There is still some time before digital assets see the kind of adoption needed to propel them fully into the mainstream, the author of this article argues.
The rise of cryptocurrencies such as Bitcoin and the Blockchain distributed ledger technology that underpins them have become part of the business conversation. No longer seen as weird or niche areas, the area that goes under the term “digital assets” is now a busy one. But there remains a lot to be done in explaining what such assets are and, just as importantly, what they are not. To contest a number of myths about such assets is Irfan Ahmad, vice president, digital product development and innovation at State Street, the US financial services group. The editors are pleased to share these insights and invite readers to jump into the conversation. The usual editorial disclaimers apply. Email firstname.lastname@example.org and email@example.com
What exactly is a digital asset? For investors and regulators alike, the asset class has given rise to intrigue and continuous debate, as efforts to pin down the opportunities and challenges they hold have proven a curiously tricky task.
For many, digital assets will conjure thoughts of Bitcoin and Ethereum, but increased appetite to digitize other ‘traditional’ assets – and expand the applications of “tokenization” – mean that the term encompasses much more than just cryptocurrencies. Here are some of the most common myths surrounding digital assets as they increasingly edge towards the mainstream for the institutional investor.
Myth One: A whole new world
Among the more pressing concerns for investors assessing the place of digital assets in their portfolios, there has been the sense that their digital form makes them inherently different from those issued in a central securities depository - an organization, representing a central point for depositing securities such as equities, bonds and in some markets mutual funds. That is not necessarily true. Though there is an underlying difference in the infrastructure creating and issuing such assets, with digital assets leaning on a decentralized system like blockchain, both digital and traditional assets can capture value electronically.
While this entails less centralized oversight for digital assets, there is, in turn, more independent verification activity happening jointly across the entire market infrastructure.
Myth Two: The same rules apply
To date, many regulators have classified digital assets into distinct categories of payment, utility and security tokens - an attempt to define them in the context of existing regulations. But this may be an incorrect recourse for what are altogether different asset types. Because digital assets are created in a fundamentally different way from traditional, non-tokenized securities, it may not be appropriate to apply the same regulatory framework to them, as the status quo may not account for all the complexity involved.
Regulators, for their part, have become more alert to this. In September, the European Commission introduced a proposal for a new pilot as part of its digital finance strategy to tackle the disparity, acknowledging that existing rules were designed before the emergence of cryptocurrencies and similar products. (1)
Myth Three: Instant settlements at no cost
Part of the allure of digital assets has been their potential to make settlements in almost real-time, a benefit often heralded as a “win-win” outcome. But is it desirable in all cases to have instant settlement?
The traditional securities industry has done much to reduce settlement cycles, shortening the window by days, but veering towards instant payment processing inevitably means increased liquidity requirements for those involved.
For market participants, it would involve pre-funding transactions before moving a trade to a settlement, meaning that the verdict is still out on whether or not the offer of instant settlements from digital assets will be to everyone’s favor.
Myth Four: Automating the full lifecycle
Another key selling point for digital assets is that all stages of an asset’s lifecycle can potentially be automated through smart contracts, which when used on a distributed ledger could allow major efficiency gains in post-trade processing. In practice, however, there are still hurdles to overcome in seeing the potential of smart contracts become fully realized.
Take interest or dividend payments. Usually, there are tax implications and deductions that need to be made in the process, all of which would have to be taken into account at the issuance stage of a digital asset i.e. when the smart contract is designed and put into production - something that presently, is not necessarily guaranteed, and requires further deliberation.
The question of liability is related to this. Will the creator of the smart contract take full liability for the correct processing of this information? This is more than a simple question of automation. The other important thing to note is that all parties involved, including the investors and asset managers, become direct participants of that new distributed ledger technology network. It can only succeed if all participants are working in partnership.
There is still some time before digital assets see the kind of adoption needed to propel them fully into the mainstream, but the faster the myths around them are dispelled the faster they will find a secure footing in the market - and the better the outcomes will be for the industry as a whole.
1, Digital Finance Strategy, legislative proposals on crypto-assets and digital operational resilience, European Commission, September 2020