Talk You Book: How to Fix the Plumbing of the Financial System

0:00Today's Animal Spirits Talk Your Book is brought to you by Chainlink. Go to Chainlink. Chainlink to learn more about how Chainlink is trying to create the industry standard platform for capital markets on chain and empower the majority of decentralized finance. That's Chainlink to learn more. Welcome to Animal Spirits, a show about markets, life and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:38Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:46Welcome to Animal Spirits with Michael and Ben. Michael, I think we found the use case for crypto, potentially. I think the traditional finance people, we've talked to a handful of people who've made the shift from TradFi, which is a word I just don't like. I don't know why. TradFi doesn't do it for me. But traditional finance into crypto. And those conversations are usually around people who understand it from the Rails perspective, right? Like how the financial system works, the stuff that we usually don't see, the plumbing, as they say, right? So it's the transactions, it's the cost of transactions, it's the speed of transactions.

1:19And the whole idea is that the blockchain technology and crypto can help make those things more cost-effective, more efficient, and faster. That's it. I think that's the hope, right? I always say that's it. I mean, that's everything. It's the whole thing. Yeah. And the financial system is obviously huge. We're due for like a Windows upgrade, right? That's what it seems like. Getting from here to there is obviously the hard part that no one knows about. The timing of it, obviously. Today, we talked to Ryan Lavelle. Ryan is the director of Capital Markets at Chainlink Labs. And Chainlink is essentially trying to do this.

1:50They're trying to take all these other blockchains, how many of them there are, and bring them together and be like the middleman, for lack of a better term, to make all these rails happen. And we're still at the early innings because they're still figuring out all the regulation behind this. The rules are being written as we speak. But I think Ryan, who actually comes from Vanguard, is an interesting person to talk about this stuff because he's worked in the plumbing for his career. So here's our talk with Ryan Lovell from Chainlink.

2:22Ryan, welcome to the show. Pleasure to be here. Pleasure is ours. So let's start here. Before we get into Chainlink and the Oracle and the tokens and the stables and all this good stuff, I want to learn about you, Ryan, because I can't imagine that there are dozens, forget about hundreds, of former Vanguard employees that now work in the crypto industry. So I would love to know your origin story. How did you get, is it red pill? Is that what they say? It's the red pill, right? Just remember, in 1975, Bogle did have a disruptive idea, right? It did get very boring because everyone else just copied it and passive indexing took over the world.

3:14But it really starts from a point of curiosity on how markets work and how the plumbing of market works. And I think that if you've just interacted with a brokerage platform, there's this smooth surface that you think this is how things occur. I click button, stock appears on the website. I click button, mutual fund appears in my account. But there's obviously this iceberg under the ocean, which is the plumbing. And at Vanguard, I worked more on the institutional custom side. So a large client would come in and they'd say, I want nothing off the shelf, but I want something crazy. like a custom stable value fund or like a custom separately managed account.

4:07And the team was that I was on managed all of that like soup to nuts. So I really got to understand just, you know, settlement systems, clearing systems, custody systems. And then the very moment that you learn how these things work, it kind of naturally leads you to this technology. so started to get into this technology around 2017 2018 and then during covid when kind of like this giant wave of shall we say like institutions started to dip dip their toes into this space it was almost like it was like it was safe now like this is not going away like people are starting to invest large entities are going to start like talking about it so So I made the shift four years ago to come from Vanguard directly over to Chainlink.

5:03So it's been a wild ride. So we have the biggest, deepest, most liquid financial markets in the world. So obviously, we're doing something right. But obviously, there's ways to improve that. So maybe you could start by talking about like, what do we do right here with the plumbing of the financial system? And what do we need to improve upon? So I think like what we did right was react to what happened in the late 60s, which was it was all paper and paper crisis occurred and the infrastructure couldn't handle all of this processing of paper. At the same time, technology, the NASDAQ just started.

5:42I think what we did right was dematerialize paper into essentially database technology. What really hasn't happened is that same technology that's been in place since 1975 hasn't really changed. So it's still end of day batch based. You're still buying essentially like static things, just entries in a database. And I think that in the same way that you're thinking about this from like a foundational infrastructure perspective, this would be the moment of like what I feel like going from wood to steel. It's just a better material to build financial market structure out of that takes us from like the paper era to the database era into now where we're entering the blockchain based era.

6:40So I am experiencing the wood. I moved money into my brokerage account on Tuesday of last week, and I needed to move it back, and it didn't settle until today. I don't know if it's eight or nine business days, and it's outrageous. How is this possible? It's crazy, right? Because it goes back to plumbing. Are you guys familiar with the ACH system? No. I used ACH, but tell me why it's such a piece of garbage. The ACH system is essentially, there's no confirmation that the payment has actually received the destination. So it's simply a file, which is a set of instructions, which is telling an originating institution, send money from Ryan's institution to Michael's institution.

7:39But Michael's institution never tells Ryan's institution that you've gotten the money. So you kind of just send it. And the reason it takes three to five days is because if there's any issues, there needs to be like a timing lag to figure out why Michael's institution never received the money because there's no positive confirmation, which is simply just old plumbing, end of day, batch-based cycles, no instant settlement. But more importantly, there's no confirmation. The system is not sending another system a confirmation back that your money is there, which is kind of crazy in this day and age.

8:22I guess the wire fixes this. I could have just paid 25 bucks and have done it that way, which I guess I'll do going forward. But nevertheless, I know a lot of things are still ACH-based, so super annoying there. What is it about Chainlink that got you excited? Because there's all sorts of different technologies in the space. What is it that's unique about Chainlink that you said, I want to go spend my life building there? Yeah, for sure. In the 2017, 2018, 2019 era, there was this belief that there was going to be one or two blockchains, and that was it. It was like there was going to be a private blockchain for institutions and then a public blockchain for DeFi or more crypto natives.

9:09the opposite has happened. And I was kind of early on in seeing this, which is that in the same way that like the database industry, it became like cheaper to create a database, faster and efficient to create a database. It's become faster and efficient to create a blockchain. So there's so much fragmentation out there and different blockchains. And to weigh that decision, I wanted to be in a place that's completely neutral and agnostic to the different blockchains that kind of sits as like an orchestration layer that helps all of these blockchains talk to one another. So that was really exciting for me is you're not taking like an individual bet that Ethereum is going to win or Solana is going to win.

9:59You're taking a bet that like the whole ecosystem is going to win because Chainlink really sits as like the neutral kind of connective tissue that kind of makes all this work at scale. So the one thing people have been saying that the crypto skeptics have been saying for years is show me the use case, right? Show me what it is. And I think what you're saying is the plumbing is the use case. Is that that fair? Right? That like we can we can rewrite the whole plumbing. Now, what is what's the bottleneck here? Is it just the legacy financial system in the inertia? And hey, hey, we do it this way because we've always done it this way.

10:34Like, what are you running up against? What's the brick wall you're running up against that's going to make this hard to do? Because I assume that this is not going to be easy to totally transform the plumbing like this. I think what we've seen is like different phases where there's been institutional toe dipping and they're waiting on things like regulatory clarity. But since all of that has changed now, a lot of these institutions are opening up their existing infrastructure for settlement, trading, utility on the different public blockchains. And this is just going to take more time than I think we originally hoped because a lot of this foundational kind of clarity has only come in in the past couple months or so.

11:21And even Clarity Act is coming. So there was almost a risk, Ben, in like you could have put a lot of investment in a certain type of application. But without clarity, you may have had run the risk of like just tearing the whole thing down because you couldn't do it. And I think that that's been like foundational in what's holding back adoption. So the one thing I've heard that like the best case, best use case for this or the best, like the pro argument for this is, listen, call it what you want. I don't know if it's 1 % fee extraction or two, whatever the financial system takes out of everyone else, right?

11:58I don't know what the actual number is. that if we did this, we can kind of eliminate the majority of those fees. So my question is, what's the incentive for the big banks to go along with this? Or are they going to have to be pulled kicking and screaming into this? Think about this. With the iPhone launched, and I love analogies, so we'll use analogies. Banks didn't think we need to rebuild our entire infrastructure for mobile. They thought we need a mobile app, a thin interface layer on top of existing systems. But look what happened. Like over time, mobile became like the primary interface for most customers.

12:37So the banks that won weren't those with like the best app skins. They were the ones who like re-architected around like mobile first experiences. Venmo, Cash App, Robinhood, they didn't like port desktop experiences to like the iPhone. They built from scratch. So I think to answer your specific question, if you aren't thinking about how to service the wallet in the same way that you may have not been thinking about servicing the iPhone, there are competitors out there with licenses that have ATS licenses, that have transfer agent licenses. I think the Fed has been more open around opening up potentially the master account to different types of stablecoin issuers.

13:33You can't ignore these competitors anymore. And I don't think you can ignore it and say, well, let me pull you back into my legacy rails. I think the competitive forces of like the new emerging fintechs, very similar to the fintechs that won the mobile revolution, are competitive forces. It's kind of like Robinhood. They did zero dollar trading. All these other firms had to go along with it because guess what? You had to. Right. Yeah. And I think both of you guys know this. We're sitting kind of at the impetus of like the largest wealth transfer the world has ever seen coming up in the next five to 10 years.

14:11And it's like, okay, if the average age of an investor at Vanguard or BlackRock or Fidelity is 65 to 75, and they're used to this static, set it and forget it, my financial advisors got it in the 60-40 Benjamin Graham model portfolio, they're going to be in for a rude awakening. if that gets passed down and someone's like, well, I'm going to transfer this to Robinhood and all of my financial services and the experiences I am are there. That's a reality of just how things could shake out over the next 5, 10, 15 years. Let's talk about a headline that we got last week. This is the Wall Street Journal.

14:58The New York Stock Exchange said Monday that it was developing a platform for trading tokenized securities, putting the heft of the 233-year-old exchange behind Wall Street's growing embrace of the technology behind Bitcoin. All right, my first question is this. What is the benefit to tokenized securities that trade 24-7? So I think 24-7 is a feature, right? And I'm going to go back to the wood to steel analogy. The biggest benefit is not necessarily cost savings, operational efficiency, settlement times. Those things really matter. But when you think about it as in the lens of programmability and composability, that's where the real benefits come through.

15:52So on-chain assets are different because they're software objects that interact with other software objects. Let me give you an example. A tokenized treasury bill could simultaneously serve as collateral for a loan, earn yield, be fractionalized, all through smart contracts that execute automatically. So let's use another analogy. Right. So but before Spotify, right, you bought albums. They were discrete static bundles. If you wanted songs from 10 artists, you bought 10 albums. The music was trapped in a container, a CD. After Spotify, music became easily composable at a user level. So individual tracks flow into playlists, algorithmically generated mixes, social sharing like the platform learns your preferences.

16:47Music became programmable at a user level. So when you think of the outcome of all of this tokenization, instead of buying a mutual fund or an individual stock, hence the static bundle, you're buying this dynamic thing that can respond in real time. So things become massively flexible because of the programmability and composability of the asset. And I think the fund managers have the most to gain here. Because going back to my Vanguard days, to set up a new fund, it had to be scalable. It had to be like, because the cost of setting up a new fund and composing it in a static way had to meet the needs of like, let's say, 50 ,000 people.

17:36If you get faster, more composable, flexible infrastructure, and Michael may want his own custom fund and his advisor wants his own custom fund and Ben wants his own custom fund, the very moment you can spin those things up, there needs to be proper liquidity venues that can cater to that type of format. That is like what the New York Stock Exchange and a lot of these other exchanges see is like there are service providers that just have to have that capability. Otherwise, they may miss the boat on, you know, who is an execution venue that could be, you know, front running kind of the future of what that could look like.

18:18So where does Chainlink sit on this whole thing? Like, what is it that you guys do? What are you trying to facilitate? Like, where do you sit in this whole process? Think of Chainlink as a global standard on how to get data into, out of blockchains, as well as how to connect chains with each other so that the transactions that occur on the New York Stock Exchange can work in like a secure, reliable, compliant way. So, so far, our system has processed and enabled over$27 trillion in US transactional value. We're very widely adopted in DeFi, but now we're becoming more widely adopted in capital markets.

19:00We work a lot with these firms already. We work with SWIFT, DTCC, JP Morgan, UBS. So think of this as connective tissue. All right. So getting back to the tokenized stuff that NYC is doing and presumably others will follow suit. What do you think this means for the end investor? Is there going to be 36 different wallets or is this going to be integrated at the custodial level? How do you think people are going to interact with these tokenized securities? The biggest benefit to the investor is really just that composability. And I think for the first time, you're going to have optionality on if you want to do self-custody or rely on a custodian.

19:47Something that just hasn't been available in the system so far. Because I think that there's two worlds, right? There's compliant capital. And I'm sure Michael and Ben, you're both familiar with DeFi. There's non-compliant capital. So in the non-compliant capital world, you have the permissionless innovation that's occurring in DeFi. You can clear trades at a market setting price that a protocol determines. It's called an AMM. You have a peer-to-peer borrowing and lending protocol where you don't necessarily need a bank to do that. It's called Aave. So what we're trying to really do at Chainlink is merge both of those worlds into a way to do that in a secure and compliant way.

20:44so that the investor of the future all of a sudden now has optionality into self-custody and directly interacting with a lot of this permissionless innovation, which is brand new for the industry, in a compliant way, which means KYC, AML, who am I interacting with? Is that secure? How am I getting yield? Is that compliant yield? We're kind of sitting in between of like, how do you merge these two worlds of like non-compliant to compliant to create like brand new products? Is the hope that people will be using blockchains, but they won't really even notice? Exactly. Yeah. Is that the best case scenario where you're using all these new technology and it's faster and maybe you're getting a yield and you're able to borrow against it.

21:34But most people, it's just a line out of their screen and they can't even tell they're using it. You're exactly right. Like the Robinhood UX, we're not going to disrupt that. That is extremely mature and very good. What you do have now, though, is, okay, I have options on a yield strategy. What is your yield strategy? Do I have it? Like, say, interest rates come down back to zero again, right? Which, you know, may or may not happen. All of a sudden, people are going to say, where am I going to get yield from with 0 % interest rates? Okay, there's protocols out there that are facilitating yield from user-to-user interactions.

22:15But to get to those applications, it's kind of complicated. You got to use a wallet, you got to manage private key, you got to sign transactions. I think that's where we're headed in the future is like a lot of these existing platforms and user experiences. And this is a lot of what Chainlink does today is we abstract a lot of this complexity. so those platforms can interact with these applications is that you say, hey, let me adjust the slider here. If we have a 0 % SOFR, maybe I want to go out the risk curve to 4%. Okay, which approved protocols can we deploy your capital? X, Y, Z. I have$10 ,000.

22:53Deploy that in those three different applications and give me a yield bearing instrument that I would have had before because now I can interact with DeFi protocols that can give me yield at a 0 % market environment without actually having to know and knowledge. But these platforms need help. These brokerage platforms need help in validating who are your blue chip applications? How is that yield being generated? And this also goes into the regulatory environment as well. I think you're exactly right in kind of like a long-winded answer and saying like, it's the exact, like it's going to be all abstracted away.

23:32You're not going to know you're interacting with the blockchain. I think there are advanced users who want to do that. Like if you're a hardcore user and like, you know, you believe and you should keep your money under your mattress. So this is like a new way of doing this where it's like I self-custody stable coins now is like the new kind of like money under the mattress. So yeah, there's going to be different levels of, you know, users. But all in all, I'm pretty excited about where we're headed. And hopefully you guys are too. This future, well, we'll see. I'm just kidding. This future that you're describing, no, I am very excited to not have to wait eight business days for my money to be my money.

24:12This future that we're describing, do you think this is 12 to 18 months away? Is this like five or 15 years away? What's your best guess? So my best guess is that right now you have$300 billion in stablecoins. By all intents and purposes, compared to an asset manager, that's not that massive amount of money. So they settle a quadrillion dollars, bring those assets on chain. I think what you're going to see in the next 12 to 18 months is foundational infrastructure, which is like the first or second inning in figuring out how do we get equities on chain? How do we get equities to interact with stable coins?

25:02How do on-chain applications adhere to existing security laws, such as national best bid, best offer? I think you're going to see a lot of the large qualified custodians, right? Like I'll give you an example. Bank of New York Mellon has$40 trillion,$50 trillion in assets under custody. I think firms like that, State Street, JP Morgan, they're going to finally start to offer custody solutions in this space. And that's going to really unlock, I think, the third and fourth inning, which is probably three or four years away when we get to see sort of this adoption at scale. Because the existing players today, and I'm going back to what I said earlier, only a couple months ago had clarity from the OCC that they can hold cryptocurrency and pay for fees in cryptocurrency.

25:53So the regulatory clarity is there. And a lot of these players are going to offer products and services in this industry. And this is just foundational infrastructure that we need in place first before we can get to the mass adoption phase. So Ryan, who are your customers? Are your customers, your clients, is it the blockchains? Is it financial institutions? Like who are you working with? Both. Okay. One of the core beliefs at Chainlink is that existing systems are not going away. Like the Swift system, like the ACH system, like all these different systems, there's too much value on them today.

26:33Like all of Michael's money at the wire he had to wait for. There's just too much money and value on these systems today. And the cost of replacing them and just putting them on a blockchain is just far too great. So what we really do at Chainlink is we say, okay, don't replace your existing system. But what we do is we add additional capabilities to that existing tech stack. So I'll give you an example. Swift has been in business for over 50 years right now. I think they just celebrated their 50th anniversary. industry, they've created a set of standards on how financial messaging and how different components of the financial industry communicate with one another.

27:12There's no reason to change that. So what we do is we integrate with a lot of these existing standards to make them talk and communicate with blockchains. The other half of this is blockchains themselves, which need our core services, which is data, which is cross-chain connectivity, which is orchestration to a lot of these TradFi players. When I say connective tissue, like we really are kind of sitting, everything a blockchain can't do as a service, we're like a feature and an additional capability to that specific blockchain, if that makes sense. So Ryan, anything else we missed that you wanted to cover today?

27:50What do you guys think? As a whole, I think we talked a lot about like what we do, where we fit into the ecosystem, what are the benefits? And like the big thing was about, this is not about like a specific use case. This is like foundational infrastructure. All right, Ryan. So if this is the way that the financial system is going, is Chainlink going to win regardless of what the dominant blockchain is? Like in other words, if the tokenization is powered by the Ethereum blockchain or a blockchain that doesn't even exist today? Like, are you guys positioned well, regardless of who ultimately wins, even if there's multiple winners?

28:31We are positioned extremely well. What hasn't happened is that there hasn't been a single blockchain that has won the market because of certain restrictions around scale and speed and features. So some features, some blockchains don't have privacy of transactions, some do. Some blockchains have faster transactions. Some do. It's no different than the existing financial system. You use the Fedwire to do high value, like infrequent payments. You use ACH to do smaller, more frequent payments. Use MasterCard system to process certain transactions from a car. That is going to be no different in the blockchain world.