21X: The European token exchange with a reassuringly German personality – Part I/III

Future of Finance interview with 21X CEO, Max Heinzle
Part I/III

In late January 2024, Dominic Hobson, editorial director at Future of Finance, undertook an interview with Max Heinzle. Lasting an hour, we posted it on 25th January in its entirety:

Though we recommend viewing the video, we also understand that sometimes the good ol’ fashioned way – reading it – is just as valuable. So, we have edited down the interview a little and will be publishing it in three posts over the next three weeks, starting today.

We have included a timestamp for each question, so you can easily go to the relevant section in the video if you wish. While the flow of the text may not be perfect, we have tried to remain as faithful as we can to the recorded interview.

Enjoy the read – and do tell us what you think of Max’s perspective on developments in 2024 and further into the future, for both 21X and digital assets in the capital markets.

00:14 Dominic Hobson: Hello, I’m Dominic Hobson, co-founder of Future of Finance. My guest today is Max Heinzle, CEO of 21 X, a fintech that’s developing a blockchain powered trading and settlement system for tokenised equities, stocks, bonds and funds. 21 X will be licensed as well. The company submitted an application to the European Securities and Markets Authority [ESMA] to be licensed as a European token exchange under the [European Union] EU pilot regime, and that licence is expected to be granted this Spring. Max, thanks very much for joining us.

00:52  Dominic Hobson: What is the history of 21X?

01:47 Max Heinzle: So, we started off as a platform operator to then pivot into becoming a [Software as a Service] SaaS solution provider for specifically digital asset issuances and distributions through our white-labelled distribution platform. In the next step, what we came to understand was that the likes of financial institutions, or also intermediaries, were looking to enable secondary market functionality. And with then the regulatory developments in the EU following those closely, with the announcement mid-2022, we came to the strategic decision that we would actually apply for the licence under the EU DLT pilot regime and actually stopped operating as a SaaS provider to solely focus on that regulated market infrastructure.

When I talk about the infrastructure, the market infrastructure, it really derives from the nature of the regulatory framework, which is basically encompassing three different licences. One of them is the DLT-based multilateral trading facility [MTF]. The second one is the DLT-based settlement system, and the third one is basically the combination out of both the MTF – so the multilateral trading facility – and the settlement system, which is the so called DLTTSS [DLT Trading and Settlement Systems]. And that then in the next step, with the application process starting last year in March in the EU, we basically handed in with the beginning of that regulatory regime in the EU to, in the next step, obtain the licence to operate both a primary and secondary market, which has a clear B2B2X [Business to Business to any end-user] focus.

With the likes of the clients that we have already gathered, but also with the likes of obviously new partners that we will be announcing shortly, we are now in the preparations of preparing the Go Live of 21X, which in essence is a company which we founded last year. Given that we applied for the licence, [21X is] actually a 100 per cent subsidiary of 21 Finance. 21 Finance is a Liechtenstein based entity which is the original start-up, if you so wanted, that we founded back in 2017. And now with the addition and the fact that we have applied through a German subsidiary of ours, 21 X, we are actually going through that licence and approval process with both BaFin [Bundesanstalt für Finanzdienstleistungsaufsicht, the German federal supervisory authority] and ESMA.

04:40  Dominic Hobson: Why has Germany been an attractive jurisdiction for 21X to start its business – and tell us about the experience of your German board members?

05:42 Max Heinzle: We just recently announced that at 21X, our Board members, Alexander Höptner, and also Peter Grosskopf have joined us. I mean, looking at both their experiences in the field of fintech and also regulated capital markets, like you rightly so mentioned, Börse Stuttgart, or also Deutsche Börse. Actually, also, to name another player in the field of banking and fintech, which is Solaris Bank in particular, both Peter and Alex have extensive experience in that field. So for us, that is certainly something that is very important also in the light of us being a regulated financial institution that will be operating an on-chain market infrastructure to ensure that we have people on our board and also within the team, the operational team, that have both a combination out of tech expertise, but also in particular, obviously on subjects such as risk compliance and obviously also exchange experience.

With that being said, I think, nevertheless, it’s pretty clear that with this innovative regulatory framework, we are entering basically a new playing field. It is an entirely new way of combining in a single entity both an MTF and a settlement system. And so there are some interesting comparisons, obviously, delving into traditional requirements from so called regulated TradFi (Traditional Finance) markets to the intersection of blockchain-based capital markets. That being said, we hope to be able to add also in the future further expertise from the likes of experts that have gathered an extensive amount of experience and know-how and add that basically to what our mission is: to basically drive the future of capital markets.

07:59  Dominic Hobson: Why did you choose to operate as public, permissionless blockchain network on Polygon?

08:35 Max Heinzle: So, making use of Polygon was a decision that we made already back in 2022. At the time one of the – I mean, besides the technical, say, KPIs [Key Performance Indicators] and also metrics of the blockchain itself – [considerations was that] it was obviously also a key decision point or argument. It was to say, okay, we need to make sure that projects and actually pilots are being conducted of the likes of also capital market participants that are proving like institutional adoption. And Polygon was surely one of the blockchains where a lot of those projects were already happening back then. And I think we’ve been proven, to a degree, it has been proven that we’ve made a good choice given that a lot of the newer projects and products that have been launched on public blockchains were on Polygon. So, there are some very large asset managers and some public projects such as, for example, Franklin Templeton money market funds and other products. The idea of matching, trading and settling on a public blockchain for us, it was pretty obvious that we wanted to try and automate as much of the, say, market infrastructure and really leverage smart contract functionality. And for the sake of, if one takes a closer look at the regulatory framework, in order to leverage the new possibilities that actually derive from such a framework for us, it was clear that we would go down that route, even though there are some, say, limitations or also challenges that come with that, right? Obviously with the target, one of the main objectives, being fast to realise T+0 (Trade Date plus Zero Days) transactions to trade and settle atomically.

10:53  Dominic Hobson: Will users connect to the 21X platform directly or indirectly?

11:08 Max Heinzle: I briefly mentioned earlier that we have a B2B 21X model, and keeping in mind that the regulatory framework actually allows for direct access also to this market infrastructure. It’s also one of the big, I would say, differentiators, really, between what we see in today’s TradFi markets. If you and me, as individuals or even non-regulated, say legal entities, wanted to onboard directly with an exchange, whether it is the London Stock Exchange or also Deutsche Börse, that doesn’t work in today’s world just yet. We all have to go through, say, respective market participants that are connected to the trading systems. And so for us, even though the regulatory framework allows for direct access, and that’s a game changer in itself, we decided that we would try and connect our to-be-regulated market infrastructure to the likes of players that are already operating in capital markets and enable them to this new form of actually matching and trading and settling security tokens.

So, with that being said, we have already, and will be announcing shortly some of these partners that we are planning to launch 21X within the next couple of months, obviously requiring for the license to be approved. Happy also to share more on the status there. But really the reality is that we provide them in the next step, access to the likes of their clients, which are buyers and sellers of security tokens, in the next step. And obviously also tap into the side of the, if you so want, agents that are working out in the market that can assist with also product issuance, tokenisation services, custody services, given that we have a very open market approach. So really that’s the way we’re tackling it. And it might be the case that in the future we see that it makes sense to also open, if you so want, our services, directly to clients. But for the first steps that we’re looking to take, that’s not part of our strategy.

13:32  Dominic Hobson: What types of financial assets can your trading model accommodate initially and are you using a central limit order book (CLOB)?

14:34 Max Heinzle: Just to clarify also here, because sometimes people get confused by the fact that it is a CLOB and that in itself doesn’t mean that it’s centralised. I mean, given that matching, trading and settlement is smart contract-enabled and running on Polygon, we have obviously smart contracts that are making all this possible, right? And it is, after all, peer-to-peer. So one of the key aspects of the EU DLT Pilot Regime are that clearing in that case is no longer a necessity. You don’t really have a central counterparty sitting in between the buy- and the sell-side. So that really differentiates us strongly also from the likes of AMM (Automated Market Maker) models – so AMM standing for automated market makers with a more centralised point of failure, if you so want. And we know that these are still at an early development stage and also bring certain weaknesses along.

You mentioned a very important point, and that is efficiency, right? We are still, if you so want, at the beginning of a journey of infrastructural layers, whether it is a Layer 1, a Layer 2, that comes with certain technical limitations and that in essence also plays back into the types of products that we can actually admit to trading. So, when we consider, for instance, high frequency trading, that in the first step will not be possible to happen on a systematic set-up as we are going for it in the first step. But, with that being said, maybe it’s also important for the viewers to understand that when we are launching 21X on Polygon, then nevertheless we still have a multi-chain strategy that we’re looking to execute.

We see that real world assets are one of the mega-trends now, in particular in the Web 3.0 space. Talking to the largest infrastructure providers globally, there is hardly any of them that don’t have it on their agenda at the moment. And when we come to understand that security tokens are already being issued in a regulatorily compliant form and manner by various players globally in the market, fintechs that are specialised on that part of the security token value chain, that in the next step, what they are all looking for is liquidity, right? So the fact that we can then, in the next step, under the restrictions of the EU DLT Pilot Regime because it says and states very clearly, you can do equity, you can do debt and you can do fund structures. And there are some other thresholds and limitations that come with the EU DLT Pilot Regime, as you know, Dominic.

But I think that then comes to make sense nevertheless, because we know there are certain types of products that have still a very, say, cumbersome processing and back office operations and procedures where there are huge efficiency gains already, even though they are not being able to provide it in the first step for high frequency trading and for us, as a to-be-regulated financial institution, but still being a fintech if you so want, we clearly see advantages in focusing, in obtaining the licence in the first step, sticking to that strategy of doing it on a public blockchain and then adding potentially also other EVM (Ethereum Virtual Machine) compatible chains that have different, say, efficiencies or advantages as opposed to, for example, Polygon.

18:32  Dominic Hobson: Why won’t atomic settlement increase funding costs and eliminate the benefits of pre-settlement netting?

19:15 Max Heinzle: I think that’s a very interesting topic in general because obviously there are certain, if you so want, models that have been made use of in terms of the systems that TradFi markets are running on. I would even like to call them maybe systematic weaknesses of systems that allow for also, or that actually provide for the possibility for this to actually happen in the traditional capital markets. If we look at the new way that we at least see that markets will be moving towards and where they will be developing, then I believe that that will be compensated also through fee structures that in essence make use of the benefits of the new market infrastructure and that these benefits that are still existent if you so want in TradFi can be counted to some extent also through the efficiency gains that can be realised.

I think that’s really such an attention field there. But for sure there will be an impact and certain mechanics as we see them in TradFi today will no longer actually have a role in the future. It’s kind of also, maybe to give another example, right, because we were talking about what made us decide to go for public blockchain. And in essence, we saw already a few years ago a clear trend from financial institutions to push more for private blockchains. We see, and that’s also the clear feedback from the market, financial institutions not being really that much focused on self-custody set-ups, but more making use of custody service providers or integrating custody services themselves. And nevertheless, I think if we think further and longer down the line, if we consider where the market is likely to move towards in the long term, I think there’s also a space for self-custody.

And also here the European regulator considered this, right? They do allow the investors, buyers and holders of the assets to actually make use of self-custody on a market infrastructure such as ours. And I think that just goes to show how decentralised the future of capital markets will be able to be, right? Maybe to make it even more so specific for the listeners and viewers, is that it could mean in the future, Dominic, that you and me, that we just connect our wallet and that we place a buy or sell order because we have connected directly as the UBOs (Ultimate Beneficial Owners) of the settlement currency or the digital asset, or if you so want to call it, the security token. I mean, the EU regulator calls them DLT financial instruments, maybe to clarify also there.

Watch out for part two next week.
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