Digital assets, digital securities and blockchain-enabled asset tokenisation are slowly but surely gathering pace within traditional financial institutions. We take a look at the benefits and opportunities driving this and the associated challenges holding back mass adoption.
Digital Assets: The Opportunities and Benefits of Tokenisation
The opportunities and benefits of digital assets and tokenisation are hard to ignore. Although the most movement has been in financial services other industries are taking note of some of the transferable benefits outlined below:
Tokenisation opens the trading floor to assets that were previously too illiquid to trade, such as non-listed shares. This has the benefit of allowing investors, particularly retail investors, to gain access to asset classes and risks that may otherwise have been beyond their capacity, for example, participation in private equity funds and real estate industries.
At the same time, digital assets can serve as a fraction of a stock, which you can trade directly peer-to-peer. This allows investors to hold fractional ownership of assets or interest in funds, permitting them to participate in capital markets with lower minimum tickets or portfolio sizes. Improving liquidity works to prevent the issue of traders offloading illiquid assets for less than they are worth, which then typically bolsters investment activity.
TRANSACTION COST AND SPEED
Digitalisation of assets enhances the efficiency of related processes by removing the need for some types of infrastructure. Meanwhile, the potential to remove intermediaries such as banks, brokers and exchanges from the value chain can substantially reduce or even remove costs relating to issuance and trading.
The time and cost savings at different stages of the asset lifecycle, from the execution of transactions to their clearing and settlement, through the custody of assets and the management of rights associated with them, can be substantial. Consultancy firm Deloitte estimates that transaction costs for cross-border payments, for instance, could be cut by 40-80% thanks to blockchain.
A distributed ledger of transactions secures traceability of every transaction and becomes the “single version of the truth” on which a very large sample of participants can rely but which none of whom can unilaterally control. In a very long chain of partners, intermediaries and competitors, this leads to absolute proof of ownership and fosters confidence in the information that is being shared.
While manual processes are subject to human error, the distributed ledger technology that underpins digital assets and securities means that transactions that meet all required conditions “must be” executed and are registered in a tamper-proof ledger. This is turn simplifies the associated administrative process by automated things such as share registry updates and even reporting and taxation and could, for instance, ensure creditors receive payment for coupons and help them verify the payments. Such transparency could also be put in the hands of regulators, who could benefit from a privileged viewpoint on transactions.
Connecting actors from all over the world grants issuers access to a wide investor audience. Unlike many traditional financial vehicles, digital assets are under the complete control of their holders and providing you hold the private keys to your assets, you can do with them what you please. You’re not limited to certain trading hours or restricted by a controlling centralised entity.
With this autonomy comes great responsibility. Lost keys, mistyped addresses, forgotten passphrases – investors are inadvertently parting ways with their digital assets every day. Fortunately, custodial solutions are gaining ground, helping investors of all types to store their digital investments securely.
Digital Assets: The Risks and Challenges of Tokenisation
While the opportunities and benefits are clear, there of course also remain risks and challenges:
The combination of an embryonic market and rapid development of solutions means that interoperability is one of the biggest unanswered questions in blockchain and a huge barrier to blockchain adoption. Industry has yet to create well-established data standards that are understood and accepted by trading partners.
Some argue that developing standards while the technology is at a relatively immature stage of development could hamper innovation. The flipside is that the creation of interoperability standards might create trust in the technology, which would in turn progress the market and increase adoption. At this stage, projects focusing on seamless interconnection between multiple public or multiple private blockchains, as well as integration between blockchains and legacy systems are very much at the early stages of development.
Digital assets bring with them specific threats – transaction replacement, 51% attacks and network partitioning, to name but three. Needless to say, institutional investors will not enter the digital asset economy until the security of their assets is assured and they have full confidence in the secure storage and custody of decentralised digital assets.
Addressing custody issues for institutional investors is one critical step for these markets to continue to develop. The development of professional custody solutions will demand the continued efforts of market participants including wallet providers to security firms, technology developers, and regulators.
REGULATION AND COMPLIANCE
One of the big challenges facing the digital asset market is how existing rules and legislation be applied to digital assets, and how regulators will respond to the growth of this asset class with new rules and guidance. The lack of a clear and consistent definitions for digital assets complicates regulatory debates. Developing a harmonised understanding of digital assets could provide a basis for discussions surrounding their regulation. Legal certainty will both help players formulate a long-term vision for their business and public authorities better monitor the growing digital environment.
In July last year, the FCA published guidance to help firms understand whether their cryptoasset activities fall under FCA regulation. This will offer a better understanding of whether firms need to be authorised and what they need to do to be compliant.
The main focus of EU tax policy is the smooth operation of the single market, and ensuring that individuals and businesses do not have to face obstacles relating to cross-border economic activity. Transactions in digital assets follow the same general tax rules as transactions in any other form of asset. The same applies to businesses providing services related to digital assets, such as e-wallets.