Mike Cagney (Figure) on Blockchain Capital Markets (EP.673)

Thanks for having me.

It's been good. Look, I mean being public is a step in a long process. We're in this for the long game and we see an enormous amount of value that we're going to be able to create out of public blockchain and its application of financial services. But it was an important milestone. Great for the team. It's testament to all the work that's gone in, especially given the last four years of regulatory headwind that we've had being able to come out public, not just to make it through the regulatory process, but have a public markets want to have access to blockchain businesses, public blockchain businesses. It's great to see and I think super encouraging for the ecosystem.

Yeah, I mean if you think about last year, 2024, we were trying to go public. We were GAAP profitable last year and the regulators just made it really, really difficult. We were a blockchain business. We did a lot of stuff in crypto. We had a lot of infrastructure around blockchain and crypto. In an effort to try to go public, I split the company in two. I said, well, look, I'll take the really heavy blockchain stuff and put it over into Figure Markets. And I brought in my Cane to run Figure. Mike and I have worked together for a long time. He was the chief revenue officer at SoFi when I was CEO there. It just became apparent that we weren't going to be able to go even by splitting the business apart. And so what happened in November when the election occurred, we started thinking, well, this has pretty significant ramifications for the SEC. And that was one of the considerations, but it was also is there a public market appetite for this? I went to the bankers and I said, 'Hey, does it make sense to recombine the business?' I gave them the story of why we would recombine and the direction that we would take the business and they said, 'Yeah, it makes absolute sense.' The reality was it was going to be hard to take them public separate anyway because there was so much interdependence. Investors don't like being invested in a public entity when there's a private entity that's critical to the operations and I understand that. We said, 'All right, well, let's go ahead and do this recombination.' And we started talking about retesting the IPO waters. And it was actually one of my investors that came in and said, 'This is the incredible time. You need to do this.' And we just gone through this massive pain of separating the business. And it was brutal, miserable. And I'm like, 'All right, it's a sunk cost. I can't make the decision based on how miserable that experience was. We have to think about what is best for our shareholders.' And it became pretty clear pretty quick that recombining was best. But in the beginning when we were working through with the bankers, Goldman was left on our S1 and Goldman went through and they're like, 'God, you really want to tone down the blockchain stuff.' And they really wanted to make it like a fintech 2.0, which SoFi pioneered. And I'm like, 'But it's not that.' And they're like, 'Yeah, but you know, you should talk about your loan origination system.' I'm like, 'But we give the loan origination system away for free.' We might talk about the blockchain and the fact that we built like a whole market on blockchain and we're the only ones who have done that and it creates liquidity and like all this hugely differentiated stuff and I literally just fought with the bankers for like the first couple of months and they're like don't use the word DeFi and I'm like what do you mean? I'm a very true decentralized blockchain person. There's lots of like Coinbase is a centralized exchange other than Base which is moderately decentralized but it's a centralized brokerage exchange and I'm a decentralized person and I don't take custody of anything and I believe in the true premise of decentralization and the value that brings through blockchain. I see three value props of blockchain. There's transactional efficiency, there's liquidity and there's DeFi from a financing standpoint. To me, DeFi is the most powerful thing. When you connect sources and uses of capital, you unlock huge opportunities of rent extraction. The whole premise is we're trying to get to DeFi. DeFi is the promised land here when we no longer have warehouses with you, Goldman Sachs. It's all on-chain. And they're like, yeah, you know, that scares people. Don't talk about that. Blah blah blah. I'm like, well, I'm absolutely going to talk about it. I'm fighting the whole time. Then the Circle goes public and then they come back. They're like, 'Hey, Mike, we really think you should emphasize DeFi.'

All the stuff that you're doing. And I'm like, 'You kidding me?' Oh, okay. You guys are right. Good thing we've got you bankers here to help us. [laughter] Let's emphasize DeFi. The buy side was there from the very beginning. What we had with the buy side was a discussion that I think we made very accessible to them. What we did is we talked through, hey, we used credit to demonstrate two of these three things. We've demonstrated transactional efficiency. We demonstrated liquidity. And now what we're trying to do is demonstrate DeFi in the financing side. We launched this product democratized prime. That's how we're doing the DeFi approach. But we're also taking assets to other L1s. I was on a call this morning. We're taking Yield, which is our stablecoin and loan participation onto Solana and SUI and other networks as part of what our ambitions are. We've demonstrated that on the credit side and what I said is look, I'm going to do something very interesting for you, the buy side. I'm going to do a second QIP. I'm going to do a second version of Figure. I'm going to try to launch a second QIP and that equity will be pari passu to the NASDAQ security, right? Same rights to profit, same governance, same everything, but it's only going to be on the blockchain. It's not going to be on DTCC. It's not going to trade on the NASDAQ. It's going to trade on our alternative trading system. And our ATS is unique in that it's an actual deep ATS. You and I face off directly and transact there. There's no intermediation, no custodial construct, just bilateral settlement. And I think it's the only ATS that can do that, by the way. Other people might argue with me on that. And they're like, 'Well, that's great, Mike, but why would you do that? The NASDAQ works fine.' And I said, 'It does.' And so, let's be cognizant about where the value prop is. I think there's some transactional efficiency here, just like I cut 150 basis points of cost out of the securitization process. I'll cut some cost out of this. Like the transfer agent now is just listening to the blockchain. You don't have notification. Like there's some opportunity cost that's out there. Not a huge number. And they're like, 'Oh, is it liquidity? Are we going to trade this 24/7?' And I'm like, well, you can, but I don't know how valuable that is. A lot of people are touting 24/7. It's so important, blah, blah, blah. I've been on FTX to lift them out of bankruptcy, and they had a US equity per business that traded 24/7. And I can tell you, if all that mattered was 24/7, that business would have been flying. And it wasn't. It was sideways. 24/7 isn't actually a real value prop either. But here's where it's going to matter for you guys around DeFi. You're going to be able to take that equity and cross-collateralize it and buy Bitcoin and vice versa. You're going to be able to use Bitcoin and buy that in a way that's fully integrated and seamless. You can't do that through Prime Brokerage. You can't do that in your Robinhood account because it's segmented out. But more interesting, today when you guys lend stock out and it goes on special, it's suddenly yielding 40% because there's a squeeze. You don't get the 40%. Your prime broker is still paying you bonds or not funds anymore, SOFR or whatever they're indexing to. But now you hold the stock, you control it, you let it out yourself. You set the rate and you get the economic. And they're like, 'That sounds really cool, but what if they don't trade in sync?' I'm like, 'I will set it up where our treasury will swap the NMS security for the blockchain security one for one.' And that way by definition, however much liquidity there is on the NMS side, there's the same amount of liquidity on the blockchain side and vice versa, whether it's Jump or others. I will get them to come in and make market on this and cut across. And that's when everyone was like, well, what does that mean for DTCC? And I'm like, no, no, you're not thinking about it the way I'm thinking about it, which is, yeah, there's no DTCC here. Like, you don't need a registry. DTCC I think they generate like $2 billion a year of revenue and they hold about $50 billion of trapped capital. That's rent that's great to release back into the ecosystem but it's tiny in the big realm of economics here. The more interesting thing and what I think the security is going to demonstrate is well you don't need DTCC but you also don't trade on the NASDAQ you trade on a DEX. You and I can take our MetaMask or Phantom or Figure Wallets and attach to that DEX and execute the trade. Not only is there no centralized exchange, there's no introducing broker. So, we don't need a Robinhood account or a Schwab account or whatever. Like, we just attach the DEX and trade. And it's like, well, if you don't have that introducing broker who deals with margin, who deals with stock loan, DeFi, there's no prime brokerage. Goldman Prime, which on the sell side, the prime brokerage is the crown jewel of the business and they generate a ton of money for these guys, all goes away. That's what this is going to be able to demonstrate, which is blockchain has two aspects. There's the disruption of existing financial infrastructure and there's a greenfield. Equity is clearly a disruption of existing financial infrastructure and I think we have a very defined path of how that's going to work. And I was out I think we did 150 investor pitches as part of our IPO roadshow. And about a third of the way through I started pitching everybody this on the buy side. And they were like yes. I'm like and what I need you to do is I need you to then say hey this is so good I'm going to go to my other portfolio companies and say why don't you have a second QIP on the blockchain because it's way better for me for both a margining standpoint and stock loan standpoint. I have the same liquidity. I have the same transactional economics. Why don't you do this? And I think we're going to be able to affect change from within the way we've always done it, which is we go first. On the other side, with credit, that's greenfield. There is no marketplace for credit. We created that, but we did it with our loans first. Now, we have 170 third parties that originate on our platform, and we're a small amount of that production, but we had to be the first ones to do it. My hope is by the end of this year we'll have demonstrated the full vertical into DeFi on credit and the horizontal expansion into a new asset class being equity all native on-chain where we have a greenfield example and a disruption example that indisputably demonstrate why blockchain is so important and so powerful.

So one, this is being hotly contested as part of Clarity. The challenge we have with Clarity is with the GENIUS Act. There was a lot of momentum and a lot of political reason why no one wanted to stand in front of that and it went through pretty quickly. Now the banks all feel they got bamboozled on it because post execution they realize Coinbase is paying interest on USDC balances. Since it's not Circle paying interest, it satisfies the GENIUS Act, but you're still getting interest on coin which is what the banks were trying to avoid. With Clarity, you're in a much different situation where you've got the centralized exchanges that have a very different perspective to the decentralized folks like myself. I care a lot about how do you deal with a transfer agent in DeFi? And to me, those are things that are super important. Well, a centralized exchange doesn't care about that. And then you have the existing players like ICE and NASDAQ DTCC that are like well how do we take the system we have and apply it to crypto or blockchain assets and I view as lipstick on the pig in terms of that process because the benefit here is to rip everything and start over. The challenge from the regulatory standpoint and best X is a big issue. DTCC had this view of, hey, we're going to be able to take a DTCC security, we're going to vault it, and we're going to sell a security entitlement to it. And that security entitlement can be used in DeFi. It can, you know, blah blah blah blah blah. When they told me this, we were at a dinner when they were talking about this. And I'm like, there's no way you can do this, at least not under the current regulatory structure. Sure enough, after they explained this to me, Commissioner Peirce did that memo that said, by the way, a security entitlement of an NMS security is still an NMS security and still subject to best execution. The issue with best execution is you basically have to direct to best bid best offer at least for a portion of the transaction. It's unfortunate because NMS is sort of classic the road to hell is paved with good intentions. It actually is not a good thing for people in my view, but the reason was it was there to prevent you from being gouged by your broker sending it to off-market exchanges and so forth. It's actually created a huge market for order flow and other things that aren't necessarily accretive to consumer market participants. But the issue is you have to be able to route to best execution. So a blockchain exchange where you and I are both encumbering the asset and bilaterally transacting. That's the whole definition of blockchain exchange or decentralized exchange. We don't take counterparty or settlement risk. But that means when I lift your offer or you hit my bid, we swap those assets. We do not then go and look at across 12 other pools of liquidity as to where we're going to route the trade. A blockchain native ecosystem won't work in an NMS construct. This is a gap that I think a lot of people in the space are just getting their arms around and realizing because I think some of the brokerage firms are like, 'Oh, we're going to set up our own blockchain and we're going to create securities on them. We're going to be able to trade Tesla and Intel and Coinbase, whatever.' No, you're not because those are NMS securities. This is why when I talk about what I'm trying to do, I have to do it as a second QIP because it can't be the same security. I can't take the NASDAQ security and put it on the blockchain because that's an NMS security no matter how I do it. So, it has to be a different security that doesn't touch a national market exchange. Then you have the ability to create a blockchain native ecosystem where you can transact bilaterally and self-settle, self-clear. And the key is to keep that locked in. There's a convertibility aspect that you can do at the treasury side to swap that security. Now, there's a bunch of reg considerations, other regulatory considerations you have to have as part of this. So, it's not trivial at all, but it's doable. That's kind of what I'm trying to lean in on.

There's sort of two aspects to it which is what is the immediacy of it in terms of its value to the ecosystem. I think Chairman Atkins has been very clear that for example they don't view DeFi as being under SEC purview. There's a question of how do we define DeFi. Is DeFi decentralized custody or is it all logic on smart contracts? Is it governance of market system etc etc. And so in the near term I don't know that it's as important to all of us because I think the SEC the first thing they did that was huge is they said we're not using enforcement as a policy tool and that allowed lots of us to be able to wake up in the morning without fear of an arrest warrant being out there or the Friday afternoon Wells notices or all the things that were happening give us some degree of comfort. They've enacted a set of policies or announced a set of intentions that have given a pretty clear indication to the industry what you can do and what you can't do. The problem is it's not codified in the law. So just as this is interpretive to the current chairperson, another chairperson coming in, they go back to the way it was before. I think we have a longer runway with Clarity. It's not that we have to get it done this year or the industry is going to suffer. We've got to get it done in the next two and a half to three years or we're going to introduce a huge amount of uncertainty as to our businesses function against election cycles. That's not a good thing.