‘You can use blockchain programmatically to reduce counterparty risk’: Fireblocks’ Michael Shaulov

Today’s guest on the Tearsheet podcast is Michael Shaulov, co-founder and CEO of Fireblocks. Michael strikes me as one of the smartest guys in finance – Fireblocks, on the other hand, is a platform for creating blockchain-based products and managing the day-to-day operations of digital assets. Banks such as BNY Mellon and BNP Paribas use the firm’s wallet technology for digital asset custody.

For an industry in flux, Michael positions Fireblocks as an important layer in the digital resource technology stack. Our discussion took place before the SVB failure and the closure of Signature Bank. Michael’s pragmatic approach is refreshing and speaking to him, you get the sense that he is building something for the long haul.

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The following excerpt was edited for clarity.

Fireblocks’ history of creation

So initially, to be fair, we faced this problem. When I was at Check Point, we investigated a breach that occurred in South Korea. Back in 2016-2017, the North Korean hacking team hacked four exchanges in South Korea and they stole $200 million worth of bitcoin. At the time, Bitcoin was worth $1,000. So you can multiply by 23 at the moment.

The year before they hacked the SWIFT system – they’re kind of famous for compromising financial infrastructure to circumvent sanctions against North Korea. And that sparked my interest in that domain.

Honestly, I was not a bitcoin maximalist. Unfortunately, I didn’t invest in bitcoin in 2010 or in 2011 or anything like that. What really happened at that point, after we did our part of that investigation, I started going down the rabbit hole and learning about the technology. And what I realized is that it’s a transformational technology for finance on the one hand, and the other thing I learned is that there was no infrastructure to work in a transactional way with cryptos and digital assets, which was clearly the basis for the whole narrative of what to do with the technology.

Counterparty risk

I actually divide the world into two different domains. The first domain is actually the pure decentralized economy that frankly was the exception—of Terra Luna—most of that space worked very, very well under the stress scenarios that we’ve seen in the last couple of months. And the reason for that is that, to be honest, decentralized economy works. It took a while. The last couple of years were a good kind of testing ground, and some of the blue-chip protocols like Uniswap and Compound were battle-tested and they survived the various collapses and stressful situations that the market threw at them in the last 12 months.

The part that didn’t work so well, unsurprisingly, is the part of decentralized finance that underpins some of the speculative environment around crypto. If we take a small step back, it’s important to understand that bitcoin is much more a kind of reserve instrument than all the other public sharing protocols, whether it’s Ethereum, Solana or Avalanche, or Polygon. Some of the things that people are familiar with—the fact that they have a token and the fact that that token is valued or has some sort of dollar price attached to it—is actually a play on the fact that the underlying blockchain will be dominant rail for to represent assets and operate financial infrastructure.

Fixing things forward with technology

We argue at Fireblocks that actually in the last two or two and a half years for our customers (we currently serve 1,500 customers, which are basically all the major players, financial institutions, fintech companies, hedge funds, web3 companies, and so on in this space) that we want to introduce technical capabilities that they will be able to achieve counterparty risk reduction against some of the centralized actors and counterparties, in the form of on-chain escrow capabilities, you can use blockchain and can actually programmatically create an escrow that is visible to both parties. It reduces the counterparty risk that you do not need to pre-finance, which happened with FTX.

As an example, we introduced the technology that allowed you to actually have a remote view of the positions of your counterparties, which could have saved some of the lenders at 3 Arrows, right? For a long period of time, space wasn’t very interested in adopting that technology, although you would argue that this is kind of part of the narrative of space: they prefer to operate using the existing methods that you would see in traditional financial place. And interestingly enough, now all this is washed out. And there is a huge demand for the things we have been proposing and considering for a few years already. So on that front, it’s a little encouraging.

Fireblocks’ model of custody solutions

The narrative that was created with the beginning of bitcoin was this “unbank yourself” thing. That was the first story. And there’s another narrative over there, which is basically ‘not your keys, not your crypto’. Even though both kind of led you to this self-custody model – the self-custody model that Firelooks provides is actually a form of the institutional form of custody. We call it “direct custody”. So it is a safe non-custodial model for most cases. And the benefit is that you definitely eliminate counterparty risk from relying on someone else. You remove the counterparty risk, you remove the operational risk.

And then that very basic structure can be developed using smart contracts and using MPC technology that we’ve implemented to extend the model to create trustless structures between you and the people you interact with in your trade. And it can be in the most institutional form of how a lender will gain visibility to a borrower or how a decentralized clearing can work between several counterparties. And it can actually be applied to the most consumer-like interactions that people have on the internet.

The best example I always give is: imagine you have a ticket to a concert and you don’t want to go to that concert. And honestly, you don’t want to pay the ridiculous fee that someone like Ticketmaster or StubHub will charge you to cancel that ticket or transfer it to someone else. Selling someone that ticket over Facebook or Instagram or a random messaging platform to someone you don’t know carries counterparty risk. Who goes first? Do you send them the ticket and they send you Venmo? Or, you know, they send you Venmo and you send the ticket and how do they even know if the ticket is authentic?

The interesting thing about crypto is that interaction can actually happen in a completely reliable way using atomic swaps using an NFT and via a stablecoin. You can make something that will cost a fraction of $1. And the rail is just like a regular internet rail that is agnostic to what application you want to do without any intermediary.

So I think when you give this example to people, they can intuitively understand why it’s a breakthrough in the most simplistic interaction that exists between two people. We want to do business with each other. And how do we guarantee that neither of us will defraud the other person without having a centralized party that we both trust? You can expand from that. And it’s actually changing the world in terms of how commerce can be done, and how financial transactions can be done, both at the individual level and at the institutional level, I think that’s super powerful, as more and more of our lives become virtual and are conducted over the rails of the Internet.

CBDCs vs tokenized deposits

What is much more attractive to banks at the moment is what we call tokenized deposits. So effectively they take a cash deposit and tokenize it. It is still held under the shared reserve requirements for the bank. And the advantage for the banks is that it does not reduce their influence in the system. This is why central banks liked that model a bit more from a scale standpoint, compared to the fully supported one.

We have a few banking clients, such as ANZ Bank and two other banks in Australia, who have already gone public. We have non-banks like GMO, which is a large Japanese brokerage house, issuing Japanese yen. And it’s a very interesting example because on the back of those structures, and just like things like USDC, we’ve been working with the best payment service providers like WorldPay, Checkout.com and so on that use stablecoins for cross-border transactions.

The US is figuring this out

The main question is how long that friction will last, but it could definitely hurt US competitiveness in global financial markets. The US has traditionally been the innovator in financial technology. It is the largest financial market and the most sophisticated.

Unfortunately, I think that everything that is currently coming from the SEC, OCC, Federal Reserve, and so on, is hindering its adoption. The incumbent players do not buy into this technology. They make it much more difficult for fintechs to try in the US. And what is happening is that everywhere abroad people are moving. And obviously this technology is moving very, very quickly. So at some point it will start to become difficult to catch up. And that, I think, is the main concern.