It’s been a crazy week. I won’t opine on what happened with Silvergate and Silicon Valley Bank in this email. Will discuss this further in coming days.

This is a quick note to reassure you that we at Layer2 have had zero loss of client or corporate funds as a result of these two events. In fact, we engineered our  platform from the ground up to be multi-partner, to mitigate these types of risks. 

1. Silvergate –
   1. We did NOT have any corporate funds held at Silvergate. However, Silvergate was the settlement bank for one  of our liquidity/exchange partners.
   2. We, along with our exchange partner, proactively halted trading on the first sign of trouble, immediately settled open trades and wired out ALL in transit client funds from Silvergate.
2. Silicon Valley Bank –
   1. We are fortunate that we did NOT have any corporate or client funds held at Silicon Valley Bank, either directly or via partners.
   2. Many of our friends, partners, clients however have been severely impacted and we will do what we can to assist them in any way we can.
   3. Once this crisis passes, there is a broader discussion to be had around how to spread assets between various deposit accounts, and deposit/treasury accounts. 

What are we doing to help our clients mitigate these types of risks?

1. Multi-partner – Layer2’s  Banking/Payment as a Service platform was engineered from the ground up to be multi-partner, all accessible via a Single API, which means:
   • multi-custodial – 2 qualified crypto custodians  (1 OCC bank, 1 Trust)
   • multi-exchange – 5+ crypto, fx exchanges/ liquidity partners
   • multi-bank – 4 fiat banks, trusts for fiat deposit, treasury, payment products
2. Safe, qualified custody – While we are a Money Transmitter in some jurisdictions, we strongly believe that Money Transmitters should use qualified custodians.
   • Qualified custody – All client digital assets are always kept safely with multiple qualified custodial trusts.
   • Full transparency, control – Clients have full transparency, and control of their assets. Funds are never used to lend out to counterparties, unless you choose to lend it to a licensed lending facility.
   • No co-mingling – We (Layer2 + our partners)  will never co-mingle corporate funds with clients funds. 
3. Fiat Treasury Accounts –  We are launching treasury accounts in the US very shortly. Assets are backed by US Treasury Bills (fully transparent) and kept off balance sheet, safely at a trust. More to come on this new feature.

If you have any questions, or concerns, please reach out to us via your dedicated slack channels or support@layer2financial.com.

As a financial institution or financial technology company you must find a balance between mitigating risk and exploring new opportunities. Thankfully, by adopting a multi-partner model you achieve both.

A multi-partner model is where a company works with multiple partners (e.g. custodians / exchanges), by leveraging a combination of products across the various partners. This is in contrast to choosing only one partner and being limited to the products they support.

Financial institutions and fintechs should approach custodying and trading digital assets like their cloud infrastructure. If you asked your technology team to host all of your technology infrastructure with one cloud provider, they would explain at length why that is a bad idea. It’s best practice for companies to use multiple cloud providers (e.g. AWS, Azure, GCP) instead only relying on one.

The same is true for digital assets. A multi-custodian model spreads assets (and risk) across multiple custodians and banks, while a multi-exchange model uses multiple exchanges and liquidity providers to broaden trading options.

In a multi-custody model, an institution uses multiple crypto custodians and or banks to hold assets (fiat + digital assets). You might hold 50% of assets on Coinbase and 50% on Gemini. Or a third each on Coinbase, Gemini, and Anchorage.

The exact split will be down to customer preference and market incentives (such as insurance limits). This model helps companies and customers in three ways.

1. Risk Management

When you use a single custodian, you are completely reliant on that custodian. This is a fundamental issue with digital assets, all the way down to self-custody—if everything is in one cold wallet and you lose the private key or secret phrase to that wallet, you’re out of luck.

The same goes for using custodian services. If all your customers’ assets are with a single custodian, any problem with that custodian propagates down to you and your customers. In this rapidly changing crypto environment, we’ve seen this at least twice in recent months:

1. Crypto banking firm Juno had custodian Wyre as its single custodial option. When Wyre started experiencing liquidity issues in late 2022, this led to Juno having to stop deposits and tell current customers to withdraw their funds.
2. Crypto company FTX was acting as a custodian as well as an exchange. When FTX went bankrupt anyone with their assets custodied at FTX lost access to their funds. These people are now embroiled in a legal battle to recover their assets.

With multi-custody, these issues are mitigated. If one custody partner goes down, assets are still available via other custodians. If assets are locked in a legal tussle, other assets can still be called upon from other custody partners. Even with temporary technical failures, your customers can always access at least a portion of their assets.

2. Compliance with Regulations

Though the concept of country or continental borders doesn’t really work with blockchains, digital assets are still subject to different regulations in different countries. Two recent examples.

1. The wider tech analogy here is with GDPR. With GDPR, EU regulators want to restrict the storing and processing of EU citizens’ data outside of the EU. This requires global companies to have servers, data centers, and teams within the EU specifically for EU customers’ data. They have a multi-cloud approach imposed on them.
2. Likely, a similar issue will come to crypto where US or EU regulators want their citizens’ assets custodied in their domain. EU regulators will want EU customers’ assets custodied within Europe, and US regulators will want US customers’ assets in the US. If you are working with customers around the world, you’ll need custody partners in different jurisdictions to support these customers.

Complying with emerging regulation is going to mean that fintechs looking to operate in multiple jurisdictions will have to work with multiple partners.

3. Customer Protection

Using multiple partners to custody fiat assets (banks), means you can utilize the FDIC insurance of all banks to insure more of your customers’ money. The limit for FDIC insurance is $250k per depositor, per bank, for each type of asset. So a multi-bank (i.e. multi-custody) approach is used for fiat as well. You can spread your money across multiple banks, taking advantage of the insurance per bank. So if you invest $750k in one bank, only $250k is insured; if you split that $750k equally over three banks, all $750k is insured.

Though crypto insurance is nascent, you can take advantage of insurance across custodians with a multi-custody approach rather than being subject to a single insurance policy with just one custodian.

A multi-liquidity approach uses multiple exchanges and liquidity providers to expand trading options and services for end users. Multi liquidity does help mitigate risk—e.g. outages at one exchange will not stop your operations—but the main benefit of a multi-liquidity model is that customers have access to a more diverse selection of trading options, at the most competitive prices.

1. Reduce costs by ensuring you get the best prices

If you use only one exchange provider to execute trades, you are at the mercy of the prices they set and the fees they charge. By using many exchanges you can compare the prices across your partners and route trades in the most cost effective manner.

Exchange A may charge fees of 25 BPS (basis points/0.25%) for BTC-USD trades, and 15 BPS (0.15%) for USDC-USD trades. Whereas Exchange B may charge only 15 BPS for BTC-USD trades and 20 BPS on USDC-USD trades.

In this example, it makes sense for a company to route BTC-USD trades to Exchange B, and USDC-USD trades to Exchange A. A company can pass the cost savings onto customers for free or turn it into a revenue generating feature.

2. Offer a wider range of trading pairs

Different exchanges offer different trading pairs. If you are locked into one exchange, you are locked into only those trading pairs.

It also means you can’t offer more interesting and riskier trading pairs to those customers who want a higher return and will shoulder a higher risk. For example, if your exchange doesn’t support Solana, your customers can’t buy Solana. The same for niche or newer assets on the market—you cannot offer these assets to your customers until your exchange partner supports it.

3. Offer a wider range of trading products

Working with more exchange providers can give you access to different products.

• Limit orders – Exchange A may offer the ability to create limit orders as well as market order.
• Derivatives – Exchange B may have derivatives markets where customers can long and short assets.
• Leveraged Trading – Exchange C may allow customers trade with leverage, with different exchanges likely offering leverage limits.

By integrating with multiple providers, companies can provide all of these revenue generating products to their customers, whereas this would be impossible relying on only one.

4. Increased efficiency in executing trades

With a single exchange, you are locked into any problems with that exchange:

• High traffic: Cryptocurrency exchanges can experience high levels of traffic, especially during times of high market volatility. This can cause delays in processing trades and updating the order book.
• Technical issues: Technical issues such as system outages, software bugs, or network congestion can cause slowdowns on a cryptocurrency exchange.
• Poor infrastructure: Some exchanges may have poor infrastructure, such as slow servers or inadequate bandwidth, which can result in slow trading times.

If you are using multiple exchanges, you can a) split your trading volume to speed up the process from your side but also b) mitigate these problems by moving trades to better-performing platforms on demand.

This also helps during market volatility. In 2022, trading platform sFOX were able to reassure customers during a peak in volatility because they were using multiple liquidity providers. From a customer email at that time:

sFOX has taken precautionary measures to mitigate any client risk. Our trading and settlement operations continue to operate as normal, with no impact or disruptions on your activities or funds.
In addition, SFOX offers 50+ liquidity providers and during these times we are able to route customer orders to other venues.

At Layer2 Financial, we provide our clients the benefits of multi-custody, multi-exchange through one easy to use API.

By adopting these approaches you ensure a reliable and efficient fintech stack. Using multiple custodians to improve resilience, adhere to regulations, while using multiple exchange partners to drive revenue while limiting costs.

Layer2 Financial is a Crypto as a Service infrastructure that makes it easy for fintechs, banks, and neobanks to launch fully compliant crypto products, in a matter of days. Layer2 provides seamless access to compliant custody, trading, payments, fiat ramps, and yield; all through one user-friendly API. Click here to learn more.

“My guess is that in 10-20 years, we’ll see a substantial portion of GDP happening in the crypto economy.”

Brian Armstrong, Coinbase CEO (Source: Bloomberg)

How do we get one billion people using crypto and make it a “substantial portion of GDP”?

The answer lies in onboarding the world to crypto without them ever knowing. By integrating crypto products into current channels, and abstracting away complexity, people can realize the benefits of crypto without realizing they are using it.

This is similar to how Apple Card works. You don’t really have an Apple Card—there’s no such thing as an Apple bank account—you have a Goldman Sachs account. People can realize the benefits of banking with Goldman Sachs without knowing it.

Here are five ways more and more people are using crypto without realizing it, and how we’re already on the path to that one billion.

As more and more fintechs, begin integrating crypto into their product offering, they will realize that crypto can be a good method of transferring value.

Currently, people must wait for 1-3 days to send a Fedwire or ACH transaction. It is easy to see a scenario where instead of using these traditional payment rails, fintech may choose to use blockchains to transfer money. The introduction of stablecoins ensures that the money will retain its value in transit, and new scaling solutions like L2s or subnets ensure costs are kept low.

However, to the end user initiating the payment, it will look like they are sending a payment like they always do. Unbeknownst to them, their payment was sent to the payee using a blockchain. Or maybe a combination of blockchain and traditional payment rails.

On both ends, the payor and payee will not know crypto is used; all they’ll see is their regular currency. But the process is streamlined by using crypto payments. These payments can be instant and cheap, meaning that people remitting money back home will see more of their money reach their families and reach them much quicker.

More to come on this in the future.

The other opportunity for crypto investments is asset tokenization.

Tokenization is the process of representing digital or real-world assets, as a token that lives on a blockchain. Tokenization is used to increase the transferability of assets; increasing speed, reducing cost and unlocking liquidity.

These tokenized assets can be anything. They can be tokenized versions of traditional financial investments. For instance, private equity group KKR tokenized their Health Care Strategic Growth Fund on Avalanche. A primary benefit of this is that it lowers investment minimums. Whereas before, you would need millions of dollars to invest in such a fund, tokenization pulls that minimum to $100,000.

Tokenization is growing incredibly fast. Finoa predicts the tokenized market volume could be as high as $24 trillion by 2027. Boston Consulting Group puts the opportunity at $16.1 trillion by 2030. Asset markets like IntainMARKETS, are being created to manage and trade tokenized assets, such as securities, at up to 100bps fewer transaction costs.

Big banks are also getting involved:

• Goldman Sachs has recently released its own digital assets platform to make investing easier for a more significant percentage of people.
• J.P. Morgan released Onyx in 2020 as a digital asset exchange.
• HSBC is hiring a global product manager for digital assets to build its own platform.

With these technologies, more people can invest and take advantage of growth only previously available to the highest-level investors.

(source: finoa.io)

Then there are the more interesting tokenized assets: houses, cars, art, watches. You can buy a token in all of them and take advantage of their value growth. Of course, you can’t hang the Picasso on your wall but you will own a part of it and can take advantage of its upside.

This is not investment advice.

Reward points are, for the most part, pointless. You might get a free basic coffee once in a while, but the schemes are a marketing ploy.

Starbucks Odyssey is a bit different. Instead of points, Starbucks uses ‘Stamps’ to reward customers’ loyalty. People can earn stamps by buying coffee or by ‘playing interactive games or taking on fun challenges to deepen their knowledge of coffee’. The more Stamps you collect, the more cool things you can do; go to Starbucks events, buy merchandise, get access to collaborations, and even take a trip to a coffee farm.

The unique angle is that these ‘Stamps’ are NFTs on the Polygon blockchain. Like all NFTs, Stamps can be bought, sold, and transferred with others in the Polygon ecosystem. If one member is one Stamp shy of that Costa Rican coffee farm trip, they don’t have to jump through Starbucks’ ‘challenges of coffee’ hoops, instead, they can just buy their missing Stamp on an NFT marketplace.

NFTs can be used as gift cards or vouchers. The transferability of NFTs means that if you receive an NFT gift card for a brand you don’t like, you can sell it. Again, they can be sold on an NFT marketplace without the user needing to understand the technical underpinnings. You won’t need to go to OpenSea to sell your Starbucks Stamps—you can do that from your app. Many users won’t even have to know they own NFTs—they just have Stamps.

Likewise, ERC-20 tokens can become a new version of reward points or store credit. Tradable with others on decentralized exchanges. What value will these reward points command? The market will decide that but if you can buy $100 worth of product for 100 tokens you can infer that these points definitely have a tangible value. They can be issued by the company giving the reward, so the value stays within their ecosystem but can be exchanged more easily by users.

The NFT subreddit is one of the worst places on the internet. Full of scams and hate for NFTs. So Reddit being the launch platform for one of the most successful NFT projects to date is interesting.

That’s what’s happened with Reddit’s Collectible Avatars. Every Reddit user has a regular avatar, a version of Snoo, the Reddit alien mascot. Collectible Avatars are NFT-versions of Snoo available to Reddit users either through airdrops, having high ‘Karma’ on the platform, or by buying them in the Collectible Avatars Shop.

(Meme Regime #464389 on polygon)

As of January 2023, there are over 6 million Collectible Avatar holders, according to Dune:

The main reason for the growth is the ease of adoption.

Reddit users did not know they were getting an NFT. Reddit users did not know a wallet was set up on their behalf. Reddit users did not know that all of the complexities of crypto like gas, passphrase management, were abstracted away from them by Reddit.

For the millions of users on Reddit, they were simply getting a cool new digital avatar to show off to friends, unknowingly becoming first-time NFT owners overnight.

The reason why Starbucks and Reddit succeeded is they focused on creating great experiences first, crypto tokens second. Both brands successfully onboarded millions of new crypto users without them ever knowing.

If you have a run-of-the-mill savings account, your yield is at the mercy of the interest rates set by central banks. The best savings rate currently is about 4%.

Thanks to Defi (decentralized finance), there are many new ways to generate yield. In some places, you can double the yield that banks provide.

You can earn yield from digital assets in a number of ways:

1. Yield from lending protocols such as Aave, where you lend digital assets (stable and non-stable) to borrowers. The yield is determined by the demand for the lent assets.
2. Yield from validating blockchains certain erc20 tokens (Ethereum, Avalanche) can be ‘staked’ to earn rewards in return for validating the blockchain.
3. Yield from providing liquidity to protocols like Uniswap. LPs (liquidity providers) deposit assets in pools to facilitate trading. In return, LPs receive trade fees based on the amount of liquidity they have deposited. Uniswap pays LPs 0.3% on each trade and has paid out over $40 million to LPs in the last 30 days.

By July 2022, these yield options had almost $50 billion combined in total value locked (TVL):

(source: coinchange.io)

In the future, it is likely that a portion (or all) of the yield provided from a ‘savings account’ will have been generated using digital assets. To the end user, however, it just looks like a high APR.

People don’t care about whether something is crypto or not. They care about good experiences. If the experience is cheaper, faster, more engaging, a person is more likely to use it.

If we can get 1 billion people involved with crypto, then 1 billion people’s lives will be better. Either they’ll be able to do something cheaper, like transfer money or invest, or they get more value from what they are already doing, like investing, drinking coffee, or arguing in r/politics.

Either way, users won’t have to actively seek out the better crypto solution. As financial institutions and companies come to understand the benefits of digital assets and crypto for themselves, they are wrapping these into their traditional offerings. Stop focusing on crypto and start focusing on creating great products.

Layer2 Financial is a Crypto as a Service infrastructure that makes it easy for fintechs, banks, and neobanks to launch fully compliant crypto products, in a matter of days. Layer2 provides seamless access to compliant custody, trading, payments, fiat ramps, and yield; all through one user-friendly API. Click here to learn more.