The Breakdown - The Relentless Convergence of TradFi and Digital Assets feat. Sergey Nazarov

Episode Date: July 17, 2023

Today, NLW is joined by Chainlink's Sergey Nazarov to discuss the massive convergence of the traditional financial world and the web 3/digital assets space. They discuss the broader themes, as well as Chainlink's new Cross-Chain Interoperability Protocol, which is being tested by SWIFT, BNY Mellon, Citi and more. Find our guest online: https://twitter.com/SergeyNazarov Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Monday, July 17th, and today we are talking about the blending of tradfi and crypto. Before we get into that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown. Hello, friends, happy Monday, welcome back. Today, we have a returning guest, Sergey from Chainlink is back, and nominally the context for this is that today they announced their cross-chain

interoperability protocol or CCIP. CCIP is basically a way for developers to build applications and services that operate across different chains. It's an attempt to bridge the archipelago of smart contract chains that have risen over the last few years, and to hopefully do so in a way that addresses some of the problems that have led to bridge exploits of previous attempts. Now, as part of the launch, they announced AVE and synthetics as early users, but even more interesting, from a macro and big picture perspective, is that the initial group of CCIP testers also includes SWIFT, i.e. the messaging protocol that banks use,

plus the depository trust in clearing corp or DTCC, and a huge array of extremely large banks. city, BNY Mellon, Lloyd's Banking Group, B&P Parabas, and more. The goal is to enable these banks to move between digital asset transfers and traditional bank transfers effortlessly, and in that, I think it's an interesting example of a much wider and more significant trend, which is, of course, not just the institutionalization of crypto and Web3, but the actual convergence of TradFi and crypto more broadly. This is a trend that has gotten nothing but more unignorable over the past few months, and frankly, especially the last couple of weeks. The announcement of BlackRock's ETF application has unleashed the floodgates, and everyone who had been

quietly working on something in the TradFi moving into crypto space is now not so quietly working on it. So in this conversation, we talk a little bit about CCIP, but much more about this convergence, broadly speaking. All right, Sergey, welcome back to the breakdown, sir. How are you doing? Doing well. Thank you for having me. All right, this is going to be really interesting. I always say this, but a lot has happened, even though it hasn't been that long since you are on. on the show, but there has been a number of shifts, I think, in terms of how people are looking at this industry, how it relates to the traditional financial space, and some of the announcements that you guys have had recently, I think, are part and parcel of that. Now, we're going to dig into all that

today, but where I wanted to start with is a quote from you guys that you wrote in a document or a blog post, and it said something to the effect of, just like Web 2 needed TCIP to connect isolated islands of computer networks, Web 3 needs an interoperability standard to connect to islands of blockchain networks. So where I want to start is I would love for you to explain just briefly what you mean by interoperability standard and why it's so important right now in the context of how the industry is evolving. Sure, absolutely. So an interoperability standard is a way for all the systems of a certain class or category to communicate and interact with each other. And the more systems that get on that standard, the more valuable it is to each subsequent system, because they

have more other systems they can interact with. There's a kind of network effect there. So the internet is, for example, a collection of standards like HTTP, TCP IP, different protocols for email, and so on. And once those standards were established, and everyone that made a website was on that standard, me making a website could allow anyone else to view a website as long as they were on the same standard, in that case, TCPIP. This is something that our industry doesn't have, right? What our industry has is lots of siloed ecosystems basically focused on a specific type of chain, and the applications within that chain and the value within that chain can't really interact with the applications or value outside of that chain. So there can be 50 chains with hundreds

of applications in each chain and billions of dollars in value, but their ability to interact between the applications and between the value is very limited. This is not that different from the very early days of the internet where you actually have multiple separate intranets, not able to interact. You have local area networks that can't interact. You have, you know, consortiums of different terminals that make their own little internet and they can't interact with the others. And so it's very fragmented. And so if you want to launch a website or if you want to provide something on that version of the internet, you can only provide it in one place to a limited part of the world. Whereas if you have an interoperability standard that connects all the different

parts of the world. Wherever you offer your website or offer your token or offer your decentralized application, the whole world can access it. So basically what an interoperability standard does is it raises the value you get when you launch an application into a blockchain. It doesn't, it shouldn't matter which blockchain. It should just be that you're launching a blockchain application like you're launching an internet application. And then you should get access to the entire world of value and other applications. And that's really what an interoperability standard would do. And that's why we're very excited about CCIP, because similar to TCPIP, CCIP has many of the properties that you need that previously haven't existed to create that interoperability

between all the different chains, so that you can actually even build applications made up of different contracts on different chains, all interoperating to make one big, valuable application, similarly to how Web2 applications are built across multiple clouds connected through protocols like TCPIP. So this is a perfect segue. Could you explain a little more about CCIP, perhaps for a non-technical audience in terms of what it does and also maybe how it's different or differs from other solutions that people have tried to bridge different on-chain assets or different protocols?

Basically, what is CCIP doing specifically? And by extension, I think what are some of the use cases that it enables? Sure. So you could think of each blockchain that you've heard of as a kind of island. And some islands are bigger and some islands are smaller. And then you can think of CCIP as like a communication cable between those islands. Right. So the more islands that are connected by these communication cables, the more islands you can contact from your island. Right. So the more islands get connected into the network, the more places you can, for example, make a phone call. In CCIP's case, the equivalent of a phone call would be message transfer. So information transfer, right? CCHIP really has two basic things it does. It transfers information and messages so that you can transfer data and then it also transfers value. So now imagine that that communication cable between all these islands could allow you to make a phone call and it could let you send money. So now you can send money between the different islands so the different islands can trade with each other and you can

communicate about what you want to do in terms of the trading. So if you had a whole kind of ocean full of these little disconnected islands, some bigger, some smaller, and then you connected all of them, that would be very valuable to all, right? Because they could conduct conversations through messages and phone calls, and then they could send value to each other to basically trade. And what that means is that you can get a resource on one island, and then you can contact the other island all the way on the other end of the ocean, and you can agree on what they'll pay you for the resource, and then you can even receive the money and go send the resource, right? So really it's about taking the blockchain world from this siloed, separated, tribalistic place with multiple

different chains to an internet of contracts where launching a contract allows you to connect to all the other contracts and systems that are out there to connect to. So I think the rest of this conversation is going to be in large part about the convergence with the traditional space, but what are the parallels in the traditional financial ecosystem in terms of how the archipelagos of these different systems interact with one another, and how does that sort of play into what you guys are doing now? And maybe this is also a chance to talk a little bit about Swift and how that relationship has evolved.

Sure. So there's a history of new systems coming about, coming about in different forms and then needing to be connected with each other in order for the people using the different types of systems to transact. That's a common recurring pattern in the history of technology. Swift had a similar pattern where it emerged in the 70s to replace telex machines. So as a way for banks to communicate about the most valuable messages and information, namely the sending of money and value between these very valuable financial institutions. Our work with Swift is about how to use the private key infrastructure that they've created in order to continue to sign blockchain transactions

that can be affected on various chains. So what we're doing is we're taking the infrastructure that Swift is built and together with them allowing that infrastructure to sign transactions on all of the blockchains. So now you can use the SWIFT infrastructure to sign transactions that become executed on various blockchains. And the signing happens on the SWIFT, side because you do need to sign using private keys and cryptography, because that's how Swift also works. You sign with private keys. And then those private keys can sign things in a way that allows CCIP to transmit them onto hundreds of different blockchains. Whether those blockchains are public or private blockchains. So this means that all the world banks will be able to eventually do transactions

both across different private bank chains. And I do believe that all of the different banks will end up having their own chain, and they'll have to connect those chains in order for there to be a kind of bank grade internet of contracts, but that they will also want to transact and interact with the public blockchain ecosystem. And so CCIP allows both of those to happen, but using the existing technology that banks have instead of replacing the technology they have. Because historically replacing the technology of banks is very complicated and often impossible, because the value that sits on that technology is so large. So you're much better off taking the existing bank assigning systems and routing methods and messaging systems and allowing them to interface

with blockchains in an efficient way. And this way you can get hundreds of trillions of dollars basically enabled to transact in a blockchain-based way, which I think once that happens and once the regulatory clarity kind of gets cleared up a little bit more, you'll be in a position for tens of trillions of dollars to flow into various chains and various financial products, on-chain finance products. And that's really what I think will hopefully happen if interoperability standard, if CCIP can connect the banks to each other and it can connect the banks to public chains. So what's an example of something that zooming out a couple years, this infrastructure is built, Swift and CCIP are connected? What's an example of something that banks or other financial

institutions will be able to do then that they can't do today. Sure, absolutely. So firstly, I believe that all banks will end up having their own stable coin. So I already see multiple banks making their own bank stable coin. And the competitive nature of stable coins is you want more people to use your stable coin. You want your stable coin to be the stable coin for settlement and holding value and trading and all the things use stable coins for. So in the very first iteration of this, the banks that make stable coins will want those stable coins to be used, and therefore, the more places their chain where their stable coin originates is connected to, the more places that can adopt their stable coin. So the first big question is going to be,

how do I get my stable coin adopted? Oh, the answer is I connect it to all the places where my stable coin could get used, and that allows it to be used and transacted in more places. The second thing that banks are actually very well suited to do is real-world asset tokenization. So real-world asset tokenization is kind of what banks know how to do. They know how to package assets into financial products of various kinds. The only difference here is they're packaging them into tokenized technical form. So after banks go down the custody rabbit hole and custody other people's coins, they then move on to make their own coins. and those coins usually start in a stable coin, but not always.

But they, in all cases, I think, will move on to making real-world asset tokens. And the real-world asset tokens will be tokens about real estate or carbon credits or any number of other things. And then those will be essentially assets issued by the bank that they once again want to have sold. They want to sell them. And so once again, the more places they're connected to, the more places that they can transact and in that asset in, the more places they can send that asset, the more places they can sell it to, the bigger the market. And so my expectation is, as the market size for where a stable coin from a bank or a real world asset token from a bank can be sold grows, which is one of the things

that CCIP accelerates by connecting that bank to more places, both other private bank chains and public chains. So as the market size... for where you can make your stable coin used and your real world asset token bought grows, the incentive to make them gross. The incentive to make stable coins grows. The incentive to create real world asset tokenized real estate or real world asset tokenized whatever from a bank grows. And actually what I see happening eventually is that the crypto world and the capital

market's banking world become largely the same thing because the method through which you would transact in in terms of blockchain technology is just better. Some assets will only be able to purchase by some people and other assets will only be able to purchase in certain ways that meet the requirements of banks. But at the end of the day, banks exist to service their clients and to make money. Their clients are demanding custody of blockchain assets. Their clients are eventually going to need a stable coin, which that bank will be happy to offer them. their clients will need real-world tokenized assets. And the bank will offer that, and then it'll look for more clients to buy that service and product,

as they always invariably do. And what I think they're going to find is that the public blockchain part of the market, which CCIP will also connect them to, will be quite attractive as a market. So really what's going on here is that we're launching CCIP, and we're making it successfully able to connect multiple. key defy applications, multiple key public chains, and that's creating its own kind of internet of contracts, public blockchain defy internet of contracts. Then at the same time in our work with Swift, DTC, Citibank, Bean Y Mellon, many of the other people in the Swift POC, we're working on making

a kind of bank grade internet of contracts for the private bank chains, CSDs, and custodians to transact. And then these two Internet of Contracts will eventually merge because fundamentally the transactions and the financial products and the activity that they want to engage in, they're both engaging in. And they both have a market. So the public blockchains will be a huge market for bank real world assets. And the bank Internet of Contracts will be a huge market

for all the different assets created in the public blockchain world that have large yields or seem to have large growth or something. And so both of them, for each other, are a big market that they want to access. And by enabling that access to each other technically and securely through CCIP, I think what we're actually able to do is grow the industry. So the most exciting thing for me, actually, would be CCIP gets widely adopted by public blockchains and defy protocols, gets widely adopted by private bank chains, CSD chains and custody chains.

And then the connection between those two worlds begins to grow more and more, and the total value that we have in the blockchain industry isn't $1.25 trillion. It isn't $2 trillion. It's $10 or $20 or $30 or more trillion. Because that's how much value we're talking about moving into the blockchain world when we're talking about connecting the bank Internet of contracts with the public blockchain internet of contracts. into one global internet of contracts that starts to define both the crypto world and the global

financial order. Question six. It's super interesting. It strikes me that there's sort of three convergences happening right now that sort of get to the scenario that you're laying out. One is, let's call it a market convergence. You know that your example is stable coins where there's very clearly a product that has product market fit.

And obviously we use it in the crypto world, but it's very clear how interested other people are here as well. I think real-world assets are another one that people anticipate just because the financialization of assets has been an interesting thing to finance in the market for so long, so it seems like a more efficient version of that that allows for new types of products seems likely to succeed as well. So then you have this market convergence between what we now call the crypto world and the Tradfai world. Secondarily, you have a regulatory convergence, and we're not fully there yet, but if you look at the most recent drafts of things like the Lumas-Gillibrand bill, they explicitly create, for example, a new type of

bank charter that's just for stablecoins. So it means that existing banks can go get a stablecoin license, and it also means that startups or existing crypto institutions can get a banking regulatory grade stablecoin license, even if they're not regulated like banks to do other types of bank things. So you've got some sort of regulatory convergence there as well. Given that, it sounds like the goal of CCIP is in many ways the third leg of that stool, which is the technological convergence that allows this to all come together. Is that an accurate depiction? Yeah, I think, I think that's right. I think what you need is a market incentive. You need clarity for how people can transact, and then you need the technical means to transact. CCIP creates those technical means

so that everyone can be connected into a global market, irrespective of which chain they started on, and irrespective of which chain they want to go buy or sell an asset to or from. Just like on the internet, you don't have to decide to launch an application in the Amazon cloud or the Microsoft cloud or the Google Cloud. You just launch your application and your application is connected to all the other applications running in all the other clouds. And you don't have to worry about it because that's how the internet works. Because there's an interoperability standard called TCPIP and others. So this is the obvious next step of our industry is that instead of having these siloed islands where people can only transact in that island, everybody,

can transact across all the islands very efficiently and quickly and securely. This actually creates a larger global market. And then if you have the incentives, so it's worth it for you to make a real world assets, it's worth it for you to generate a stable coin. That incentive leads you to do more of that. And then, yeah, if people have clarity about how they can do this legally and all those things, that I think once that appears and once the technological rails are in place, then things will accelerate very rapidly. And anyone who isn't already connected or integrated correctly will have to do it. It won't be a choice. It'll be like having email or not having email. If your client says to you, yeah, I'd like to buy this asset, you just send it over here to me and my chain. You won't really

have a choice. You'll have to send it because that's how you and your client want to transact. So I think we'll cross that threshold. By that point, it'll be obvious. Right now it isn't obvious, because there's all this uncertainty. There's all this uncertainty on how to legally do it. There's all this uncertainty on the incentives and whether the market will continue to grow. But my view, as it has been for over the more than 10 years, I've been working in this industry,

is that the fundamental value of the technology is so many orders of magnitude better than what exists today, and it solves so many fundamental, both transactional and societal problems, that the legal issues will get figured out, the incentives will continue to be there as the market grows. And our goal and my role in all this is really to create the technological systems and infrastructure that once those problems are solved, everything can smoothly and

securely happen. So that's the thing that I'm very grateful to be a part of and everyone here working with me on this and our community I think are very excited about is how do we create the technical foundation for the world to work in this way, similarly to how TCIP and other key protocols running the internet allowed the internet to become the internet. internet. And so that's really what we see ourselves is doing. Listen, I'm extremely excited that this is moving from the realm of entirely theoretical to applied in a lot of ways and really excited to see what you guys build next. Sergey, it is always great to have you on the show. Thanks so much for taking some time away from building to come chat with us. Thank you for having me. Always a pleasure

to speak with you. Thank you. All right, guys, back to NLW really briefly here. There is a really interesting moment we find ourselves in right now. It's a moment that I think was going to be inevitable in any successful trajectory for digital assets, frankly. That's the moment where two very different and potentially divergent value propositions of crypto and Web3 and however you want to call it, are both on display at the same time. One of those is its value to the existing system, the increase in efficiency, the borderless nature of it, tokenization is a way to build new financial products in the traditional ecosystem. All of these things are digital asset or web three value propositions that really do make things work better that exist today. Then, of course,

on the flip side, there's the value proposition of Bitcoin in particular as a straight-up alternative to the existing system. I think one interesting question to hold close as we see this convergence come online is to understand in what ways one mission impacts negatively or positively the other. Does it, for example, undermine Bitcoin's counter-system alternative to have a Bitcoin ETF integrated with traditional financial institutions. I think in many cases we'll find that the answers aren't as clean and crisp as the Warriors on Twitter might have you believe, but there's still really good questions to ask. Whatever one thinks of those questions, though, the trajectory is clear. The move to converge and take advantage of these new systems and the new technologies

that have been built over the last five years or longer feels absolutely unstoppable right now. So if nothing else, it's going to be an interesting ride. Anyways, guys, that is going to do it for today's breakdown. I want to say thanks again to Sergey for joining us, and of course, thanks to you guys, as always, for listening. Until next time, be safe and take care of each other. Peace.