In this interview, CLST CEO Michael Guzik sat down with Anton Golub for a conversation surrounding his recent opinion piece on the current crypto crisis. Below you can find the entire interview: “Shadow Debt Market: The opaque, hidden crypto credit market at the origin of the 2022 crypto crisis”. This is an interview of an goinging CLST Insights series.

Michael Guzik

Anton, nice to have you here. Thank you very much for coming. You are very well known in the digital space of crypto assets. So maybe you could just spend a couple of minutes or seconds to introduce yourself.

Anton Golub

Thank you very much. It’s a pleasure to be here and thank you for inviting me. Long story short, I originally come from traditional finance: I was a market maker – a sort of hybrid situated in the foreign exchange markets. Then I was at the right place at the right time and a long time ago I have co-founded the second-ever crypto company in Switzerland called Lykke, where we’ve build a digital asset exchange and a lot of other things and where I had the pleasure to meet you as well – so overall that entire experience was really awesome.

Running the exchange was an amazing experience. There’s something beautiful that happens the first day when you launch an exchange, you really learn the hard way that liquidity is really what’s needed and that in general, most exchanges do not work. You learn quickly that this challenge is a massive opportunity. As a result, I launched a market making company, FlovTec, which I ran for the last five years and also had the opportunity again to work with CLST, with you and your team from the position of both a market maker and running an exchange as well. 

I think CLST is at the epicenter of what is happening in the crypto space and I was very blessed and fortunate to see how the crypto ecosystem works. I call it the crypto-plumbing, the plumbing infrastructure of the crypto world. I very much saw how it works and it’s a great learning experience and that’s why I’m also very bullish on a lot of new companies that work in the debt space.

The lending and borrowing space I think is going to be an amazing opportunity because of the challenges that we are seeing in the market today. In summary, this is a bit of a background about me.

Michael Guzik

Thank you Anton – Let’s get to the topic of today. You know that over the last two years we’ve seen a huge hype cycle in the crypto space. The crypto prices exploded to an all time high back in 2020-21, then basically everything crashed in 2022. Can you tell us what happened over the last two years, particularly in the short-term debt space? There’s been a lot covered in the news and since we operate heavily in the debt market, it would be great to hear a little bit on the status quo, what actually happened over the last 24 months.

Anton Golub

You’ve described the last two years really perfectly. How it happened from a price perspective and the perspective of the growth of the industry. For me the whole situation led to a big realisation, namely to what has fuelled this massive price spike and market growth. As I reflect, based on what I’ve known and what I’ve seen, in the back of all of this there was this big debt market that was fueling a lot of the growth in the crypto space. This means that speaking of the past two years – what’s been going on is that behind the curtains, there has been this massive, opaque, debt market developing between huge borrowers who are trading firms, funds, investments firms, market makers….everybody who was taking liquidity and trying to deploy it forward.

And add to it important players who are the liquidity suppliers and I think we are hearing a lot about the liquidity suppliers in the news lately, namely, big players like BlockiFI, Celsius, even FTX. They were sourcing this enormous amounts of liquidity, be that coming from the professional investors and coming from retail investors and what happened is that we had this fusion in the back. I really want to point out that this market, its environment, this interplay was kind of hidden from everyone. You have these liquidity suppliers and massive amount of capital coming in from professional investors and on the other side you have the liquidity takers who needed to deploy that capital. So this fusion was brewing in the back and growing and enabling the growth of the entire crypto ecosystem. What happened, you know, in the last months, is that you had an implosion of that shadow debt market. Meaning that the big borrowers, some of them, went under – and all of this led to where we are today. I think what we’re seeing today is a result of a contagion. So whenever we hear about a new firm going under, I actually think we’re still seeing the echo of the implosion of the shadow debt market.

Michael Guzik

Let’s dive into the last point you talked about – about the shadow debt market, something you wrote about on social media recently. It was met with a huge response. “Shadow debt market in the crypto assets space.” Insanely interesting. What do you mean by that? “Shadow debt market” doesn’t really sound legitimate, right? Or is it more just because there were very few players who were organizing the deals, in, let’s say, the intransparent market. Tell us a little bit more about it because that’s very interesting.

Anton Golub

I did not invent the name myself actually. When you look at the shadow debt markets, they exist in traditional markets as well. So for instance, you had the shadow debt market in 2006, 2007 and 2008 that led up to the financial crisis where we had a lot of players in the back who were participating in borrowing and lending and levelling up a lot and sourcing capital from all over the world across different client segments and kind of brewing that, which then obviously had a fallout. The same happened in China for instance a few years ago, as we actually had a shadow debt market there as well.

So exactly, drawing on that terminology, I think this is what happened as well in the crypto space, how you correctly describe it, it was in the shadows because it was completely non transparent and opaque. You had a couple of players, I actually think it was a very small group of players. Big ones – and today we can mention some of the names like Genesis, who were on the lending and borrowing side. BlockFi for instance, Celsius also had issues a bit earlier on and all of these players in the back were doing bilateral borrowing and lending.

I think from my perspective of how I have seen it, all of this happened without a lot of understanding of risk. Risk can be assessed and categorised in many ways. Market risk, counter party risk, settlement risk, many different ways, but not a lot of us assess how that risk is priced, how then that risk is managed and how to make sure that it does not blow up. One last point about the shadow debt market is that it was full of uncollateralized borrowing and lending. 

Michael Guzik

Why uncollateralized borrowing?

Anton Golub

It’s very interesting when you actually go and try to borrow collateralized as a professional counter party, you kind of learn very quickly that it’s highly capital inefficient from the perspective of the borrower. To borrow capital, I have to have a lot of capital. And when you realize actually that not a lot of counter parties in this shadow debt market actually had the capabilities to do something of that sort, you realize that the preferred way of borrowing was very much uncollateralized, where the risk was credit risk. Meaning, can I repay it, and how do I actually manage that debt. I want to point something out, which I hope is not to much of a shock to the readers but uncollateralized borrowing is the norm. Because the problem with collateral borrowing is that the capital that you provide for this collateral, you really don’t want to lose it when the liquidation happens. Imagine I borrow against my house, which would be an interesting example. I really don’t want to lose that house, right? As a private individual or as a professional entity, you really don’t want to lose the capital that you fundraise or obtain through earnings, you really don’t want to lose them. 

Michael Guzik

So this is an interesting concept, right? When you think that on the lending side the lender doesn’t want to lose its loan, right? So it’s an interesting dynamic.

Anton Golub 

And a very asymmetric one. I think there was a very interesting post that was written I think quite some time ago by Jump Trading, their crypto arm, when they tried to segregate debt and they mentioned that indeed there are different kinds of debt – and concluded the future of debt, at large scale, will be uncollateralized. The shadow parties that where brewing completely intransparently in the back, nobody had any idea what was happening. So when the first fallout happened, which was the Terra Luna collapse, which is a Cryptocurrency that went under very fast, you had a single counter party, very well known. Three Arrows Capital, as we know today. They went down very quickly and then kind of took down the uncollateralized loans with them. And then a sort of chain reaction happened from there. This is how I would describe it.

Michael Guzik

Interesting. You mentioned that risk was not really possible to assess. I would even go as far as to say that there was no risk assessment, due to the imbalance on the supply side, which you have when you have many retail and professional investors, maybe sometimes also institutional investors deploying money into yield products, whereas on the borrowing side, you have majorly unsecured borrowers who became literally cash rich in order to finance their trading, correct? Or maybe market making positions. 

Tell me when you look into the future, how do you see the future going forward with regards to the credit market? We don’t expected anything to change immediately, but what type of major building blocks are needed to actually regain the trust in the credit market? Because just because it imploded, it doesn’t mean that it’s gone. It’s basically just a cycle, because short-term debt is the key pillar for derivatives, also for spot positions in order to actually be financed. What are the key pillars needed to be built or rebuilt moving forward?

Anton Golub

So reflecting on how it was done before, it was very much bilateral, untransparent as you mentioned, with not a lot of risk assessments on both the borrowing and the lending side and also then without a lot of oversight on how the capital is deployed. If we take that and look into the future, I think this is a big opportunity for a platform, that actually matches borrowers and lenders and in a very transparent way enables them, maybe still bilaterally, to negotiate. But also provide them with an assessment of the market price – what is actually the yield that is the reference rate for the borrowing and lending. 

Also, what will be key is, once the deal is struck, to actually have a transparency around it. Which not only provides transparency to the market, but also actually builds up your credit rating, right? So actually if we strike a deal with a specific interest rate and you repaid successfully, then it’ll contribute a lot to your further lending abilities. I think a key going forward is also going to be active real-time risk management. Because as you mentioned, a lot of people were drawn to the high yields, because in the real world they were very low. So if you could get 8% in the crypto world on your money, then it was it was amazing opportunity.

The issue is, I think that not a lot of people actually asked the questions: “But where is the yield coming from? What risks are you taking? How are you mitigating the risks in the activity that you’re doing and still earning me actually 8% or 6%?” 

Therefore I believe there is a massive opportunity for a platform or many platforms to fill this gap in the market and to meet this need for transparency. Finally just to mention my thoughts – I think that retail participating in these kind of activities will become highly restricted going forward. I think, what players like Celsius, BlockFi managed to achieve is source liquidity from the retail and then deployed in the professional trading investing space. I believe this will be very difficult to pull off in the future, because it’s very hard for retail players to actively and professionally assess risk in this kind of activities. So their access to the debt market will either be made more difficult or if they do have access, then it will be to a highly regulated debt market where the yields will of course be lower. 

Michael Guzik

Interesting what you mentioned around risk. Which leads to the question of – when players were lending and borrowing, there were literally no market rates. Right? So for example stable coins, Bitcoin – it was a little bit like a bazaar, right? Basically we were talking on many Telegram channels and just asking: “ what is your rate? Let me give you 5%.”

So interesting because one of the founders of QCP Capital actually said one of the major components which are important for adoption and maturity in the short term debt markets, are actually interest rate curves. The interest rate curve in the end just means the duration of the loans you have different types of prices of how you price the capital along said duration. Let’s go back to that. That sounds actually very interesting. Right? So what is actually needed to establish these yield curves? Or interest rate curves? I think that in order to actually establish a yield curve, you need to assess the risk. You also need to assess, what is the global market rate. In TradFi, traditional finance, you would say – you have the Libor, you have, let’s say, at least some sort of interest rate benchmark, right? And then you can see according to the credit risk or a credit rating, you can start assessing the companies. But in the crypto space or digital asset space, there’s nothing there. So how do you see this going forward because that takes years to establish.

Anton Golub

Yeah, I think what you said now is fascinating. As always, I was reflecting, how does it work in traditional space: you have the overnight money markets, that are mandated or managed by the monetary authority, so this is the domestic dollar market. Then you have the foreign dollar market, which is the so-called Euro Dollars – not Euro against Dollar – but Euro Dollars. You also have a country, U.S, who is issuing bonds of different durations on a fairly scheduled basis. And then you have futures on all of those markets that I actually described and futures markets are then used for pricing. Because obviously, you don’t have the US issuing new ten-year bonds every day, but you can trade futures on bonds. It is actually a fairly well functioning market. Then you go to the crypto space and you realize, well there are no big entities issuing Dollar stable coins on a day-to-day basis and there is no futures market on those stable coin bonds or Bitcoin bonds – at least not yet. I remember from working but also from studying, you would usually have an interest where you would say – what is the risk free rate, plus, your credit rating and so on – so what you do, you basically decompose the interest rate.

I think we have a massive challenge ahead of us, still, with establishing the so-called risk-free rate. So today what happens, we assume that when the issuing entity is supplying debt into the market, that’s how you know – we can price the risk-free rate and then the add credit risk to it. This is still a big challenge for us and to be honest, it’s not a straightforward answer, how that will be solved.

Michael Guzik

Just as a side note – There are components and currently, at least for the Ethereum market, the risk free rate of Ethereum is at least the staking yield in the space, right?

So we see some new components coming into the crypto space, but still when you go a little bit into the centralization of components, it always goes back to the counter party risk. I did not meant to interrupt but I thought this was interesting to mention at this point.

Anton Golub

I didn’t even recall that, but I think this is an amazing point that you mentioned. What you said actually for proof of stake systems – you can say that the staking reward is the yield. It is a very interesting to think about how to actually construct it. But regardless, an amazing opportunity would be for somebody to publish a reference interest rate. Because there is nothing at this point. Of course you can then argue how is this interest rate constructed because as we mentioned there are many different ways but even that is an opportunity – to publicly state what you think is the reference rate on Stablecoins or Tier 1 counterparties. You will then of course have different assessments, how to attach meaning to each word that I’ve just said – such as Tier 1 counterparties, which means certain balance sheet assessments, etc. Defining what you mean with yields from staking, etc. All of this requires quite some financial engineering to establish it properly and it is far from straightforward.

But then at that point, once we overcome the challenge, then you can actually go and say: “For an entity that wants to borrow capital (it could be a foundation or lending/borrowing platform or trading company, whoever), we price the risk free rate plus 50 basis points.”

The truth is, however, that we are very far away from that, to be honest. It all goes back to the first point that we discussed which is that we need a transparent market, a platform with transparency on those deals, how they’re constructed around the rate and how they are being repaid and then start working from there.

Michael Guzik

It’s interesting. Maybe just one component while we’re talking: do you believe that the free market could create a benchmark for Bitcoin or stable coin rate? It’s just a thought, because in the end we were always relying on the central bank’s imposed interest rate, which might be the risk-free rate. But referring to the digital asset market, do you think this could come, or will it go back to the original centralisation? We’re not going in the details for the crypto market and TradFi now, but just tell us your thoughts.

Anton Golub

So for all our decentralized, passionate readers, let’s be very bullish that we’re going to construct that. Just the fact that we don’t have it at the moment, it just shows how difficult of a problem it is and to be very transparent and very honest with you, I don’t have the solution. It’s a thought and an amazing challenge and hopefully all these smart people that are going to read this might get inspired by what you just said and take your wise words forward and hopefully, come up with something very soon. We need that.

Michael Guzik

Just one last question. You mentioned assessing risk on-chain, and also assessing risk through balance sheets. It’s clear that those two worlds are merging or converging – traditional finances going into digital asset space or digital asset space also coming to the TradFi space. And it’s interesting because you see many smart people developing solutions on how to assess credit risk based on on-chain balances, means tracking the transactions and looking how much balance is left on the wallets. But at the same time, we see it in traditional finance from the good old times where you assess balance sheets, P&L’s and derive the risk from that. How do you see that? Could we find a way that you could assess credit risk on chain, but also off chain – which is basically based on balance sheets, it’s definitely a challenge. Maybe just one more sentence to that because everyone was also majorly relying on their on-chain “health”, while when in fact on the balance sheet, they were already near bankrupt. It’s an interesting dynamic which leads to a new market. Maybe you have some thoughts as it’s a very very interesting topic.

Anton Golub

The health of the balance sheet is a major component in assessing how creditworthy a counter party is. I think there’s an interesting discussion, which I don’t know if you’re hinting to. Nowadays, most people are very much referring now to proof of reserves. When you speak about counter parties, you assess how much reserves, assets, you have within your entity and then judge your health actually based to that. We know that there’s two side of a balance sheet. The asset side and the liability side.

The challenge remains that what proof of reserves is telling us: “If I don’t know what your liabilities are, then the asset side does not have much substance – it doesn’t paint you the whole picture. Why is that the case? You have these “black holes”, the so-called centralized entities (CeFi), centralized finance entities, where once the money ends up there, you actually do not know what’s going on with it. If the whole world was on chain, then the audit companies would go out of business, because auditing will be done on-chain with software. That would of course be a major thing. I want to say something and you can agree with me or not, but I truly believe CeFi entities are the black holes of the crypto world, because things come in, it’s like a black hole, nothing ever comes out actually and you just don’t know what’s going on.

Michael Guzik

I agree to that and maybe I at least I’m not sure if you share the same type of perspective, but I think going forward the ultimate vision probably from the whole blockchain world is, that you can depict the assets and the liabilities on-chain, which leads to a balance sheet on blockchain. But then the question is how much you really want to disclose? I mean I had a good conversation with my co-founder about that and in the end publicly listed companies must publish their balance sheet on an ad hoc basis. Maybe we’re not too far away from a vision for listing the balance sheets of assets and liabilities in real time for the blockchain. This may be a component and this could potentially change the credit market. Do you share the same vision? 

Anton Golub

I think your vision of the future you just decribed is the one that’s going to happen. I’m reflecting today it’s very topical in the pure Blockchain spaces. The so called ZK roll ups or zero knowledge proofs. Basically it’s a methodology how you can actually execute transfers or transactions on the Blockchain in an anonymous fashion. One can execute a transaction or transfer with minimal leakage of knowledge or private confidential interpretation. 

A zero knowledge rollup could potentially enable that. I could show my balance sheet through this technology, without disclosing where each of the assets went, nor where each of the liabilities came from. Nevertheless, I can actually use this technology to disclose my whole balance sheet. So you kind of see a box, where you see what’s on each side of the box, referring to double entry bookkeeping, but I’m not really disclosing to every specific detail how I deploy that. 

Michael Guzik

So that way, you’re in control of the positions that you reveal.

Anton Golub

Exactly. This is really fascinating. The methodology of zero knowledge proof is a methodology usually considered nowadays as something highly technical in the crypto space, rather than traditional financial audits of companies. Sometimes we have to reflect where is the technology coming from that will enable us something ultimately very useful. 

Michael Guzik

Do you see any loopholes which could be exploited by fraudsters, or do you see that this could be the ultimate game-changer for the market? Obviously you will always find fraudulent activities in the market, but do you think this could improve on the transactional level or on a company level in general market activities or do you think this is just another hope and promise in the market?

Anton Golub

I’m very much bullish on on-chain activity and on-chain disclosure of your own balance sheet. I believe it will be highly useful in the long term for the build up of credit score and credit rating. I think it’s very challenging for me to say that technology can eliminate all shortfalls or drawbacks, so I’ll reserve myself from saying that. Nevertheless, I’m extremely bullish that this will introduce a lot of value. 

I think anybody who has ever done an audit of a company knows what kind of painful process it is, with a lot of papers and auditors running around, so if we can automate that and replace those kind people with technology and give them smarter work to do, I think everybody would be super happy.

Michael Guzik

One last question to you Anton. Would you use the term “crypto assets” or “digital assets”?

Anton Golub

I would say digital assets.

Michael Guzik

Digital assets. Fantastic, thank you very much for attending. Much appreciated, and thanks a lot for your time.

Anton Golub

Thanks a lot Mika. Really a pleasure. And thank you for having me. 

Michael Guzik

Cheers.

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