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?
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”?
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?
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?
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?