In September, Coinsilium (AQSE:COIN | OTCQB:CINGF) announced a major new investment in Greengage Global Holding Ltd ("Greengage"), a UK-registered company with plans to become the first merchant bank for the digital finance sector via its wholly-owned Gibraltar subsidiary Greengage & Co. Ltd, subject to which it is currently engaged in the regulatory application process with the Gibraltar Financial Services Commission ("GFSC") to receive a Gibraltar banking licence.
The investment transaction was conducted via Coinsilium's wholly-owned Gibraltar registered subsidiary, Seedcoin Limited ("Seedcoin"), whereby Seedcoin invested GBP£200,000 in convertible notes and has also taken GBP£300,000 equity in a secondary stake sale that values Greengage at GBP£27.3 million. The full announcement can be seen here.
Separately and at the same time, Coinsilium also announced that it and Greengage intend to start collaborating to explore new regulatory compliant Decentralised Finance (“DeFi”) solutions that are fit for purpose in terms of mainstream adoption.
DeFi is the latest commercial use case in the ever-evolving blockchain technology space where “Smart Contracts” are delivering tremendous cost savings and efficiencies within a new generation of decentralised financial models, enabling peer-to-peer financial transactions in cryptocurrency products and derivatives without the need for intermediaries. DeFi activity has grown exponentially over the last two years and there seems to be no let up, with an astonishing $225 billion in value currently ‘locked’ on DeFi platforms.
There is no doubting the power of blockchain technology and its potential to deliver tremendous efficiencies while collapsing the costs of doing business across the entire regulated financial services industry, from savings and loans to insurance and pensions. However, until there is an effective regulatory framework under which these services can operate, mainstream adoption still remains very much a pipe dream. So what will it take for the technology to make the leap from operating in a regulatory grey zone to full integration in the $22.5 trillion global financial services industry?
The DeFi market is still extremely young and unregulated so is very much ‘Wild West’ territory with little or no protection for investors when things go wrong. This means that, for the time being at least, while the objective of many DeFi related initiatives is one of financial inclusion and the removal of centralised intermediaries, in reality it remains the exclusive territory of young tech-savvy crypto investors.
In this article we take a detailed look at the world of DeFi, where it’s going, and why this could be a golden opportunity for Coinsilium in particular.
The DeFi revolution
Decentralised Finance models have been around for a little over two years now and in this relatively short space of time the market has grown exponentially. This is now presenting a significant challenge to financial regulators worldwide, with agencies and various DeFi products and providers coming under increasing scrutiny.
It’s fair to say that regulators have struggled to keep up with DeFi’s growth and evolution, whilst the sector appears to have become unstoppable. However, the compliance risks of huge global unregulated payments networks are a reality that will need to be dealt with at some stage.
In layman’s terms, “DeFi” refers collectively to all of the products and systems that make up a new, 21st century smart contract-powered financial system that is open to anyone for use.
So, where our financial needs have traditionally been provided by middlemen such as banks or brokerages, who require their clients to have an account, a government-issued ID, national insurance number, and proof of address up front, DeFi is made up of systems and software written on blockchains that make it possible for buyers, sellers, lenders, and borrowers to interact peer-to-peer. This means the need for KYC has effectively been replaced by the certainty of asset ownership as demonstrated by blockchain transactions.
In other words, DeFi transactions, which are typically powered by a mix of open-source technologies, blockchain, and proprietary software such as smart contracts, are facilitated entirely by a strictly software-based process rather than a company or institution.
There are a wide variety of benefits to these automated and decentralised systems, many of which stem from the removal of middlemen. The most immediate is the lack of friction, enabling instant or extremely fast transfers and the global availability of the financial products. Likewise, users can experience benefits such as much higher interest rates for deposits than generally available for traditional products, as well as more favourable terms on instantly available liquidity through crypto loans.
But beyond this, DeFi can also offer a type of extremely high yield trading known as “yield farming”, which allows investors to lend their coins at much higher rates than traditional banking and investments. Likewise, it is much more accessible than traditional financial systems—after all, it can be accessed by anyone with an internet connection. It is for all of these reasons that DeFi applications have seen a massive upswing in usage in a very short space of time.
The key to mainstream adoption
Despite DeFi’s varied benefits and strong growth momentum, there is a major factor currently holding it back from the holy grail of mainstream adoption; that being its incompatibility with existing financial regulation, and the sometimes slow pace of development of new regulatory standards or regimes to deal with a new phenomenon.
It all boils down to the fact that, more often than not, DeFi applications are based around “permissionless” blockchain networks that are open to and maintained by any member of the public. There’s a number of benefits to this, such as immutable signatures for all records, anonymity, transparency, and quick and easy transactions. But the problem is, permissionless systems only really work when whatever takes place does not require anyone else’s permission.
This, of course, does not fit at all with the current approach typically taken by financial regulators. After all, these bodies exist, in the main, to protect consumers by directly intervening when firms behave in ways deemed to be unacceptable.
Compounding this issue is the fact that permissionless DeFi systems are, by design, unable to meet almost all of the consumer protection standards required by regulators. For example, the onboarding, verification, and background checks that take place when you join a high street bank cannot take place in a network that’s open to all through anonymous wallet addresses. Likewise, when permissionless services get hacked, it can be difficult for any type of intervention to take place in an environment where it's generally accepted that “Code is Law”.
A clear example of this latter point was the DAO Hack in 2016. The DAO was a decentralized autonomous organization intended to act as an investor-directed venture capital fund for Ethereum projects. However, less than three months from its launch, after raising some $150 million worth of Ether, the DAO was hacked by an individual exploiting a vulnerability in its code.
Eventually, the individual was able to hijack around $60 million worth of Ether, and there was very little that regulators could do about it due to the permissionless way in which Ethereum works.
Ultimately—after much discussion—the Ethereum community itself decided to intervene with a “hard fork” that redirected the funds to another safe haven contract where the funds would be secured. It was decided that taking action to minimize the effects of this one-of-a-kind catastrophe would be necessary given the threat the hack represented to the survival and reputation of the Ethereum blockchain. However, it wasn’t a choice made lightly—many in the Ethereum community were incensed, arguing that the intervention completely undermined the principles of a permissionless blockchain. (The story Ethereum and the DAO Hack has been very well documented in this book for those interested).
It seems that DeFi type solutions are now starting to come under increased regulatory scrutiny—Coinbase and Celsius are the latest in the sector to come up on the SEC’s radar— and it is likely that these kinds of actions will become commonplace. After all, regulatory intervention and the immutability of permissionless systems are simply not compatible.
It is for this reason that, while DeFi applications will no doubt continue to be used by those who know and understand the risks regardless of what happens, it is extremely unlikely that they will be able to penetrate the mainstream market in their current form.
Instead, for widespread adoption to take place, DeFi and regulators must find a way to work together in a way that regulations do not erase all the benefits of DeFi while enabling some regulatory oversight or defined standards for DeFi operations.
Coinsilium’s investment in Greengage
As stated earlier, last month Coinsilium completed a strategic investment in start-up financial provider Greengage Global Holding Ltd. Greengage is currently in the application process to obtain its banking license in Gibraltar. If granted, it will be the very first merchant bank to focus entirely on servicing firms and individuals operating in, or looking to join, the crypto-asset market.
This means that it will be able to offer all of the services of a normal bank such as payments and loans, but also a range of sophisticated facilities unique to the digital finance sector. This could be anything from allowing companies to use their cryptocurrencies as collateral to borrow against (with partner balance sheets) to allowing firms to diversify their portfolio by putting some of their cash into bitcoin (via a separate VASP license application).
Greengage is directly addressing the growing need for financial services among an increasingly large global pool of digital finance companies who are finding it challenging to engage with traditional banks.
And Coinsilium now has direct exposure to this huge first-mover opportunity through its £500,000 investment in the company—split between £200,000 in convertible notes and £300,000 in equity from a secondary stake sale valuing Greengage at £27.3 million.
What’s more, the firm believes that the value of its holding—which comes in at roughly 1% of Greengage’s total share capital—could receive an immediate uplift should the firm be awarded its banking licence in Gibraltar. At which point it will be able to push forward fully in its efforts to offer a range of banking services to a burgeoning and distinctly underserved market.
Paving the way to mainstream DeFi adoption
There is also a second aspect to Coinsilium’s relationship with Greengage that will see the two companies collaborate in order to research and explore opportunities to develop regulatory compliant DeFi products and solutions. The aim here is to identify models that can fit within recognised practices and procedures, allowing them to overcome the aforementioned hurdles currently challenging broader DeFi adoption.
Although the relationship between Greengage and Coinsilium is currently in its early stages, the former’s track record and ambitions within regulated markets, combined with the latter’s commercial experience and industry knowledge positions them well for this endeavour.
Coinsilium’s executive chairman Malcolm Palle tells us that he expects these models to be able to take advantage of the major cost savings DeFi can offer by automating many of the processes. However, rather than doing so in a permissionless way, they will need to fulfil their function in an environment that can be sanctioned by regulators and offer effective investor protection.
“The technology powering DeFi is not going to go away and there’s good reason for that— it is simply too powerful to ignore and has the potential to collapse the costs of financial services and create new highly effective business models for the global financial services industry.
“However, whilst DeFi remains unregulated, barriers to mainstream adoption will always remain. This problem is compounded by the fact that current DeFi models were not designed to be regulated, so trying to do so is like trying to fit a square peg into a round hole.
“Inevitably a new approach will be required and together with Greengage, we will be looking to explore and identify new models whilst also considering new approaches and technical solutions to regulatory challenges.”
Joey Garcia, advisor to Coinsilium, Non-Executive Director of Greengage Global Holding Ltd and a well-known expert in the space also commented:
“There is a huge level of interest and very ideological goals behind DeFi infrastructure, protocols and platforms, but my feeling is that it will be the groups and platforms that can make the CeFi to DeFi bridges work, and take advantage of the underlying efficiency of the technology in a way that satisfies regulatory authorities and agencies that will have the greatest success.
“I am a firm believer in the capability and capacity of decentralised infrastructure to make a significant difference to the way that many services are offered to people around the world, but I am also painfully aware of the negative and illicit use of such infrastructure, and the fact that so many of these projects are some way from meeting the test for ‘decentralisation’ and simply trying to take advantage of market sentiment.
“Defining such standards, and having this built in a way that the existing financial services infrastructure can interoperate with it, will be key in my view moving forward”.