Welcome to this edition of our hugely popular Crypto Questions with Cummings Pepperdine.
In this episode we talk to CEO and group Chairman of GMEX Group, Hirander Misra, about centralised and de-centralised exchanges, and the future of digital markets
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For a transcript of this episode, please click here.
[00:00:00] Thank you everybody for joining us for this episode of our hugely popular Cummings Crypto questions. I'm very pleased to today to be able to introduce you to Heranda Misra, who's the founder of the GMEX Group, and I think it's a particularly pertinent time for us to be discussing the work that Heranda does with crypto exchanges.
In light of the issues that surround FTX, I think that what we are going to be able to do today is provide a beacon of hope. Show people that you, the FTX, is the exception and not the rule. So first of all, Hi Heranda. Thank you very much for joining us. Perhaps you could tell everybody a bit more about GMEX?
My pleasure Claire, and thanks for having me. GMEX as a company, has been around over [00:01:00] 10 years now. Our core business at that time was enabling exchanges all over the world. I actually started out in traditional asset classes, such as derivatives, securities and commodities.
And then about five years ago, I got into digital and cryptocurrencies as well, enabling marketplaces and post-trade infrastructure - including clearing, settlement and custody in that space.
And am I right in thinking that your background is actually personally, very much in exchanges, and you have been quite successful in the exchange world before you bought and moved to digital assets. Is that correct?
My background is around 26 years in electronic trading and primarily most of which has been in exchanges. And then I co-founded a platform called Chis Europe, which actually, in a short space of time became the [00:02:00] second largest trading venue in Europe behind the LSE group.
So we ended up having 30% of UK stocks, blue chips trading on our platform, and 25% pan-European equities. So that was really exciting because it Invested into buy all the banks and trading firms. So if there's anybody who's got a strong background in building an exchange, which has got through due diligence of banks and also building an exchange, which the LSE has found strong and compliant.
You are the man and it, I guess it makes sense now, that you are moving to digital assets five years ago. And I'm guessing that everything you learned with what we might call a more traditional exchange and the regulation of that exchange, you are now bringing to digital assets to ensure a high level of compliance and also compliance point of experience.
Would you say that's [00:03:00] correct? Yes, absolutely. Because when we got into this space my view was that actually all the activity in the digital asset space in some way, shape or form would be regulated whether it's the activity, the entities undertaking that. And certainly we're seeing that and we're going to see it even more now, given recent events.
And with that in mind, as you know, I mean Claire, because you come from that background I, think to some extent in cryptocurrency markets the value of regulation, proper governance, control, risk management, a proper framework has been overlooked. And there is an overhead for this, but there's a reason why it exists.
And I think the right balance is for that regulation to be there, but for innovation to continue, but certainly not be ignored like we saw with some of these recent events. I think it's quite [00:04:00] interesting if you look at some of the publications and comments that have come out.
Government, parliament and treasury recently, it's very clear that they do, they want to bring crypto in. They're aware that it's a new class. Technology isn't really something they've kept up with, but it's going to be bought in, crypto is going to be the same as any other type of asset class.
It's just a question trying to get the peg and the hole. The same shapes. One thing which particularly interests me, and I think if we go back to talking about FTX again, I think that gives us a good example is the difference between centralized and decentralized exchanges.
Now I always find it easier to explain when I've got a piece of paper and a pen and I can draw little blobs and circles that are linked to each other or linked century or whatever. [00:05:00] Perhaps I should hand over to you as the expert and you could tell us a bit about what each one is, and then we can go through what might be the different pros and cons of each one.
So first of all, could we start with centralized? Now we can contrast that with a decentralized exchange. Absolutely. And actually centralized exchanges, because even our current stock markets are centralized even though they're in traditional finance. And then the likes of FTX were and co Coinbase is as well.
Now that doesn't necessarily mean they're bad in any way, even given recent events, but effectively what they are. Some form of marketplace where buyers and sellers come together. And orders buy, sell orders are matched to create trades. And effectively they flow through some type of centralized intermediary mechanism. Now, in some cases, some of [00:06:00] these crypto exchanges almost act like brokers in the middle of that mechanism. In other cases, the exchanges don't. But there are things like clearing houses that step in the middle of the trade to ensure anonymity and managed risk.
So, that's your centralized con construct by contrast, a decentralized exchange, it doesn't have that central intermediary. It's more peer-to-peer and smart contracts. So you have a smart contract and you want to purchase, let's say a digital asset. I have a smart contract and effectively with any given protocol that smart contract can affect a transaction between those smart contracts.
When criteria are met. So there's no centralized body and there are no intermediaries either. And likewise, there's no clearing house. You could argue. I mean, a word often uses trust less which doesn't mean there's no trust, but it means the fact that [00:07:00] by virtue of those smart contracts and the fact that those assets are there, that settlement finality can be guaranteed.
But, I always smile when I hear those words because there's always some pros and cons as you'll get into and are things ever truly decentralized in this space? Because there could be some control somewhere along the chain, whether it's a developer, whether it's someone owning more of the tokens and so forth.
There is the ecosystem as a mecca. When I, in my very simple brain, sometimes think about it a bit like, if you are trading commodities on exchange, then you know you've got the exchange there. It steps in as the dealing house and you've got membership and you've got the give up agreements that, you know, the full party ones.
So, it's kind of sort of controlled. Whereas if you're dealing in a decentralized fashion, it's more similar to transacting under Easter agreements. [00:08:00] I mean, absolutely, particularly those when there was no variation margin, initial margin. If there are, there are some base similarities in those two types of trading, aren't there?
Yes absolutely. And, what people mustn't forget as you rightly said, with reference to over counter trading has been around a long time, in fact again, if you look at UK equities, even a lot of activity happens away from the main exchanges and trading venues as well, whether it's between the banks, brokers or other participants as well.
So, all you are now doing is you're creating a mechanism here with these smart contracts for that type of activity to occur. Being driven by some form of blockchain protocol. So what do you think? So how about if we could quickly [00:09:00] talk about the pros and cons, which you sort of slightly talked about.
And at the same time, could we bring into the pros and could look at the pros and cons first, and then think about the impact of recent events such as FTX, but like, the reason I say is look at the event. After looking at pros and cons, because I think we need to set the background of the types of exchange are available and what does work better in some situations and not, and possibly just bear in mind that the other issue with FTX is that they had a trading arm and they had their own coin.
So it's a whole lot more complicated than see a standalone exchange. I mean, the pros and cons are interesting because certainly if you're looking to scale something and concentrate liquidity and find it easier for, buy and sell orders to match then a centralized [00:10:00] exchange is certainly better than decentralized because everything's converging centrally.
In terms of activity? So things like, is it a batching orders and getting a match, that's where you are right. Building up the order book and just the fact that it's easier for buyers and sellers to find each other just because you are, coming to some central points as well.
No different to lots of people meeting in the square or something to that effect, it's much easier. It's much easier to undertake that activity. Also, generally, the user interfaces whether you're interacting with those exchanges that way, or application program interfaces, they're much more mature.
And how speedy are they with that maturity? And, that's the other important point. It really scales well because obviously as we know, we're different blockchains. There's different [00:11:00] capacity constraints. And so of course there are virtues of decentral as well, which we'll talk about. But it scales very, very well. And typically these exchanges have evolved over time to be very low latency in height ruper which has been good for the likes of algorithmic trading to come in, volumes to increase as well. So, there are many merits for this type of structure and largely like I said all the existing exchanges out there that you see, traditional ones, they're all.
Centralized really, as opposed to decentralized. And it wouldn't still be around if it didn't work. Absolutely. And, for the right asset class and the right circumstances, they are in effect the providers of liquidity because they put the people together.
And that's right. I mean, they're the facilitators of liquidity so that [00:12:00] those that provide liquidity, and those that take it are matched together in one central place. And that’s truly beneficial. And we wouldn't have been able to scale this in the past, what I described, if it wasn't for that kind of mechanism really.
And liquidity is a form of de-risking as well, so, liquidity gets more liquidity as well. It becomes like a self-fulfilling prophecy to a large extent. So then the decentralized. Tell me where you think the decentralized system really comes into play and, what it's able to provide that centralized doesn't.
And you know, and of course that's a vice versa thing, isn't it? I'm a great fan of having both centralized and decentralized exchange. Or even now an interesting concept is hex instead of decks as well on where you've got certain exchange [00:13:00] constructs that are very hybrid as well now.
That have functions that are both centralized and decentralized. And I really think that's going to become an interesting trend because, you can't really ignore one or the other, they're both here to stay. It’s really interesting that recently there were some numbers released by Reuters post FTX where, prior to FTX, the volumes on centralized crypto exchanges were far higher than decentralized, and now they've more or less converged.
I mean, they're both down because generally, Synonymous with what's happened in the market. But there's been a greater convergence. Now. Decentralized exchanges offer advantage in that for you as a user, you've got control over your assets. And so you can choose what you do with them and how you utilize them.
On the flip side, typically with some of these platforms, the [00:14:00] user interfaces aren't necessarily developed. It requires a lot of technical expertise to be able to utilize those constructs effectively and harness the capabilities of those contracts and protocols. Over time, that will become easier as more tools develop, and certainly even some of the large cloud-based providers are looking at various tools to make life easier in that.
But, certainly from the perspective of control, but also democratization as well in that now all of a sudden you and I can transact with each other. Or, organizations can use those mechanisms too, but we're not beholden to an intermediary or coming to those centralized places of liquidity. But that opens up a much broader range of asset classes that can be supported and traded as well, some of which might not make economic sense on a centralized exchange. And how does this kind of [00:15:00] decentralized trade with each other system sit alongside money laundering regulations?
It's a really, really interesting question actually, because, as fortunate enough to be at the FCA crypto Sprint in person. The first one that they held that wasn't remote. And that's exactly one of the topics that we were discussing, and there's a broad section of us across the table from industry and actually said take that question slightly a step back.
Can you regulate cent decentralized exchanges or decentralized autonomous organizations? When there's no central entity that's based somewhere, there might not be certain individual that controls them and jurisdictionally, obviously, it means they're very distributed and diversified and the answer was actually, It's probably unlikely and that's why, as you know [00:16:00] as well, Claire, I mean given you speak about this often they're not part of the MICA regulations in terms of scope at this time as well.
But actually that raised an interesting question. So what do you do with them? And obviously K Y C E M L is always a challenge and I think the conclusion that was drawn - I think many of these operators, they want to be seen to be credible. And we are going to now post FTX a flight to quality as well.
Yes. And whether that's bank grade custody or other mechanisms. So the conclusion was maybe introduce black lists are quite negative, but introduce a white list, introduce some kind of bar where these entities can certify against certain criteria that show best practice.
And have an approval list that they can get onto. And that kind of gives investor confidence and, and helps with investor protection as well. And actually, whether it's coin forensics or those tools that they're out there already and actually many ways. [00:17:00] The irony of all this is that because they're decentralized all this activity is on chain somewhere.
Yeah. It's much easier. It's much easier to be transparent and to look at that activity rather than a centralized exchange where things can be aggregated, netted off. and might not necessarily be externally. You are not going to be able to pool. You could always use somebody else.
You could use a kind of nominee, but there's not going to be any Pooling of trades, block trading batches would, it could have anybody in it. I think there is always ways around it. Like you said, there's mixers where you could come in and then it's your coin that you put in, but someone else is that you take out?
But at the same time, I think, we are broadly going to see regulation move against some of these things. Because also the other thing you raised about K Y C M L is identity, right? Because when you go to zero knowledge proof and other mechanisms and you say, okay, but we've created a mechanism here where maybe identity isn't important, but when is it important?
[00:18:00] You know, if there's something. It's been subject to money laundering or counterterrorism financing. Then we said, okay, use some kind of identity token. But if you break regulatory rules or the law, then there is a give up of identity off the back of that as well - which is an interesting concept to explore.
I think the other thing is you going back to a point you made earlier, that this is all based on blockchain. Blockchain is transparent and it can't be changed. So surely blockchain is a solution for identity proof as well. So the two can be combined. So tell me that having gone through that sort of a slight compare and contrast tell me about the digital markets as we look ahead, particularly when we think about, sorry to keep going on about it, but FTX is such a big one, so you go first, but I think that actually FTX as a whole could. We could see there were some silver linings for the industry. Tell me what you think. [00:19:00] Sometimes you need a reset for something good to emerge, because if you remember with the previous crypto winter, when you look at, let's say the tum of 2018, that then transcended into the winter of 2019.
There was all this hyper and ICOs, and there had to be a reset. But then we saw a real period of innovation, and real interesting models emerge right on the back of that. And quality emerge. And I think we'd got into too much of a bull market as far as crypto was concerned. And then there were a lot of corners that were cut.
Of course, regulation was emerging, but it wasn't quite there, so things fell between them. But I think now to instil confidence in the industry I think regulation will emerge as we've discussed, but something like this needed to happen for a reset. And for the technology to really now take the four because, even recently JP Morgan.
[00:20:00] If you look at Larry Fier, BlackRock BNY Mellon, CEO have said that they're massive proponents of tokenization. And the use of blockchain for clearing and settlement and being able to make those processes efficient. You mentioned, it's a prime example of how this technology can be leveraged.
For that type of activity as well. Exactly. I mean, wouldn't it just make everything so much more efficient? Yes. And so, I really think we're going to now, after this period of reset, we'll now enter into a kind of another golden period, which doesn't necessarily mean it's all going to be about crypto now, but it's going to be about digitalized structured products.
It's going to be distribution of what the likes of Invesco and the BlackRocks are doing on the asset management sites and new forms of users with wallet integrations. and we're going to see real innovation. So I'm very, very bullish. And, and actually we're also going to now see an increasing amount of rails [00:21:00] between the old world and the new world because there's a lot of naivety on the Crypton native side where people thought, ah, yes, but all this old technology's going to go away.
But you and I know there's still IBM mainframes running that, that are decades old. And actually that's not going away anytime. Bit like paper post hasn't gone away when email emerged and instant messaging emerged. Yes, exactly. Their blockchain will be there, but they will always be always be a place for an Excel spreadsheet.
Yes, for some reason we all tend to love them. I mean it was funny - we had a demo to a client yesterday. and were saying ‘we've got various reporting mechanisms, but actually we had to create all these reports in Excel because at the end of the day, what the client wanted was just to download them and play with them’.
Exactly. I think that what we are talking about now is what we've seen before in what are now the traditional market is. I don’t know if you can remember this far back, but do you remember Long-Term Capital Management lc? Yes. And you know, they all went off.
Nobody could believe that derivatives [00:22:00] could do this. And they all went off to Bermuda to sort it out and obviously it didn't change everything overnight, but it did lead to changes in the mindset of the industry and the risk taking as well as changes to the way that the clearing brokers were lending and margining.
Homogeny. And I think also we could talk for a very long time about sort of 2007 and 2008, and we could also talk for a very long time about whether Amir is a good or bad mixture of the two. But I think that there are some things that have come out of the crisis, which have led to a more sophisticated industry and one which it does have, what the F c E call a compliance culture sitting much more strongly in it. And I [00:23:00] think what we're seeing now with all these very shakedowns of crypto, it's as much the human reaction that's always been there. And yes, I think you are right that it's brought about a certain amount of caution and control and it's made people slow down and that itself will mean there will be a speed up in non-criminal activities within the crypto world, I think. Absolutely. I think beyond crypto when you look at digital assets as a whole, it's a huge opportunity. All the major bank custodians are building out offerings now. There's been announcements during the course of this year and even post FDX, there's been low let up on that.
In fact, you know, that there's only been an increase in activity and an increase in communication and actually the positive impact of this kind of technology is inherently huge in terms of its potential. So, I think, even with a lot of the things that we're looking at as an organization, [00:24:00] we believe actually that things are going to move towards hybrid finance where you're going to have traditional finance that continues to exist. You're going to have centralized finance with some of these exchanges continue to exist. And you're also going to have a growing nature of decentralized finance, but they're all going to co-exist and integrate and interoperate as well.
And the moment you get coexistence and interoperability, then you start getting various forms of hybrid. And that, in effect, will lead to, as you rightly said, increased activity and increased opportunity as well, but with the right framework behind it. Because we've got to be careful, even on the regulatory side, not to stifle innovation, but there does need to be a framework.
It's a bit like, the police are there to maintain law and order but you're not calling up on them every day. But when things go wrong or things are on the verge of descending, then, you can dial them. So in that sense there does need to be that safety net there, but I think if we get it right [00:25:00] with UK P L c, we've got a massive opportunity to innovate.
And of course there's lots of innovation going on elsewhere across the globe as well. So we need to be very much at the forefront of that. Well, look. Hi Heranda. It's been an absolute pleasure. I wonder if maybe you could come back in a few months’ time and we could talk about the progress we've seen that, we are both sort of predicting and in, even in a short time.
And also baby talk a bit more about hybrids because I think that is something that we are going to see an increasing amount of movement in. And maybe in a few months’ time, we can talk about that in a bit more detail and we'll be at the beginning of that movement and we can take our listeners with us.
Yeah, I'd love to, and it'd be my pleasure as well, Claire. Hi Heranda. Thank you very much. It's been an absolute pleasure. Thank you everybody for listening to us. If you want to get in touch with either of us, then you just need to look for Cummings Pep on the website, cummingspep.com, and Hi Heranda. Tell us all where we can find you and [00:26:00] communicate with.
Yeah, GMEX - https://www.gmex-group.com/ and I'm very active on LinkedIn as well, so feel free to reach out. I'll see you a lot there and it's all very useful content, so thank you, Heranda on behalf of myself and all listeners. Thank you very much. And to all listeners, thank you very much as well. See you next time.
Thank you. Bye-bye.