Raghu Yarlagadda is CEO of FalconX, a $3.5 billion crypto institutional service provider and prime broker. I sat down with him this week to discuss how institutions have evolved their approach towards the industry, not only in terms of the assets they trade but also trading behaviors during market volatility. In this interview we discuss:
- How FalconX takes a unique approach to credit issuance and pricing
- Why many institutions have suddenly gotten ‘diamond hands’
- How it is no longer the ‘Bitcoin and Ethereum’ show for investors
- Why offering NFT services is no longer optional
- Which institutions really care about Tether’s controversial reputation
Forbes: To begin, can you please describe FalconX for my readers?
Raghu Yarlagadda: FalconX is an institutional brokerage. We serve a diverse set of institutions, including some of the world's largest hedge funds, asset managers, retail aggregators and crypto native funds. And with these institutions, we do three things as a brokerage. The first is trading, second is credit and third thing is clearing. One of the things that we're focused on as a company is the next billion users that are coming into crypto. They're not just going to the well-known retail crypto exchanges. But what we see is that they are going to existing FinTech applications tand traditional brokerages. FalconX is looking to power that revolution. If you're a FinTech company or if you're a traditional broker it could take two-four years to offer those services. We are enabling the transformation in a matter of 72 hours in some cases. So for institutions, we had a brokerage that's focused on trading credit and clearing, and we are powering a lot of FinTech applications and traditional brokers as well as their offering crypto users.
Forbes: The prime brokerage space in crypto is getting a lot of attention right now. What sets you apart from the competition?
Yarlagadda: The number of traditional institutions coming into the space is just tremendous. As these institutions come in, the big pain point they care about is having access to credit and clearing under the same roof. Why? Without that seamless interplay of clearing and credit, your balance sheet is not as efficient. The generation of institutional crypto was largely going to retail exchanges. Now a lot of players are coming to brokers because they want this cohesive, integrated institutional workflow. Now, what first sets FalconX apart is pricing advantages. We use a variety of machine learning and data science techniques to extract pricing in a very reliable, secure way and give it to our customers. The reason why they stay with us for the long term is the integration of services like creating and credit coming very, very closely together. For example, without FalconX, they used to go to a credit shop, get a $2 million loan on a long-term loan and then go to a retail exchange to express their views on the market. But this workflow used to take a month. With FalconX all that can be done with by with 120 seconds
Forbes: How many exchanges or liquidity partners are you integrated with right now?
Yarlagadda: We are integrated with more than 40 different venues. The reason there are so many is because really good pricing is no longer just available from exchanges. Sixty percent of the time it's coming from other OTC pools market makers and, in some cases, miners as well.
Forbes: Can you give me a sense of the geographic distribution of those?
Yarlagadda: It's almost an even split between North America and Asia. It’s built this way because during the Asian hours, the liquidity on Asian venues is tremendously higher than the liquidity on some of the North American venues. So that is why we have a footprint spread across the U.S. and Asia.
Forbes: Can break down how credit is offered and rates calculated on your platform?
Yarlagadda: Three years back, the way that crypto underwrote credit was not healthy. Specifically for institutions, there was a lot of under collateralized credit that was being offered, but it was very subjective and not done in a programmatic way. So that caused a little bit of a systemic risk to the entire crypto ecosystem. But over the last one year, there have been tremendous advances in terms of how crypto institutions are being underwritten. If you look at a platform like FalconX, the way we think about credit, we start with the traditional elements like your balance sheet, where they're based out of, all that good stuff, just to get a subjective assessment of the institution. This is the same as the traditional world. But the big advancement, which is creating a lot of positive value to customers, is using trading patterns and other onchain data with the permission of the customers. And with all this data we are able to underwrite customers really effectively.
The second reason a lot of times is yield generation. In a world where the world is printing a lot of money and inflation is clearly acknowledged, then spanning out the yield becomes a very important construct. If you look at digital assets, and specifically crypto, the yield potential is so much higher in many folds than the traditional markets. Sometimes that yield comes from centralized services and sometimes that yield comes from decentralized services; it keeps hopping around. Why? Because volatility in crypto inherently is much higher than traditional assets. Whenever there is volatility, there are market neutral strategies that can convert that volatility to yield. Sometimes those market neutral strategies play out on centralized services like FalconX, and sometimes it's the decentralized protocols like Compound. Ultimately, institutions want their brokers to simplify that experience. They really don't care just yet about centralized or decentralized, they just want the best deal.
Forbes: Are you currently integrated with DeFi protocols, especially ones such as Aave and Compound that are specifically catering to institutions?
Yarlagadda: From a technology standpoint, we are really ahead of the curve in terms of going deep into DeFi, whether market making on decentralized exchanges. Likewise, we have the technology to deeply integrate into some of the lending protocols as well. However, even with the technology being absolutely ready, we are trying to line it up in the right areas within the world based on the local and regional regulation compliance frameworks. So in some regions, specifically on the Compound and Aave question, we have the ability to tap into those lending markets, but we don't do it globally. It's very customized to the local jurisdiction and local compliance.
Forbes: How has your business grown during this most recent bull market?
Yarlagadda: Our revenue grew 30X through our last fundraise announcement in August and we’ve seen significant growth since. We’ve also tripled our customer base organically, without a dedicated sales or marketing team.
Forbes: Let’s talk about trading patterns on your platform. How are institutions thinking about the market?
Yarlagadda: I would break that into three buckets, as there's a lot to unpack here. First, it's no longer just the Bitcoin show. The market diversified first from Bitcoin to Ethereum. But as we looked at the data this morning, most of our institutional customers are trading at least eight other tokens other than just Bitcoin and Ethereum. We’ve never seen that in the history of the company. When I speak with some of the large institutions about why they are going away from Bitcoin into Ethereum is because of the London fork, which added a deflationary element to the token. That is a very powerful thing, especially when the world is getting inflated, when money printing is a very real thing. Ethereum is beginning to emerge as an inflationary hedge as well in the eyes of these institutions. When I ask them about these eight other tokens, the hunt for yield generation is a very important nuance that a lot of institutions care about. For instance, hedge funds for the yield part, are beginning to make investment into smaller crypto funds that specialize in market neutral strategies. And because these funds also trade with us, we're seeing that we made a lot of capital inflows from some of our largest hedge funds to other funds that are doing tremendously well. So market neutral strategies for generating yield is very hot right now. The third thing is the true power of decentralization and crypto. Two weeks back, two or three large macro funds, bought more than a half a billion dollars worth of digital assets over a weekend. This is unheard of, right? I mean, you don't expect these traditional institutions to be trading over the weekend. Banks don’t work on the weekends and these are not small quantities. And these are not small names, either.
Forbes: Can you share or contextualize those other eight tokens?
Yarlagadda: These are mid-cap other Layer 1 tokens that compete with the likes of Ethereum. When I ask institutions what they like about these tokens they talk about the user adoption story within DeFi, and then slowly NFTs as well.
Forbes: Are there any days that have stood out to you this year in particular? How are your clients responding to market concerns stemming from the Omnicron variant?
Yarlagadda: I would break this into two buckets: When the market is going up, and when the market is going sideways or in the middle of a brief correction. In the latter case institutional behavior has changed tremendously over the last two years. Two years back when the market was going sideways to downwards, a lot of institutions were just going with the market. When the market was selling, they were selling faster. Obviously, they were not selling in bulk in market orders. But more broadly, if you look at whether it's during Thanksgiving Day, as the world was talking about Omicron, some of the momentum funds definitely sold—there's no question they sold, but the selling was like not as amplified as the traditional equities. I mean, the Dow dropping 2% is not what we saw. Remember, I was talking about the macro funds that basically bought two, three weeks back? None of them sold a single token. So the macro funds are holding very steady, primarily, because the inflation data is much more validated now that the world is going through inflation. It's only 5% here in the U.S. Note the latest numbers from October indicated a 6.2% increase. And if you look at emerging economies, it's close to 7% to 9%. Already, from that standpoint, the macro view of Bitcoin and Etherium being an inflationary hedge, those investors are holding very strongly.
When the market is going up, the behavior is very interesting. The market is going up, the biggest buyers tend to be the macro, who are doubling down. Obviously, when the market move is powered by something explainable because of new inflation data, big NFT partnership or DeFi trend that's emerging, macro investors are continuing to double down. The momentum traders take advantage as well. Largely when the momentum is upwards, we're seeing people buying, but when the momentum is sideways and downwards, most of the institutions that are holding are relatively steady. That explains the exchange outflows, like not that we see on the blockchain network as well. When the market is going upwards, you see big tickets coming into exchanges either through us or directly. When the market is going sideways, it's a lot of small sizes that are bleeding away from these exchanges, which shows a lot more retail activity.
Forbes: What stablecoins do you support?
Yarlagadda: We support USDC, TUSD and Tether.
Forbes: Tether is no stranger to controversy. Have your clients expressed any concerns?
Yarlagadda: Especially over the last 30 days, we heard a lot of those concerns from our customers, asking questions like whether they had the right amount of collateralization. They also care about the level of transparency. So from that standpoint, we saw a lot of chatter specific to tether both from the U.S. and Asia about a month back. Today it has fallen a little, but the concern is definitely there. The way institutions are thinking is they want a stablecoin that has transparency and plays well with regulators. From that standpoint, we're seeing USDC adoption much more than tether. However, some of our Asian institutions are still very much centered or anchored on tether. And when we ask them about their thought process they say that first for them any stable coin is truly transactional. Meaning there is enough liquidity that even if there are concerns, and these guys don't sit on tether, they convert all their tether into their local currency anyway. So from that standpoint, because it's transactional, especially on Asian institutions, we're seeing them trade heavily on tether. But the mega trend there or the trend that we're seeing is more shifting towards the USDCs of the world.
Forbes: What's on your roadmap for 2022? Also, do you have any predictions for next year?
Yarlagadda: I think if we look at all the research that's coming from some of the biggest institutions in the world, and what their analysts are saying, the forecast for crypto—unless there is an exogenous event across all markets, not just crypto—is looking very healthy. What we mean by that is we are anticipating first and foremost, Bitcoin and Ethereum continuing to do well. Unless there is a massive tapering from the Fed and then globally. The second trend that we're seeing is the layer ones will continue to perform but again, there will be some local correction. The third thing is the whole metaverse narrative is getting stronger and stronger, even within institutions. One of the things I strongly believe is that the metaverse is a fundamental innovation in terms of how we represent the internet. And the metaverse cannot be centralized for a variety of different reasons. I don't think anyone will benefit from a centralized metaverse. So from that standpoint—advances and enhancements—the metaverse is going to be very powerful, whether through NFTs or crypto as a foundational building block. People are expecting a lot of movement there, simply because there is a tremendous amount of retail interest towards the metaverse.
Forbes: Do you support NFTs or are you planning to in the future?
Yarlagadda: We have to. Two of our customers launched NFT-specific funds, and they gave us a call asking when they can start trading and posting them as collateral? We have to because some institutions, especially the forward looking crypto, native institutions, are definitely playing in NFTs. So we are very actively looking into it. Regarding our 2022 roadmap, the most important thing to do is catch up to demand, which is just insane. It's tremendous. From the last time we announced the fundraising to now the revenues grew tremendously. So the most important thing is scaling the infrastructure to support the incoming demand. The second thing is continuing to build on that one stop shop narrative, whether it means acquiring a few other companies to bolster an offering, which is something that we are looking at very seriously. The third thing is for the longest time you only played in the spot markets. So all that growth is completely playing in institutional and spot. Now, we're slowly thinking about getting into futures, obviously, in a regulatory compliant manner. The last thing is the payments. A lot of flows of cross border B2B payments are happening through the FalconX network already, and we want to make sure that we build in that vertical.
Forbes: Thank you for your time.