Key Insights From This Interview
• Swiss digital exchange SDX has launched a cryptocurrency staking service that enables holders of Ether to earn income on their assets by claiming “mining” rewards for running software that validates or attests blocks of transactions for applications running on the Layer 1 Ethereum blockchain.
• SDX is running the validator nodes on behalf of users, the beacon node that coordinates the activities of stakers in the Ethereum Proof-of-Stake blockchain and the execution node that makes transactions added to blocks valid. The aim is to provide an infrastructure that enables investors to participate in the staking market automatically, using standard documentation.
• The service was launched in response to client demand in Switzerland, though the intention is to extend it to other jurisdictions in Europe as it matures. Similarly, although the service is initially being offered to regulated banks only, SDX does not rule out recruiting non-banks – such as family offices and high net worth individuals – as clients in the future.
• SDX expects to extend the service beyond Ethereum (it is already looking at Avalanche, Cardano and Polkadot) but is proceeding cautiously to avoid exposing users to any protocols liable to Terra-style instability. Any protocols admitted to the SDX service will be audited to an agreed set of principles designed to detect any signs of fragility.
• To protect users from incurring penalties (reduced rewards) for being offline, SDX has built redundant capacity into its Cloud-native platform, allowing it to activate a back-up node as soon as a node goes down. SDX also welcomes third-party providers of insurance cover against reduced income from both penalties and “slashing” (losses inflicted by malicious actors).
• The service is overseen by the Swiss Financial Market Supervisory Authority (FINMA) but, because it offers users access to a public blockchain, it is legally, organisationally and technologically separate from both the SDX exchange and central securities depository (CSD) and the SIX traditional stock exchanges and CSDs.
• Counter-intuitively, given the capabilities of the Swiss stock exchange in the provision of custody services, the initial SDX service does not include cryptocurrency custody (or digital wallets). Instead, users can continue to make use of existing wallet providers. However, SDX expects to add a custody service of its own in the near future.
• The service, which went live with its first validator node in April 2022, operates on a Cloud-native platform. The aim is to support substantial holders of Ether, so the number of nodes it supports scales quickly, and users can fully automate their staking activities without the intermediation of SDX as system operator.
• However, integrating the service with the systems of potential users is complicated by the variety of custody providers currently used. However, this problem of inter-operability is a familiar one in digital asset markets, which the gradual adoption of inter-operability standards can be expected to diminish substantially over time.
• The service is confined initially to private banks in Switzerland that hold cryptocurrency on behalf of investors. The Swiss banks are more comfortable dealing with the Swiss financial market infrastructure than cryptocurrency market alternatives, because of its reputation for reliability and because of the familiarity of the Swiss legal and regulatory environment.
• Any banks admitted to the service will be subject to full KYC, AML, CFT and sanctions screening checks, as will the contents of any digital wallets they operate, but SDX will not conduct customer due diligence checks on the underlying investors. In checking the status of tokens in digital wallets, SDX will make use of a third party service provider.
• The service is likely to provider the foundation for expansion into adjacent fields such as running Oracle nodes that feed smart contracts. Though the initial service is explicitly not aimed at helping users lend cryptocurrency into Decentralised Finance (DeFi) protocols, SDX does not rule out an extension into DeFi either.
SDX, the digital arm of the Swiss stock exchange, has launched an income-generating crypto-currency staking service for clients of the private banks in Switzerland. Owned and operated by a separate entity within the group, the Cloud-based service enables holders of crypto-currencies to collect a yield on their portfolios by staking their assets to claim the rewards for validating or attesting blocks of transactions. Dominic Hobson, co-founder of Future of Finance, asked Alex Smith, Crypto Product Lead at SDX, what services SDX is providing for clients both now and in the future, how it is managing the recent volatility and the unavoidable risks and what adjacent opportunities it is exploring for the future.
A full recording of the interview is available on this page. A transcript of the interview, which follows the questions below, is also available if you click on “Read the Transcript.” If you click on any question you will be taken to the exact point in the recording where the question is asked and answered.
The service SDX is offering enables holders of crypto-currencies to pledge them on the Ethereum network and so earn income by claiming rewards on the staked Ether for running software that validates or attests (i.e., checks) blocks of transactions under the Proof-of-Stake model. But what exactly is SDX doing for clients? Is SDX running validator nodes for clients?
Validation and attestation are a high volume, low margin business. How hard is it – technically speaking – to run systems and processes, as an intermediary, at the requisite speed and scale?
How is SDX planning to build scale in terms of transaction volumes?
Will the SDX staking service be confined to the Ethereum protocol or will it be extended to other Layer 1 protocols such as Polkadot and Cardano?
One risk created by this source of income is paying penalties (“slashing”) exacted by the network(s) for malicious behaviour, validating blocks on the wrong chain or falling behind the network so validations fall out of sync because of congestion – and yet clients will want to maximise their earnings. How will SDX balance the risk of maximising client earnings and mitigating the client risk of getting “slashed”?
How powerful are the incentives for SDX clients to get involved in the market?
Has SDX been tempted to go further and help clients lend crypto-currency into Decentralised Finance (DeFi) protocols?
The service is non-custodial, which is counter-intuitive for a group with three CSDs and an international custody network. What explains the SDX decision to leave custody arrangements to the users?
Does leaving wallets and custody arrangements with users make it harder for SDX to on-board clients?
Is there standard documentation in place to on-board clients?
How does SDX handle the customer due diligence checks for Anti Money Laundering, Countering the Financing of Terrorism and sanctions screening checks at on-boarding?
Will SDX also do due diligence on the wallet providers and custodians clients use? How will SDX manage the risk of allowing clients to choose their own providers? Are any providers off-limits for SDX?
How difficult is it to give clients who retain the assets and private keys and run their own wallets access to a node-operating infrastructure – would it be easier for SDX if it provided a full service including custody?
The new staking service depends on SDX linking to the internal systems of clients, which will vary a lot. How heavy is the workload needed to accomplish that?
Are existing SIX connectivity to clients and existing account structures any help in on-boarding clients efficiently?
It is a Cloud-based service. What are the pros and cons of that? What happens, for example, if the Cloud provider fails?
SDX was originally established to exploit the security token markets. What attracted SDX to the crypto-currency markets as well?
SIX Group services a lot of Swiss (and foreign) private banks, and it is the clients of the private banks in Switzerland that are driving interest in crypto-currency services. Will SDX be restricting its service to Swiss private banking markets or will it become a global service?
Is it only banks that SDX expects to service as clients, or do the potential users of the service include non-banks?
Why are Swiss private banks looking to SDX rather than, say, Blockdaemon or Coinbase Cloud, to service their staking needs in the cryptocurrency markets?
How important is cyber-security to the thinking of the Swiss private banks?
SDX is setting up a separate entity to host the crypto-currency service. What are the arguments for placing the business into a separate entity from SDX’s point of view and from the client’s point of view?
Where has the service got to in terms of the separate entity being in place, the systems being tested and ready and clients signed up and ready to start?
If the service is a success, and scales quickly and becomes profitable, what additional services (beyond custody) might SDX develop to build on it?
What is your own personal blockchain journey? I know you first got involved with blockchain at UBS back in 2014-15, but how did it lead you to this SDX service?