''Above all, we're working to increase access to financial markets''

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Meet Dolf Diederichsen, Co-Founder & CEO of Hyphe – a man on a mission. “Every day, Hyphe’s liquidity pool is helping European banks and brokers welcome more and more people into the market at the lowest possible cost – that’s what excites us.” Hyphe is the Amsterdam-based digital asset liquidity provider that enables European financial institutions, from retail brokers to asset managers, to offer digital currency trading to their customers.

By Jan Jaap Omvlee

Hyphe states that financial institutions use the liquidity provider to avoid the costly fees, risk, non-compliant protocols, and other barriers associated with digital currency exchanges. By creating its own principal liquidity, Hyphe can quote competitive bid/ask prices to clients on request, and act as the sole counterparty for every off-exchange trade it makes. Direct-to-client liquidity means institutions go live faster and maintain digital currency trading at a lower cost.

How can both consumers and professionals distinguish crypto hype from crypto reality?

“The industry has always had cycles: periods where digital currencies were en vogue and in the news, followed by periods of negative coverage and prices going down. While I understand that it can be challenging to distinguish hype from reality, or to know which currency to invest in, in every cycle, more infrastructure is being built, more products are designed and more companies starting. The dip after the hype is always on a higher level than the previous dip. Having been through a number of these cycles, I know that it is the nature of the industry.”

Are Dutch wealth advisors/bankers allowed to offer and sell crypto currencies to their customers? Are there any exceptions in the current top-10 of digital currencies?

“In order to provide any kind of crypto currency service to customers, financial institutions require a registration from DNB. Without a registration it’s not possible. Hyphe acquired its DNB registration last year. What we saw when we went through that process was that DNB wasn’t taking things lightly. We were actually very happy about the serious discussions we had with DNB. Because as Hyphe, we believe that it is absolutely necessary to have sound regulation in order for digital currencies to become accepted by regulated players. We were pleasantly surprised by the level of knowledge at DNB. They are focused on driving standards for crypto specific regulation, like transaction monitoring.”

“As regards exceptions, we have committed to DNB not to offer any privacy-enhancing cryptocurrencies. Because the blockchain itself is actually quite transparent. You can track very well how funds move. Once you associate identity with recipients you can actually build tight KYC and identity systems around it, allowing for very effective transaction monitoring. There are some digital currencies, however, called privacy coins, which make it deliberately hard to track ownership and movement, but we do not offer these at Hyphe.”

How does the actual buying process of cryptocurrencies for consumers look like?

“Every consumer who wants to trade digital currencies needs to go through a registered party. Then, there are a few options. The key difference is whether the registered party offers an open system or a closed loop system. In an open system, a customer opens an account with a provider, transfers money and buys cryptocurrencies. They can then also withdraw these currencies and store them in their own personal wallet. I quite like this setup. It is true to the nature of cryptocurrencies because it enables customers to be their own bank. On the other hand we see a movement in the industry towards a closed loop approach. Here, similar to an open system, a customer opens an account, transfers money and buys currencies, but the currencies are stored with the provider. The consumer can’t actually withdraw these currencies and take full ownership of the coins and the private keys.“

And what are the implications for the risk profile of a retail investment portfolio?

“Obviously, cryptocurrencies are a risky investment and everyone needs to be fully aware of these risks. Having said that, you do get an asset with a risk profile that’s different from other assets. The risks of cryptocurrencies are uncorrelated with other equity classes, like stocks, bonds or real estate. That makes it interesting as part of a retail portfolio, because it can lead to a lower overall risk for the portfolio, with a kicker for the return.“

“Many financial institutions, pension funds for example, see digital currencies as an asset class. They are looking for yield and uncorrelated risk. Some institutions are open and more willing to take on this new technology, others are more conservative. But the early adopters are in already. “

“On the other hand, some banks that don’t want to venture into digital currencies as an asset class, are looking at tokenisation. They are looking to tokenise the assets they already have, and track ownership on a blockchain. There are very few financial institutions in Europe anymore who are not looking at either of these approaches.’

Digital currencies are said to be the inevitable future. In what way will these optimise the global financial/ monetary ecosystem?

“There have been three key developments in the industry. The first was the emergence of Bitcoin in 2008. The second was the development of other digital currencies and competition in the blockchain space. There is competition between protocols, where different algorithms can do different things, like establish ownership. This led to the ICO (Initial Coin Offerings) boom in 2017-18, and continues to this day with NFTs (non-fungible tokens).”

“The third big development is the move towards central bank digital currencies (CBDC). China is moving towards a digital yuan, and the European Central Bank and the Fed are also looking into digital currencies. This means that state actors, the guardians of money, are looking into this new technology to see how it can improve consumers’ lives. It shows how broad this technology has become, and it also echoes what attracted me to this technology in 2012: there never was a system to settle value digitally. No matter what payment system you look at, it’s all credit based.”

“International bank transfers take a week, and you never know where the money is. Banks just debit and credit accounts. The only way credit card companies or players like Western Union can make it look like you get your money instantly at the other side of the world, is because they have credit everywhere. But if I send an email, it arrives instantly. If I give someone a gold coin, it settles instantly. There is nothing in the financial system that represents this. Until Bitcoin came along. Bitcoin is the first digital native system that allows you to settle value. That excited me, because it is basically an Internet of money.”

What (supranational) actions or (legal) actions are required to bring the use of digital currencies to the next level? Can you walk us through the current regulations, like MiCA (European Commission’s Regulation of Markets in Crypto-assets)?

“I’m very happy that there now is European regulation and with it, a clear framework on how to operate as a company dealing with digital currencies. We believe regulation can be improved in some areas, but what is more important at this moment, is harmonisation of regulation. Regulation is based on the 5th EU Anti-Money Laundering Directive. But every EU member state has turned this Directive into its own laws, that are similar, but different across states.”

“For example, the German regulator BaFin regards digital currencies as a financial instrument. This incorporated digital currencies into existing legal structures. It has the benefit that financial institutions in Germany do not need a separate registration to trade digital currencies. The upshot is that German banks are very active in this space, but it doesn’t help with harmonisation. Because, say, a Dutch bank with a Dutch license to trade financial instruments, can trade financial instruments in Germany, but it cannot trade digital currencies in Germany, because that is not covered by the Dutch license! A German bank can trade digital currencies in Germany, but they cannot do it in any other EU member state, despite passporting of banking licences, because trading digital currencies requires a separate registration in each member state. It is a nightmarish situation for a company that wants to operate across Europe. And it is against the pan-European ideal. Hopefully, this will change once MiCA will be implemented in 2022 or 2023.”

What role is there for Hyphe in this process going forward?

“Hyphe is all about improving access to financial markets. We want to make access to this new technology as simple and easy as possible. What that means is not that we go to a bank and say: would you like to buy digital currencies? Here they are, and now you figure out the rest. That’s not how it works. We bring our proposition to banks and that proposition is: we enable you to trade digital currencies, in the most efficient way possible, using the expertise we have acquired over the past eight years. And being compliant with all regulation is one of the key building blocks in making this happen.”

Australia’s fifth biggest pension fund, Queensland Investment Corporation (QIC), which manages USD69bn of assets, told the Financial Times (15 October 2021) that it is open to investing in cryptocurrencies in the future. Other retirement vehicles including Canada’s CDPQ, one of North America’s leading long-term institutional investors, have also bought into the digital asset space. Yet, not all pension funds are convinced. Why should cryptocurrencies be part of a pension fund scheme?

“I can’t really argue that they should. If I knew the direction of digital currency prices, I would not have to run Hyphe! But the technological aspects of digital currencies are interesting. And the digital scarcity is something that could make it more valuable. That is an interesting aspect. As I mentioned before, there are ups and downs but the general trend seems to be up.”

What are the threats and opportunities for cryptocurrencies going forward and in what way can Hyphe contribute to the success of cryptocurrencies?  

“Hyphe started out trading digital currencies, but we see security tokens as the next big thing. This means that you create tokens on a blockchain, and make these tokens represent something. You can tokenise any asset that you can think of, whether it’s gold, a piece of art, real estate, or farmland in Canada. But you can also tokenise an income stream. So you can have a token that represents a share of the rights to the music of Michael Jackson for the next ten years.”

“In itself, tokenisation doesn’t really change anything. It makes no difference whether you track the token in a core banking system, in an Excel file, or on a blockchain. But the paradigm shift that we’re seeing, is custody. Financial institutions that go into tokenisation need custody. They need a place to store these tokens. All the banks we are speaking with are thinking about custody solutions for their tokens. They now have the opportunity to store digital currencies and tokenised assets for their customers. You cannot underestimate the importance of this. This wasn’t even possible two or three years ago. Suddenly, there’s this whole new infrastructure. I compare it to the railways of the 19th century in the US. Railways made it easier for goods to move, but when the infrastructure was there (the rails), it also became easier for people to move. You see the same thing with these new digital rails: they were built to trade digital currencies, but we believe that ultimately they will be used to trade security tokens.”

“Banks we speak to often start out by trading Bitcoin, or Ethereum. But then they realise they would like to issue their own tokens. That can be something new, something that couldn’t be traded before, but it could also be a tokenised version of a stock, a bond or even derivatives. It is our mission to explain to the bank that when they’re already trading digital currencies, there’s also this vast array of fully regulated and MiFID-compliant security tokens out there that can be traded on the same infrastructure. With the click of a button, we can make any security token available overnight to our banking customers, and settle them like we have been settling digital currencies over the past eight years. We believe that these security tokens will replace large parts of this existing settlement infrastructure. That will make international finance much more efficient. And we’re not only talking to banks about this, but also to real estate companies, to companies in the energy sector, to private equity, even art projects.”

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