Digital Assets – A New Paradigm in Capital Markets

Digital assets are the digital equivalents of financial assets such as securities, currencies, properties, or commodities, and have emerged as a growing asset class with a renewed rise in investor interest. For example, the total market value of cryptocurrencies increased significantly to a whopping USD 2 trillion in May 2021, when compared to around USD 260 billion a year before, and USD 20 billion in early 2017.

Through this blog post, I would like to share my views on the relevance and future of digital assets from the capital markets perspective.

What are digital assets?

Digital assets can represent equity, bonds, derivatives, ETF (exchange traded fund), and non-financial assets such as arts and crafts, real estate, and automobiles. Digitalization of illiquid assets such as private equity will make the asset more accessible and reduce the cost of investment life cycle through reduced TAT (turnaround time) and automation.

A digital asset-based capital market reduces capital requirements, accelerates international fund transfers, and resolves asset availability issues faced by investors. Additionally, it helps eliminate inefficiencies that cost delays and unnecessary expenses.

Adoption across markets

The demand for digital assets is rapidly increasing across segments. According to a survey conducted by a leading financial services firm, conventional investors such as hedge funds and family offices in all leading markets have increased their exposure to digital assets. Most investors have a positive perception of digital assets.

Regulators’ view

Regulators across the world have recognized the need and have accordingly framed rules for the issue and trading of digital assets. Regulations in this context are evolving rapidly.

Early birds of digital assets adoption

Introduction of digital assets has varied impact on the entities in capital markets. We attempt to capture the nature of impact on the business of various entities. I envisage the following stakeholders as the early birds:

Custodians

Custodians can offer custody services for these assets. Digital assets are secured by a cryptographic key, which is effectively a digital bearer instrument, and gives the holder complete control of the asset.

Custodians must store these cryptographic keys on behalf of the client. Custodians who can manage private keys can offer services around assets such as cryptocurrency, securities, a piece of real estate, or non-fungible tokens (NFT). Many custodians such as BNY Mellon have announced the development of digital custody and administration platform for digital assets.

Investment banks

Digital assets can provide a new revenue stream as a new asset class. Investment banks can benefit from higher operational efficiency due to faster settlement, lesser reconciliation, and better liquidity. Considering the regulatory uncertainties and risks, it is expected that investment banks will advise clients on minimal allocation in this asset class. However, emergence of new trading venues can impact investment banks due to disintermediation.

Broker dealers

Broker dealers may benefit from new revenue streams like prime brokerage for crypto assets and crypto custody. Broker dealer operations become more efficient and simplified due to the need for lesser reconciliations and accelerated settlement on digital assets.

Issuers

Digital assets provide multiple benefits compared to a conventional issuance of asset. Issuers could create NFTs and provide better liquidity, thereby reducing the transaction costs. Digital assets have become initial investment categories, and retail investors are investing in this asset class.

Investors

With digital assets, investors will have the ability to achieve fractional ownership of financial and non-financial assets, due to which digital assets provide enhanced liquidity and accelerated settlement.

Asset managers

Digital assets create potential opportunities for new business from new asset classes and greater operational efficiency for asset managers.

Exchanges

Exchanges can benefit from trading in new asset classes. Many non-financial assets can be traded as tokens. SIX Digital Exchange (SDX) has received the regulatory go-ahead to operate a stock exchange and a central securities depository for digital assets in Switzerland.

Market infrastructure – central securities depository (CSD)

Market infrastructure firms will benefit from clearing and settlement of transactions in newer asset classes, will gain operational efficiency and may play the role of operator of blockchain platforms. However, there can be loss of new business due to disintermediation. Existing centralized infrastructure will continue with distributed ledger technology, facilitating newer business.

Conclusion

In the past, there was lack of clarity from the regulators regarding adoption of digital technologies, however, regulators have recognized the need for digital action. Digital assets will become mainstream in the next few years and will be widely accepted.