When Philipp Pieper and Timo Lehes co-founded Swarm Markets in 2017 in California and then moved to Berlin, they did a strange thing. They knocked on the door of Germany’s financial watchdog, known as BaFin, and said, please regulate us.
That’s not supposed to happen in DeFi. The whole idea is to break free from the sclerotic practices of the conventional financial services industry. But Pieper and Lehes, seasoned TradFi players who’d been through their share of market cycles, were making a bet. They wagered that financial institutions and sophisticated retail investors would love to trade DeFi products, especially tokenized versions of popular stocks such as Tesla and Amazon, but many were wary of the lack of accountability in DeFi, not to mention the skulduggery that’s made headlines of late. Between rug pulls and exploits and regulatory warnings – just look at Binance’s woes over the last few months – it’s hardly surprising that a lot of investors are having second thoughts about DeFi.
“There’s all this capital on the sidelines that can’t participate,” says Lehes, a longtime venture capitalist and angel investor in Silicon Valley.
Built and Licensed
So the two entrepreneurs built Swarm Markets on the Ethereum blockchain and obtained licenses from BaFin, making it the first DeFi exchange of its kind to be regulated. The platform is what’s known as an automated market maker, or an AMM. Its purpose is to provide investors with a marketplace brimming with participants and action to rapidly support and fulfill trades. Now Pieper and Lehes will see if their mash up of DeFi and TradFi will deliver the goods.
After launching on July 1, Swarm has attracted more than 600 customers who’ve pledged an aggregate $35 million for its liquidity pools. It’s issuing its own token called SMT to stoke liquidity as well. On Wednesday, it will begin a weeklong batch auction of millions of SMT tokens on Gnosis. Buyers who are approved by Swarm’s Know-Your-Customer process will be able to purchase the tokens and trade on the platform. While Swarm is accepting customers from most countries, it is holding off on U.S. residents because it doesn’t have a license from the Securities and Exchange Commission (SEC).
And the trading, well, that’s the truly intriguing part. You see, Swarm Markets doesn’t just cater to investors who want to trade Bitcoin, Ether or other cryptocurrencies. There’s always Coinbase for that sort of thing. Instead, Swarm is a venue for investors who want to swap blockchain-based tokens that represent all asset classes. In other words, Swarm wants to mingle assets from the traditional world – stocks, bonds, commodities – with DeFi applications on the same platform.
To do so, traders will use tokenized versions of securities or any other asset. Synthetic equities that live on blockchains have been kicking around for awhile. In traditional finance, such instruments are called derivatives because they derive their value from the underlying asset. Over the last 25 years, derivatives have become notorious because of their opaqueness and the employment of leverage, which make them wildly risky. Indeed, the 2008 global financial crash, the worst economic calamity since the Great Depression, was triggered in part by the abuse of derivatives in the subprime mortgage market. Ironically enough, it was that event that helped inspire Satoshi Nakamoto to invent Bitcoin as an antidote to centralized finance and monetary policy.
So why would anyone want a tokenized version of Tesla or Amazon shares? The short answer is that you can do more with them in the tokenized form, and realize gains that aren’t driven solely by whether the stock rises (or falls). For several years now, investors have been using tokenized stocks as collateral for loans, a form of leverage that can then be reinvested in the market. Holders can also pair tokenized stocks with other assets to pocket the difference in the price movements of both. You could construct a global warming trade, for example, that pairs tokenized Tesla shares with a tokenized oil futures contract. So when the Tesla shares rise and the oil futures fall you pocket gains from both moves. That’s called arbitrage, and it’s the type of trade Swarm Markets wants to support.
A Crypto Wall Street
The curious thing about all of this, of course, is how closely it resembles the financial engineering that’s long driven Wall Street, and turned it into a big fat target for regulators when it all blows up. Yet investors’ appetite for risk is growing: In 2020, the number of normal equity derivatives – not tokenized ones – soared more than 56%, according to the World Federation of Exchanges. Nino and Ninos Mansor, partners at Arrington XRP Capital, a digital asset management firm, attribute this trend to investors’ search for yield. It’s only a matter of time before this spurs more demand for tokenized stocks.
“The insatiable demand for U.S. assets is the first leg of this crypto-synthetics story,” they write in a recent report. “The second is the size and scope of equity derivatives more broadly.”
With their regulatory seal of approval in hand, the Swarm Markets guys are primed for this potential boom. And in true DeFi fashion, they want to swing open the doors to more exotic offerings, even the cause celebre to release pop singer Britney Spears from her conservatorship. A group of her supporters have minted a SaveBritney coin and offered it on UniSwap to help fund her fight to escape her father’s control. Applauding the move, Pieper says DeFi empowers people to create markets for any asset they want.
“The question now, like for any new token, is will there be enough liquidity to support the SaveBritney coin’s ongoing development?”
Pieper and Lehes are betting the answer will be yes.
Corrects to say that Swarm Markets does cater to investors who want to trade Bitcoin, Ether, and other cryptocurrencies.