Catherine Zhou, who heads up HSBC's venture capital activities, tells Global Venturing it is going long on blockchain and tokenisation tech despite recent turmoil in the Web3 market.

HSBC has not been deterred by recent turmoil in the Web3 sector and sees tokenisation in particular as a key technology, according to Catherine Zhou, the bank’s head of venture, digital innovation and partnerships.

“We are very long on tokenisation technology and blockchain technology,” Zhou tells Global Corporate Venturing. “In that they are going to make us work more effectively by taking friction out of multiple systems.”

“We are not long on crypto. We’re very long on things like CBDC, or central bank digital currency.”

Cryptocurrency exchange FTX declared bankruptcy late last week along with quantitative cryptocurrency trading affiliate Alameda Research having lost billions of dollars of customer deposits. The affair has cast a pall over the industry but may end up creating a clear distinction between the consumer offerings – which have attracted speculators – and the hard technology.

“What we call crypto is a product of these technologies,” Zhou (pictured) says. “We are not long on crypto at all in the current moment. We’re very long on things like CBDC, or central bank digital currency, and we have been calling for more transparency and regulation in the crypto space.

“My definition of Web3 is not crypto,” she says. Web3, in her view is “about the next generation and evolution of the internet, where tokens of value are created by a different set of stakeholders – not necessarily by the bank – and where they can be transferred, distributed and custodised by different characters to the banks.”

Although a lot of investors have been stung by FTX’s failure, the hope is that the event and its ongoing fallout will lead to more thorough regulation of the sector. Zhou says HSBC had already been working with multiple central governments on the kind of regulation necessary to make Web3 more open, transparent and safe.

Zhou believes regulation must not limit the technology itself. “That is here to stay, just like the internet is here to stay,” she says.

But, she says, there must be clear rules of engagement in Web3. “For example, in order to play in the Web3 environment you still need a KYC (a Know Your Customer identity verification). You want to understand who the characters are and if you’re working with a trustworthy third party.”

“Web3 is here to stay, just like the internet is here to stay.”

Another point is safety. “Regulation should provide some sort of safety net if you lose your money – what happens, who’s liable for it? Today, that safety net is not there.”

A third issue is that Web3 companies tend to function as borderless entities, with their platforms largely operated by software. Binance, for example, was formed in China but registered in the Cayman Islands, and it has always kept the location of any headquarters vague. Zhou says there has to be some kind of international standard where regulation can work across borders.

The fourth aspect is deciding whether tokens are commodities or securities. “The lines are pretty blurry now,” says Zhou. “Etherum and Bitcoin were commodities before but now, with proof of stake instead of proof of work, are they now securities and should they be regulated like securities? Regulation has not caught up, but I think it will soon.”

Three investment tracks: business model, tech and brand

Zhou joined HSBC in December 2020 and “laser-focused’ the bank’s investment activity on fintech startups that were a strategic fit for the bank. That involved forming a specialist unit, HSBC Ventures, and arranging its investment strategy to cover three specific areas.

“We have established a structured theme around what I would say are three tracks,” Zhou says. “One is business model innovation, the second is deep tech innovation and the third is brand innovation, which is centred around ESG-related items, climate tech and data standardisation relating to that agenda.”

HSBC has expanded its VC remit by backing venture funds in Asia in order to get insight into that region, but its central focus remains direct investments. It invests off balance sheet and is relatively flexible with ticket size.

The bank provided $38m for digital banking software provider Monese in September but can go as low as $1m for investments in interesting edge technologies like quantum computing, where it recently supplied ‘a small amount’ of seed capital for Israel-based Classiq. Quantum computing is a sector HSBC is tentatively keeping an eye on.

“In case quantum computing breakthroughs are here, we want to leverage the technology very quickly.”

“These quantum computing technologies were perceived to be pretty far out and they might still be pretty far out – 10-plus years – but they are not as far away now as they were, say, three or four years ago just based on some of the technology advances we have seen on the ground,” Zhou says.

“We have taken an early-stage investment in one of those quantum computing companies because people in my shoes really look for optionality for the bank. In case quantum computing breakthroughs are here, we want to be in a position to leverage the technology very quickly instead of spending, say, five-plus years to build our skills and learn, by which time it’ll be too late.”

Investment focus moves from consumer to B2B

The big issue on lots of people’s minds right now is the prospect of recession. JP Morgan and Elon Musk both said this week they expect it to hit the US in 2023, while it seems to be a foregone conclusion in the UK where HSBC is headquartered. From a corporate VC point of view however, a downturn provides opportunity.

“We obviously feel the recession will introduce some level of correction and rationalisation in terms of valuation,” Zhou says. “This is actually a good opportunity for us to go in for something we’ve been waiting for but couldn’t afford at the higher price levels, and we can go in now.”

In terms of investment targets, the market dip has meant a migration from consumer-facing products to business-to-business (B2B), as in China where the growth of consumer ecommerce has slowed but automation and artificial intelligence are still going strong.

In the US and Europe, Zhou cites banking-as-a-service offerings, cybersecurity, fraud prevention and regtech as ‘super strong’ areas. She cites Divido, an HSBC portfolio company that allows banks to provide buy now, pay later (BNPL) services to customers with the right risk profile, as an example of the shift.

“This is a bit related to my point about B2C versus B2B,” Zhou added. “Divido is still doing well through us and their other clients, because there is nothing wrong with BNPL, it’s a way to help our customers manage their cash flow in a smarter way. If I can pay for my $300 skis in five months, I can smooth out my cash flow. But if it is sometimes used incorrectly, it can encourage more risky borrowing people cannot afford to pay back later.

“That’s where the line is drawn. This is where the technology is there and we use the bank’s risk appetite to be very careful about who we lend to, do not overlend and do not urge a customer to overborrow. That is a bank’s obligation. This where we are careful, and therefore, certain technologies are a strategic fit for us.”

All photos courtesy of HSBC Group.