Hirander Misra, CEO, GMEX Group
Alexey Demyanov, Managing Director, Bank of America Securities
Nadine Teychenne, Global Head, Digital Assets, Securities Services, Citi
Luc Froehlich, Global Head of Digital Assets Solutions, Fidelity International
Crypto winter or digital spring?
The opening points of panellists suggested that far from experiencing a Crypto Winter, there has been an explosion of activity in recent months by institutions, banks, private banks and digital native businesses seeking to enter the digital assets space.
A plethora of new enterprise blockchain and digital asset projects for traditional financial market structures, and multiple new entrants developing digital asset marketplaces around private market assets and bonds, suggests a rapid acceleration of institutional engagement over the next 5 years, with significant take-up in the longer term (5-10 years).
‘Institutional adoption’ to date has been centred around hedge funds using systematic trading strategies to generate yield or income, with less demand from real money investors like pension and insurance funds. As one panellist observed: “If you look more closely under the hood, a lot of high-net-worth firms and family offices are keen to embrace the asset class but don’t necessarily want to go through blockchains because they don’t really understand them. We need to do more to encourage real money guys to come in by making it easier for them.” Private market assets (traditionally illiquid and non-standardised) are another area being looked at by a number of consortiums and traditional infrastructure players like DTCC.
Bringing the old together with the new
Infrastructure remains a real challenge for many organisations. Legacy infrastructure isn’t going away any time soon and still attracts billions of dollars of investment. Multiple blockchains already exist that could leverage traditional – and crucial – market infrastructure like SWIFT. At the same time, traders in banks and brokers focus only on performance/returns – they really don’t care about the ‘pipes and plumbing’, and just expect them to work.
Cross-industry collaboration is key and should encompass issuers, investors, banks, regulators, technology and service providers and other market participants. Asset managers in particular may be more receptive to partnering with external infrastructure providers; in the absence of the specialist knowledge (and resources) required to build proprietary digital infrastructure themselves, collaboration is an opportunity to accelerate their digital asset journey.
Regulation was slated as ‘the wildcard that might enable or stifle institutional adoption’ with some financial markets jurisdictions already laying down a solid framework and clarity around desired regulation. Others, including some of the major financial marketplaces, do not have such clarity about the evolving digital finance landscape.
Regulatory uncertainty around crypto and digital assets may be one of the sticking points in terms of banks’ overall speed of adoption. The very high regulatory standards to which banks are held puts them under enormous pressure with respect to service delivery and compliance. As such, the establishment of an appropriate regulatory framework will be a key driver of institutional adoption, alongside ease of market access.
While the efficiencies of instantaneous settlements are difficult to overstate, there are significant post-trade challenges with digital assets, not least achieving settlement finality on one blockchain network when your counterparty is on another, suggesting the need for a more hybrid (“HyFi”) approach.
Real-time settlement is a huge benefit; an asset can settle as soon as it is traded, which changes the landscape in terms of efficiency. Much of the asset servicing lifecycle can be automated with smart contracts, including building regulatory compliance framework into the asset. Tokenization is attractive from a post-trade perspective because it reduces friction, increases settlement efficiency and takes cost out of the system.
Distribution of data to intermediaries and participants – including regulators – is far more efficient and explains why the ‘back end’ may be more of a driver for change rather than the investment opportunities per se, particularly with respect to digital cash.
Tokenization could be a significant financial markets initiative and it’s back on the agenda in a big way. From a distribution perspective, tokenizing a share class offers benefits in terms of operational and cost efficiency.
Technology is not the challenge – it’s relatively easy to create an NFT or a security token – but many new digital platforms struggle with limited liquidity (and the challenge of finding the ‘other side’). It always comes back to access and liquidity; for example, the Singapore Exchange listing underlying bonds, and also fractionalizing them ($1,000 lots) to reach a much broader investor base.
There may also be a new breed of tokenized assets, like movie royalties or digitalization of music publishing, but who’s going to buy them? There’s a large and growing market of new e-users, for example e-sports participants – suggesting an opportunity for the new breed of tokenized assets like loyalty rewards, royalties and digitalized music publishing.
The buy side – asset managers, hedge funds, venture funds – all bring up the question of prime brokerage; whether anybody really offers it and what it should look like. Banks have big balance sheets (although perhaps not as big as they once were) and hundreds of years of managing buy side relationships. Banks engender greater trust than many new players. The question is how banks leverage this value in the digital asset ecosystem.
Even with digital assets, the balance sheet is key from an investment lifecycle perspective, alongside tradeable prices and custody, and regulation has to be in place for this to occur.
The panel concurred that insurance is an important topic that isn’t being given enough airtime in the digital debate. Financial markets are moving away from pre-funding to margin and current ‘insurance’ is not adequate relative to the size of digital assets in custody; it is a tick box exercise rather than providing appropriate risk cover.
As other asset classes have evolved, there has typically been an associated mutualization of risk (typically through centralised CCPs) so there is a precedent and argument for digital finance market mutualization. However, it is not yet sufficiently developed as a product. As one panellist said: “We’re certainly seeing an appetite for the market to come together and solve the insurance problem because it is the wrong price at the moment”.
Transition by collaboration
The financial industry is in transition and the challenge for traditional players is how they upgrade traditional ecosystems to connect to this new world. There is no question that traditional financial institutions are taking more notice, even if they’re not yet fully engaged. As one panellist put it: “The challenge with institutions is getting them to dip their toe into the water. In time-honoured financial markets fashion, no-one wants to go first, and then everyone gets FOMO (fear of missing out).”
Over the next few years there will inevitably be the convergence of traditional finance (TradFi), digital asset centralized finance (CeFi) and decentralized finance (DeFi). As a result, it is likely that we’ll see more HyFi (hybrid finance) services and solutions as markets participants start to bridge the gap between the old and the new. There are still quite a few hurdles for institutional investors, not least the lack of traditional custodians that offer access to public – and permissioned – blockchain networks. There are still concerns around risk, security, loss of assets and so on that must be addressed. There are new digital custodians and the technology has evolved sufficiently, but there’s still the challenge of getting internal stakeholders and leadership, due diligence, legal and regulatory teams over the hurdles.
Ultimately, the winners will be the players that choose to work collaboratively to embrace change and to manage the disruptive elements of new digital market infrastructure technology innovation more effectively, in order to achieve a seamless transition and harness the market opportunities.