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Strategies & Market Trends : Blockchain and Cryptocurrencies

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From: Glenn Petersen9/20/2021 3:01:50 PM
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‘What the hell is an NFT?’: How Anchorage helps Visa and the US marshals navigate crypto

Anchorage's Diogo Mónica said institutions are turning to the crypto bank for different needs, from buying CryptoPunk art to storing digital assets seized from criminals.

Benjamin Pimentel
September 20, 2021

Diogo Mónica, co-founder of Anchorage Digital, said the idea for the crypto startup sprang from an unusual request about four years ago.

An institutional investor had lost the passphrase to a $1.5 million bitcoin account and offered him 20% of the amount if he could break into it and help recover the assets.

"It was an extremely sophisticated investor that was not extremely sophisticated at all in operational security and technical security of digital keys," Mónica told Protocol. "That was my introduction to this business. I realized there's a business here."

Founded in 2017, Anchorage provides important crypto-related services, including buying, storing and managing cryptocurrencies, NFTs and other digital assets for institutional clients, including big banks, investment firms and the U.S. government.

The San Francisco-based company's profile in the crypto world has been steadily rising. In January, Anchorage got conditional approval for a national trust charter from the Office of the Comptroller of the Currency, making it the first federally-chartered digital asset bank in the country.

In July, the U.S. Marshals Service picked Anchorage to help the law enforcement agency store and manage digital assets seized from criminal organizations and individuals. And last month, Anchorage helped Visa buy CryptoPunk #7610, the payments giant's first NFT purchase.

It was an unusual and complex process that Anchorage helped Visa navigate as the "first publicly-traded institution to actually own an NFT."

"They started asking questions: How do we do it? How do we safely keep it?" Mónica said. "The legal team [asked]: 'What the hell is an NFT? Why do we want it? Why am I buying it with crypto?'"

Mónica recalled that process in an interview with Protocol. He also talked about what led him and co-founder Nathan McCauley, whom he met at Square, to start the company and what he thinks of the growing push for more regulation in crypto.

This interview has been edited for brevity and clarity.

How did Visa approach you about buying CryptoPunk #7610? What was the conversation like?

Visa had the idea that they wanted to participate in the NFT ecosystem. They wanted to do something alongside the community. They wanted to showcase that they're ahead of the curve. So Cuy [Sheffield, Visa's head of crypto] and Visa came to us.

It's not the first time that we partnered with them. We already have two other partnerships with them — a USDC stablecoin settlements partnership and a partnership in which Anchorage provides Visa with the capabilities to allow financial institutions to buy and sell crypto. So we were just the right partner for them to also go into NFTs.

They had this idea to own a CryptoPunk. They started asking questions: How do we do it? How do we actually acquire it? How do we safely keep it? How do we actually report on it? … All of these different questions when they're the first publicly-traded institution to actually own an NFT.

Anchorage is the only federally-chartered crypto bank, so we are regulated as a bank. We have the technology. We've been around for a long time. We helped out with buying ether, putting the bids, winning the bid, negotiating prices and then obviously now with custody, the actual NFT under Visa's account.

What were the toughest questions from the Visa team?

The legal team effectively asked, "What the hell is an NFT?" [Laughs] "How do we buy it? What does it look like? What is this 'digital arts?' How do we safekeep it? Why am I buying it with crypto?"

There's all of these elements of the mechanics of the sale, the marketing side of it. Think about a very thorough process to try to understand the mechanics of the CryptoPunks and making sure that there were no vulnerabilities in the smart contracts and making sure we had a seller that had a good reputation that we could actually engage and do business with.

Those are all the things that we had to go through because, again, it's the first time [for Visa]. It's a common conversation that we have with institutions, not necessarily about NFTs. Even to this day, a lot of institutions already have bitcoin and other cryptocurrencies, but we have this conversation over and over and over again.

Can you explain something to me about NFTs? The YouTube video "Charlie Bit My Finger" was recently sold as an NFT. I thought that meant you won't see it on YouTube anymore because the buyer would want to store it someplace else. But it's still there because the buyer just decided to leave it there.

Your reasoning is pretty common: "Do I own the art, the video or the picture?" What prevents somebody from copying that video and putting it up on YouTube? What prevents somebody from copy-pasting the setup of the picture and displaying it on their own website?

The best way to think about it is the following. If I have a picture of an NBA player who is very famous, let's say Michael Jordan, a picture of Michael Jordan can be endlessly replicated on the internet. No one is going to pay you anything for a printed picture of Michael Jordan. What if I went to Michael Jordan and I asked him to sign this picture, and he signed it? Now the paper is worth a lot. The scarcity of the signature is actually what makes the paper valuable.

Pushing it back to the digital realm, it's exactly the same. For example, Jack Dorsey sold his first tweet. You don't own the tweet. What you own is the signature by Jack Dorsey himself of his first tweet. You can prove it on-chain to anyone, the same way that the signature proves that you in fact had this picture shown to Michael Jordan and signed it. It's a digital signature. The whole world can know that you love Jack Dorsey or that you love Michael Jordan or that you love "Charlie Bit My Finger" because the owner of that video and the creator gave you your own authorized signature copy of the video.

The copyrights for the video itself, and the copyrights for the picture itself are not necessarily tied to the owner of the NFT because the NFT is a signature. If Michael Jordan signs a picture, I don't own the picture of Michael Jordan.

Let me point out that this is not the case for all NFTs. Some NFTs might come with copyrights. Some NFTs might not.

Let's go back to Visa. When it announced the CryptoPunk purchase, it said it was a way for the company to learn about NFTs. The amount it paid, $150,000, isn't really a big amount given the size of Visa's business. What did Visa learn from this process?

You're absolutely right about the amount. In fact, I would say that they spent, and we spent a lot more money just on working through the process to do the acquisition itself.

But it is that going through the motion of acquiring it, of showing it on a Twitter feed. For Anchorage, [it is showing] that we can custody, go through the compliance and that we can be audited. That is the thing that needs to be done.

It is paving the way for, if tomorrow, Visa, or anybody else wanted to buy instead of one, 100, or instead of a $150,000 NFT, a $150 million NFT, now they can. That's part of the learning process. The same thing that we did from a technological perspective for $150,000 can be replicated for $150 million, or $150 billion if necessary.

Once you do the first one, everything else comes and follows. So it is a learning experience, both for Visa and for Anchorage.

But why is buying NFTs important for Visa as a payments network? Why is it important for its business?

I can't really speak for Visa, but if you want to build a product on top of NFTs, the first thing that you have to do is own one. The same way that anybody who wants to get into crypto, the first thing that you have to do is you have to explore it. You have to enter the ecosystem, use the product, understand what bitcoin is all about, understand what ether is all about. This is part of the process if you want to understand and build products: You test it out.

Let's go to the other big news: Anchorage's agreement with the U.S. Marshals Service and the Justice Department to store crypto assets seized in operations.

The general idea here is that the Department of Justice, specifically the U.S. Marshals, throughout their normal operations, they seize assets of criminals, whether they're securities, cash, gold, whatever. They seize these assets and then they have to sell them. They created a public call, looking for a vendor for help with custody and liquidation and pricing of these assets.

It is a really interesting thing that is happening. For every single company that comes into crypto, buys bitcoin or participates in bitcoin, what is happening is that there's a set of other players around them that now are forced to deal with this asset class.

In this case, if a criminal uses bitcoin or uses a crypto asset or has some value, say an NFT, they are forcing the U.S. Marshals, when they seize their assets, to deal with crypto. Governments all across the world are being forced to actually find partners in regulated institutions, like Anchorage, to deal with crypto.

Another example: universities. Their endowments are now having to receive cryptocurrency designations and then price them, and sell them. It's another example of an institution being forced to deal with crypto and being forced to use crypto because of some externality, because their alumni invested in it.

In the case of the U.S. Marshals, because criminals also have cryptocurrencies the same way that they have gold and all these other assets. One of the most famous examples of seized assets was the Silk Road. That was very public. Constantly these things are happening. The assets are becoming more popular.

Walk me through the process you use for taking custody of an asset. You then store them in hardware wallets, or online?

Neither. We created a technology that uses hardware security modules; you can't really call them hardware wallets. We use hardware security modules that are purposefully built to generate these keys, and these are the types of systems that are used, for example, to store nuclear launch codes.

It's not quite a dingy hardware wallet that you'd buy as a consumer for $60. These are production-grade hardware security modules used for 15 years. We encode logic inside of these pieces of hardware that ensures the security properties of these keys.

How does the transfer of assets work? Anchorage generates a new key, a new address, a new wallet and the assets are moved after they were seized onto this wallet on the blockchain. This wallet is now under the Anchorage systems. At any point in the future, the DOJ or the marshals might say, please sell X percent, or sell everything. It's effectively like having an account, but instead of dollars on your account that you can check, it's multiple types of different cryptocurrencies.

Anchorage co-founders Nathan McCauley and Diogo Mónica.Photo: Anchorage
Let's go to your personal journey. Tell me about the first time you heard of bitcoin a decade ago. I know you were at Square around that time.

Yes, that's right. One of the things that is interesting for me and my background is that 15 years ago, I was working on something that was not very useful at the time, a Ph.D. in distributed systems. In fact, I was publishing academic papers in the area of distributed systems and hashcash, which is the mining mechanism that bitcoin uses. So in a way, I was primed to care deeply about this technology. When bitcoin came up, I read the paper just from a curiosity academic perspective. But I didn't really participate in it.

It was only after I joined Square in 2011 that I started getting more interested and started tracking it as an enthusiast. Then in 2017, I started Anchorage and started doing it full-time. My co-founder Nathan [McCauley], we've been working together for almost 12 years and we joined Square the same week. So the Anchorage story goes all the way back to Square in 2011 when we joined as employee 40 or 41 the same week. We've been working together ever since.

Tell me about the very first conversation you had about forming Anchorage.

It's a funny story. I guess the best description of it is: out of need. In 2016, 2017, I started having crypto funds reach out to me for help with custody of crypto assets. There was one fund that had lost the passphrase to a $1.5 million bitcoin wallet, and it was offering me 20% if I could break into it. That was my introduction to this business.

It was an extremely sophisticated investor that was not extremely sophisticated at all in operational security and technical security of digital keys. That's when the idea started. I realized there's a business here. Nathan and I had been working together for seven years at that point, and we're just a perfect team to build it.

How did the institutional investor ask you for help?

I got an email and we got on a phone call. They didn't really want to talk about it very much because obviously it's extremely embarrassing. They just explained to me the situation in very clear terms: "We bought bitcoin a year and a half to two years ago when it wasn't worth very much. Now it's worth a lot." And so at that time there was $1.5 million worth; today, it would probably be 10 times more, right?

It's pretty scary to think that people that have access to that type of capital didn't really have the competence or the tools because, at that time, there were no tools for institutions to do this safely: to buy, to custody. There were no regulated institutions. Four and a half years ago, when Anchorage started, there were no such tools or no such systems, which is part of the reason why we started.

And you were able to help them out?

It was actually a lot easier than you'd expect. There was no need for brute force or anything like that. They did have all the tools that they needed to recover the keys. They just didn't really know how. It is not something that was complex at all in that particular case. I will point out that if you do lose your passphrase, it is borderline impossible for you to recover them. That was a very special case in which they got very lucky.

And can you recall the exact conversation when you and Nathan decided, "Yeah, let's do it, let's launch this company?"

It became obvious at some point that we were just talking about it every day. I started bringing clients to do this work. Our conversations just started becoming dominated by cryptocurrencies, instead of being dominated by our actual full-time job. Once that happens, it becomes immediately obvious that this is a business for us to go into together. We've always wanted to create a company together. We had been working together for seven years. Both of us were sticking together. We went from Square to Docker together. We wanted to start a company. The company found us. The space found us, which I think is kind of beautiful

Why the name Anchorage?

Anchorage actually means a safe harbor, a safe place for you to drop your anchor. And that's actually pretty good meaning. We had created this concept called crypto anchors while at Square, which is a cryptographic concept around digital security.

So when we were starting a company and were looking for a company name, we were already trying to think about "anchor" and crypto anchors. So all of a sudden we wanted a name that sounded institutional, but had this homage to the crypto anchors that we had created before. So Anchorage was the obvious name.

How has interest in crypto changed among institutional investors? I have heard that it has risen dramatically in the last two years.

Absolutely the case. In 2017, institutions — particularly banks, fintechs, corporates, large financial institutions — were coming to Anchorage asking us what they should be doing in crypto. "Hey Anchorage, what should we do here? What should be our roadmap? What should we be building? Teach us."

In the past 12 to 18 months, we're seeing them come to us with very specific roadmap items, already with resources allocated. Like in the case of Visa.

Some of the things that we've been seeing, like PayPal shipping crypto support, are things they've been working on for the past two years. We're gonna see a lot more of that. Because in 2020, there was a major pickup of large institutions committing to building something, and of course it takes time to build.

Tell me about your decision to get a federal charter.

From day one, when we started Anchorage, we not only knew we had to do the right things from a security perspective, we also knew that we had to do the right things from a regulatory clarity perspective. The reason why that was obvious to us is because the first clients that came to us were RIAs, registered investment advisors. And by law, they were required to custody their assets with a qualified custodian. They loved our technology, and so they were the ones [who said], "Hey, Anchorage, I love your tech. I want to customize assets with you. But it would be fantastic if you had this designation, because we are mandated by law to have a third-party, qualified custodian."

So we started four years ago the hunt for qualified custody. It took us a long time. We explored many venues and we continue exploring different venues of regulation for different entities. We became a chartered trust in South Dakota, and that was the first way that we actually started doing custody of assets and we started becoming regulated. Then we had the opportunity to talk to the OCC to do a charter conversion.

So early in January this year, we announced that we became the first crypto bank, the first federal charter to be issued specifically for crypto assets with OCC, which is the oldest banking regulator in the United States.

And part of the reason why we're the only one is because we got in right before the administration changed. We got in ahead of everyone. Whenever there's administration change, obviously there's always a rotation of the types of people that are in these institutions. There doesn't seem to be any other approvals since then.

That's a good segue to my next question: How do you react to the debate now raging involving Coinbase, Ripple and the SEC? You said regulatory clarity is important. There's a view that there is no regulatory clarity.

What I'll say is the following. Crypto is not one thing. We started out with bitcoin, and now we're in a world of DeFi, NFTs, security tokens. So when we're talking about regulation, we're not talking about regulation of one thing. We're talking about the need for clarity of regulation across all of these elements of crypto.

There are elements of crypto that have clear regulation or for which the current regulatory regime fits very well. Anchorage being a federal bank is proof of that. The OCC has released guidance saying that a federal charter can and has the ability of integrating and interacting with blockchains, and being able to custody stable coins and other crypto assets. Those things are clear. They've been made clear. There are things, potentially some elements of DeFi, that haven't really been weighed on.

We need clarity. Anchorage welcomes regulation. But this is the process. Part of the process is the SEC, learning and educating itself around these assets alongside all these other regulators.

The more clarity the space has, the better. We are not there yet. The pace at which this space is moving, you know, it's also very hard. It's not an enviable position to be a regulator in a space that is moving so fast that not even a person that is full-time in crypto can really keep up.

Given your history at Square, what's your reaction to Jack Dorsey's announcement that the company plans to roll out its own crypto wallet?

It is a fantastic team at Square. A fantastic hardware team and a fantastic security team. And as a consumer, I'm very excited that they're going to put a product out in the market. It's very necessary. I love what Jack is doing and the amount of money that they're investing in the community, hiring designers, hiring engineers and building hardware. I'm very excited that there are companies like this that's actually putting their money where their mouth is, and helping the ecosystem at large.

Any plans to go public?

No current plans to go public anytime soon.

What are you most concerned about in this space?

It's not necessarily a concern for Anchorage specifically because we're very well-positioned in a regulatory-heavy world. We're already a bank.

But I think for the space, we need regulation. It is a hard path to create and a hard trail to blaze. We can't be too heavy-handed and just push innovation outside of the United States, because that would just be very detrimental to our country in general.

How Anchorage helps Visa and the US marshals navigate crypto - Protocol — The people, power and politics of tech
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