, we have a primary regulator who oversees us. And so that's fundamentally different from anything else that's out there: we're fully backed, we're fully audited, and we have full levels of oversight. That is much different. Being fully regulated is a big differentiator, in our opinion, to go to the mainstream adoption curve. Because the level of oversight and scrutiny that you get from regulators, as you begin to become part of the financial system in a really significant way, has to be about that safety and soundness.
There's so much promise by taking dollars and other assets and putting them onto a blockchain. But there's also the possibility that you lose a level of trust, because you can create opacity. And we've seen that in other stablecoins, where the reserves are held in things that are aside from basically cash and cash equivalents. In fact, I think we're the only stablecoin, including Tether and USDC, that is fully backed by liquid cash and cash equivalents. That's how I think you get to having products that shift into a much larger audience. And that is ultimately what Paxos is trying to achieve: how do you replatform the financial system? How do you do this on a really big basis? How do you make sure you do it right from the very beginning, so that you have an unbelievably trustworthy foundation that can enable the type of the society-changing shift that we're talking about?
The shift from holding and moving physical assets, in the form of fiat currency, is a big step. That’s why the key to stablecoins’ long term success is trust. Regulation and the forethought to ask for permission rather than forgiveness is what sets certain stablecoin providers apart from the rest.
Charles Cascarilla: The trust element is so crucial. It's so crucial because there's a reason the financial system is so regulated. And there are a lot of questions like why are there so many different types of regulators? What are they doing? And what they're fundamentally trying to do is create trust, so that the average person doesn't have to try and understand what is going on inside a bank -- you give them your money, you want to be able to get it out; so you have FDIC insurance; you have regulators that make sure they're making loans that make sense, that they hold the right types of reserves, and that they're not investing in assets that don't make sense. All those things are done, because you fundamentally want to know that you put in a dollar and you can get a dollar out. And that's what a bank is providing for you.
When you have to hold offline money and put it into the blockchain environment, you have an element of trust that's introduced. You're going from traditional holding of assets into a blockchain holding an asset. And that leap involves a trust level that is deserving of oversight and regulation. So the way that we do it at Paxos is, one, we have an independent board of directors which includes Sheila Bair who ran the FDIC during the financial crisis, senator Bill Bradley, Duncan Neiderauer who was the CEO of the New York Stock Exchange, Jim Manzi who created Lotus Notes, and Bob Hertz who was the chairman of FASB; KPMG is our auditor; Grant Thornton does our internal audits; Withum is our auditor that only audits our bank accounts against the number of tokens that we've created. Unbelievable amount of oversight across the board for us.
And of course, we have investors, and we have our regulators who come in and do exams of us. This is really meant to create trust. And I don't think there's anybody else in the crypto and blockchain space who has taken that level of trust to such a degree of oversight. And it's because that will then allow large firms and your average retail user to have confidence that this is something they can use. And that's what it's about. And, of course, eventually, you'll hit a level where everyone is using these products. I think in many industries, the adoption curve was able to happen in a way that could maybe skirt around regulation -- whether that is a taxi authority, or the hotel authorities, or whatever it might be -- there just wasn't the same level of oversight, because you didn't have as much to lose. But in the financial system, you have a lot to lose -- you can lose hundreds of trillions of dollars. How do you make sure that you're setting that up correctly? That is something that we take very seriously and have from the beginning.
Mainstreamed as it is becoming, cryptocurrency still holds a fractional value of the global economy. The lead player has been and remains cash. But fiat-backed stablecoins are helping push the envelope. They’re accelerating the adoption of blockchain and crypto among large, traditional financial institutions.
Charles Cascarilla: Many people have different views on what crypto represents. There’s a lot of different viewpoints on it. But in the case of cash and US dollars, that is the lifeblood of the system today. It's not maybe going to be in the future, or maybe it's an asset -- it is something that is the unit of count, and kind of the lingua franca of the financial system. And that's important to recognize. And so as that becomes tokenized, and it shifts how that moves, it has profound implications. And I think they're all very positive ones, but they're still profound. And that has gotten people to really focus on this as being more than just about crypto but being about how blockchain can replatform the financial system, and having dollars be able to move on a blockchain brings that home most clearly.
And I think you'll see examples of this with how we have a number of our partners who are looking at how to potentially launch their own stablecoin, how to enable accepting stablecoins, how this can change the level of financial inclusion in both the US and globally; it’s so hard for people to get US dollar bank accounts outside the United States, and that's be the number one thing people want. How do they escape from regimes where there are high levels of inflation? They can buy crypto, but maybe they want to hold US dollars. I actually think it's profoundly valuable for the US dollar to be able to find a way to create more financial inclusion, because it's what people want and what they need. And with the shift to the internet and smartphones being available to everyone, you're going to need a currency that can be available to everybody. And I think a stablecoin US dollar is the likely solution to that, barring rapid inflation or barring regulatory prevention of that in which case it might end up being something else like Bitcoin or digital yuan. This is the key thing for firms: how do you respond to the idea that your money can fundamentally have different properties to it than it has had in the past?
Fiat may still hold global hegemony, but the ways in which it flows through the traditional financial system are slow and ineffective. That’s why Paxos chose to launch its own stablecoin as a service offering for other enterprises.
Charles Cascarilla: The enterprise space is really crucial, ultimately, to create a fundamental shift, because the end customer is controlled today by lots of different firms, and it's very fragmented, but they already have a place that they go into and they trust. And so the question is, which problem do you want to try and solve? And I think that it's very valuable to change how the UI works and how you have a common place to have your financial life, which is what many firms are trying to solve.
But what we saw from the very beginning was that the infrastructure was being neglected; that the plumbing of the system was archaic and outdated. And that if you really wanted to make a profound shift in our financial system, you had to focus on the infrastructure layer, which was not well understood. It's still not very well understood, though it's becoming a much larger part of the conversation because of stablecoins, because of things like GameStop, because of crypto. But this infrastructure layer was not well appreciated, as something that could be upgraded, and that it needed to be upgraded in order to be able to enable a different financial system.
And so right now, there's $700 trillion of assets in the world. Most of those are sitting inside institutions that already exist, or are being intermediated by institutions that already exist on behalf of their end customers. The [financial institutions] want to come up with a better way to be able to move those assets. Their end customers want to have a more efficient product; they want to have new types of products; they want to have better products from what they have today.
And there's now this recognition that what's holding it back is not having a better app on your phone, important as that is; it's about how to change the fundamental attributes of those assets by putting them into a new technological platform, ie. blockchain technology. And I think that is what's crucial. That's what we recognized. And that's what we have focused on as an infrastructure layer for enterprise firms, for payment companies, for fintech firms, for broker dealers, for banks, and for frankly, just technology companies that aren't even necessarily fintechs yet, but recognize this convergence that's happening. And that is a really profound change that will happen. And I think because no one else has dedicated themselves to solving that, we're in a very unique position.
To situate itself as a stablecoin as a service provider, it was crucial for Paxos to lead with a key feature -- trust. Structuring itself as a Trust, Paxos offers enterprises the confidence that funds are safe, and every step of the way is regulated.
Charles Cascarilla: We have a New York State Trust, which was the first to be approved by any regulator, globally, to operate in crypto on blockchain -- that is the first trust we have. We have also been conditionally approved by the Office of the Comptroller of the Currency, the OCC, as a National Trust, and we were the first de novo National Trust that was approved to operate crypto and blockchain. In almost all the regulatory approvals we've gotten, we have not only been first, but in most cases, we're still the only one. And that really fits with our brand, which is: how can you create profound changes and shifts, but at the same time make sure that you're asking for permission? Trying to go back and ask for permission can be very damaging, because in a highly regulated space with lots of institutions that have large businesses who we think we can help, they need to have the confidence to use us. And so the trust that we have set up in New York, and the one that we set up nationally, was done deliberately, because they're actually safer than a bank.
Historically, infrastructure in the United States has been set up as Trust companies. Examples are the Depository Trust Company, the DTC, which holds all the stocks and bonds in the US; they hold 75 or so trillion dollars of assets -- really significant. And another example is the CDS clearing house in the US set up as a New York State Trust. Even Bank of New York, which is one of the main infrastructure banks, is a Bank and Trust. This is a really tried and true way of creating an infrastructure provider, because your safety comes from the fact that you are not making loans, you're not accepting deposits -- you're holding assets, bankruptcy remote, fully segregated.
And so that means that we're not holding fractional reserves, everything is fully reserved, fully held. If clients want to go allocate them into a certain type of asset, we facilitate that. But we're never using our clients' funds as our working capital, which is what traditional banks are doing. When you're actually putting a deposit into a bank, you're giving them a loan, and then they go out and make loans. And the difference between the two of them, is what it creates the income that a bank generally earns, plus, you know, some fees; we are really not at all following that model.
By structuring itself as a Trust, Paxos strategically positions itself as a railway for assets. Its infrastructure provides not only the technology needed to move assets, but the regulatory packaging to do it securely on all ends.
Charles Cascarilla: As an infrastructure provider, our business is about how we hold your assets and enable you to move them wherever you want, in whichever type of blockchain you want to move in. And that is the rails that we're putting our clients' assets on. We have a fee for doing that, but that's a fee for providing a technology service and a technology platform that's highly regulated, so that they're confident to use it. That's a lot different from being an intermediary, on a principle basis. We're simply an agent here. And doing that as a Trust Company creates that level of oversight, and that level of segregation that is very powerful. And that's, for instance, why firms want to use us for the crypto infrastructure -- their assets are held in this Trust Company, for their clients. That's why firms want to use us to hold dollars to be tokenized in our stablecoins, because we're doing that in the Trust Company; oversight, regulation, capital, and, of course, great technology. And we're doing this also for our gold-backed token, we have $300 million of gold that we hold, we hold it in the Trust Company. This is again and again, how we approach solving the issue of how to take assets in a really trustworthy way, put them into a different environment to move around so that you can unlock opportunity, innovation, the costs, and the capital sensitivity of the current system.