Transcription:
Penny Crosman (00:04):
Welcome to the American Banker Podcast. I'm Penny Crosman. In several recent projects, Ethereum has been the distributed ledger of choice among financial institutions. Fidelity Investments launched its stablecoin, Fidelity Digital Dollar, on Ethereum, JPMorganChase, Citi, Vantage Bank and Custodia Bank all use Ethereum on some level for their tokenized deposits. I'm not sure everyone understands what Ethereum is and how it's different from other distributed ledger options like Solana and Hyperledger. So I brought in Paul Brody, global blockchain leader at EY and chairman of the Enterprise Ethereum Alliance, who knows everything there is to know about Ethereum. Welcome, Paul.
Paul Brody (00:48):
Welcome. Thank you. I'm sure that somebody like Vitalik [Buterin, creator of Ethereum] might disagree that I know everything there is to know about Ethereum, but I will say that I know a fair amount and I've been around for a while.
Penny Crosman (00:59):
You know more than I do, so that will suffice for this podcast. So let's start with the most basic question. What is Ethereum? Can you tell us a little bit about the history of it and kind of paint a picture of what it is?
Paul Brody (01:15):
Absolutely. So Ethereum is the OG smart contract blockchain. And its origin dates back to I think about 2013 or early 2014 when people were really starting to get into Bitcoin. And I was actually one of those people when I was back at IBM. We were building some distributed computing work on Bitcoin. And what we discovered very quickly is that Bitcoin is not programmable. It is a distributed computing system that is very clever in its ability to distribute work and get consensus on important decisions, but it doesn't let you do very much. And so very early on, Vitalik Buterin and a few other people had this idea, Hey, we need something like Bitcoin. But instead of it just being for money, we want to have this idea of a world computer, a computer that can be distributed across the entire world and can reach consensus, not just on payments and transactions, but on any arbitrary type of software work. And that was the original concept of Ethereum. That's how I got introduced to it. We were struggling to make some stuff work with Bitcoin, and when a member of my team came to me and said, Paul, we could do this, but with this thing called Ethereum, we've met this guy, he's got this idea, it's going to be faster and fully programmable. It's like, yes, that is what we want. And so that is the origin of Ethereum, which is this idea of it is the original programmable blockchain system
Penny Crosman (02:47):
And applications can be written for it and smart contracts can be written for it. Can you say a little bit about that?
Paul Brody (02:57):
Yes. So basically Ethereum and small contract blockchains generally are made up of three things. This is kind of how I think about it. Number one, they contain tokens, which are just the items of value: money, assets, et cetera. Number two, they have wallets which are user IDs, user identification. It's where you keep your items of value. And then lastly, they have smart contracts. And you can use smart contracts to really do two things. Number one, you can use a smart contract to define any type of asset. This is really important. You can define an asset, it can be a fungible asset, a non fungible asset. It can be pegged to the U.S. dollar, it could be pegged to gold, it could be calculated in some way. So you can use a smart contract to define an asset, and you can also use a smart contract to define how two parties might interact or exchange assets or many parties might do.
(03:57):
So basically write a sort of computer program around that. And when I fully understood this, and it took me a while to fully understand it, but when I fully understood this, I had this light bulb moment, which is that basically every business deal on earth is some variation of a very simple framework, which is that one party has money and the other party has stuff and we're exchanging money for stuff. That's it under the terms of some kind of agreement, that's it, that represents 100% of all the business agreements on earth. And with those things, tokens and smart contracts, I can define the money, I can define the stuff and I can define the terms of an agreement, therefore I can run any business agreement that I can think of in this Ethereum ecosystem. It was like this light bulb went on my head. It was like, oh my gosh, this is going to be revolutionary.
Penny Crosman (04:50):
And what are some of the top use cases today for Ethereum for financial services?
Paul Brody (04:57):
So the main one, the one that has kind of really come out from the beginning as the blockbuster use case are stablecoins. Although people spend a lot of time worrying about cryptocurrency, by far, the thing that people want is they want regular currencies, but they want to make them programmable and transactable. They want to be able to do things like borrow against the value of their assets or send payments easily and quickly. And this completely open, decentralized, smart contract system allowed people to define money and start building applications on top of it with a speed and flexibility that just isn't possible in the traditional financial system, so on. And then on this base of stablecoins, which are dollars or euros or yen, but mostly dollars, you can layer on top of that, any other type of business agreement. You can do inventory tracking, procurement, structured lending, perpetual futures you can do. Any kind of financial transaction that you can do in a traditional exchange, you can turn into a piece of software and run it on Ethereum.
Penny Crosman (06:13):
You mentioned the speed of it and you wrote a BankThink for American Banker, an op-ed for us, where you said in its early days, Ethereum could not handle high volumes of high-speed transactions, but now it can handle 200 to 450 million transactions a day. What made that possible?
Paul Brody (06:33):
So the thing that made that possible, and the thing that really is, I would call it the secret sauce of Ethereum success over the decade is the fact that the Ethereum Foundation and the Ethereum ecosystem have continually been making updates and improvements. The original version wasn't very fast at all. It was a 1.0 version and it was clunky and clumsy and complicated and every six to nine months and getting a little bit more quickly. Recently, the Ethereum ecosystem has been releasing a new iteration of the core software, and over the last decade or so, there's been three really big transformational changes that have come from these software releases. The first is its transition from proof of work to proof of stake, and this basically changed how Ethereum validates transactions to make it vastly more efficient. It basically reduced the carbon footprint of transaction processing by 99.9%.
(07:44):
Secondly, the Ethereum ecosystem created Layer-2 networks. These are basically ways to scale the network infrastructure so that you can add your own proprietary attachment network to Ethereum. And this was done to make the network faster so you could sort of add capacity, have sort of little network shards that ran things independently and then synced up together with the main net. But it turned out to be incredibly valuable. And one of the big reasons why banks and other entities choose Ethereum is because any arbitrary corporation, business, whatever, you can set up your own mini network on top of Ethereum. So you can tap into the ecosystem's robustness, you can tap into the liquidity of the whole ecosystem. You can borrow from the security of the ecosystem, but you can build your own private infrastructure. One of the reasons why it's so compelling is that it's like a halfway house between having your own private blockchain and being on a public blockchain. And that's why you have Robinhood and Anchorage and Coinbase and so many companies not just building on Ethereum but building their own layer to private networks.
Penny Crosman (09:01):
Oh, sorry.
Paul Brody (09:02):
Sorry. There was one more change, which is that Ethereum itself is rearchitecting itself simply to handle many more transactions at the main net level as well. So it's scaling effectively in both a horizontal and a vertical manner.
Penny Crosman (09:18):
So if a bank decided it wanted to launch a stablecoin or a tokenized deposit or some other kind of asset on Ethereum, how big of a tech lift, how much technology effort and resources would have to be put into such a project?
Paul Brody (09:37):
Actually, remarkably little. So one of the big attractions of using a public blockchain is that you're tapping into this vast existing public infrastructure. So there's a ton of service providers, there's a ton of software built, there's open standards, the whole programming language, the Ethereum virtual machine is a widely used open standard. So the tech lift to launch these things is much smaller and much cheaper than, say, building your own private network. That's a big attraction. And you get to leverage all the existing standards. So you can, in theory at this point, you could white label the whole thing and you get other people to do it, and you could get it done very, very quickly. Startups are doing these things with three or four people and some good AI coding tools. I think the big thing that is in this space, it's worth spending money on is security and risk management. It's very easy to launch a token. It's very hard to make sure that if you are doing something that involves moving money, you need to really think more like a bank. And it's not the launching that's hard, it's the sustained security and vigilance that's important.
Penny Crosman (10:53):
So I think some banks are waiting for firm guidance from their regulators before they go too far down this road, as they've gone down this road in the past and then they've had to backtrack due to various problems in the past, like FTX's collapse and so forth. How much can they do today without worrying about what the regulators think?
Paul Brody (11:20):
Today in the U. S., the answer is almost everything. And I wouldn't say that they can do things without worrying about what the regulators think, but I think that what they can do is that they can do things without worrying that they will be arbitrarily singled out for a particular reason. So there's just a lot more confidence that the regulators are interested in constructively finding solutions to all the open issues. One European regulator described the U.S. environment as in a shifting from one of enforcement without rules to one that's much more rules-based and that makes people much more confident. The GENIUS Act in particular really opened the floodgates because that was very focused on stable coins. Stablecoins are the building blocks of almost all these types of applications. So once the floodgates were open with the Genius Act, people felt comfortable launching them. And that's why you've seen so many stablecoin announcements in particular. And although it's not come quite as fast, we're going to see a similar good number of tokenized securities things come. It'll again, be much faster if the Clarity Act gets passed, but even if it doesn't, it'll still move on at a pretty decent pace.
Penny Crosman (12:42):
So you're chairman of the Enterprise Ethereum Alliance. What is that? What exactly does it do?
Paul Brody (12:49):
We are an industry group for companies that are building their businesses in Ethereum, and we are set up as a talking shop for people to do. So we have the antitrust infrastructure to allow industry members to come together and discuss certain topics about things like technical standards, evolution of business models and things like that. Largely, we host events, meetups, conversations, networking. We are very explicitly not a lobbying organization, but we do host lots of discussions with policymakers and try to hear what they're saying and get their message out to the industry.
Penny Crosman (13:32):
And who are some of its members? Any names we might recognize?
Paul Brody (13:36):
Well, of course EY, Microsoft, JPMorgan. We just announced today actually Polygon is rejoining. I think Accenture is a member currently. So there's a ton of companies. We've got block apps, consensus, we have a huge range. I think we have about 75 members right now. We have a huge range of companies from very small crypto native startups to some of the world's largest banks.
Penny Crosman (14:05):
What other challenges do you think people might need to work through if they're thinking about working with Ethereum and how do they work through those?
Paul Brody (14:15):
So I think right now, Ethereum, the technology industry loves the standard. And if you think of Ethereum, not as a FinTech or financial tech item, but as just a general programming environment, it's showing all the hallmarks of becoming a standard like Windows or TCP/IP. So I personally think Ethereum itself is on a very good path. I think more generally for banks and financial institutions that are trying to navigate this blockchain and digital asset ecosystem, one of the most important challenges that they have to deal with right now where there's two challenges in particular that I'm starting to hear a lot about from clients. The first is that historically in banking and finance, every product market had its own unique tech stack. So the stock market was one system, the bond market was another system, the banking system was another system, and they were all completely different. Blockchains mushed them all together, one set of infrastructure that handles every asset, and that is very disruptive to the internal mechanics of how a lot of banks work. So that's one thing that they're trying to navigate because their whole technology infrastructure historically is siloed by its market type.
(15:45):
Second big issue that banks and other enterprises need to think about is that the crypto ecosystem, the blockchain digital asset ecosystem is not one unified market. It's actually several different markets. And it's really important to understand where your customers are coming from and who you're actually serving. And what I mean by this is a lot of the great long-term historical participation in this marketplace has come from people outside the United States who've been shut out of the traditional banking system, particularly the U.S. banking system. So if you go look at a lot of these crypto native apps, especially just the fully decentralized wallet based applications, their users are all over the world, but especially in emerging markets. And a big part of the demand for U.S. dollars comes from the fact that these users, they often operate in countries that don't have really robust independent central banks and stable currencies.
(16:49):
So one thing that's going on is you have this massive emerging markets group. They have an entirely different set of needs and requirements and customer issues than the new set of customers that's driving explosive growth right now, which are western institutions that want to use stable coins to drive down their operating costs by shifting away from traditional international payments or traditional complex contract management systems. Those companies have an entire, so if you're a shop owner in a small country and you have an individual self-hosted wallet, you are not so fussy about what the regulations say because your local equivalent to the SEC doesn't have the time or energy to prosecute you for the $50,000 you're holding. But if you're a big bank, you care a lot about being fully inside the regulated infrastructure. These two markets are operating in the same infrastructure. The dollars are flowing across this ecosystem.
(17:51):
It's very important to understand though that what you can sell to a small business owner in an emerging market who's dealing in a legal gray area, the gray economy in U.S. dollars is very different than what you can do between a big US corporation and their overseas subsidiary. We often get requests from clients like, Hey, we would love to use stable coins instead of whatever our currency is to interact with our parent company in the us. Can we do that? And we have to tell them, no, you can't because you guys can't afford to operate in a legal gray area, and you're definitely big enough that your local regulators are going to care about this, and we certainly can't help you do something that might not be legal.
Penny Crosman (18:35):
Interesting.
Paul Brody (18:36):
So this is a multi-track market and everybody needs to keep that in mind as they think about where their money is going.
Penny Crosman (18:44):
Very interesting. Well, Paul Brody, thank you so much for joining us today, and to all of you, thank you for listening to the American Banker Podcast. I produced this episode with audio production by Adnan Khan,. Special thanks this week to Paul Brody at EY. Rate Us. Review us and subscribe to our content at www.americanbanker.com/subscribe. For American Banker, I'm Penny Crosman and thanks for listening.