The digital age for finance takes off

An extraordinary year just passed in which the worst global pandemic in a century ripped most people out of their ordinary lives. Physical meetings had to be reduced to a minimum. Most of the economy experienced a disastrous year. Thankfully, humanity’s collective ingenuity developed a cure in record time. Vaccinations have already started, and many are confident that we will lift most restrictions and return to a sense of “normal” before the end of 2021.

However, one thing changed forever: The realisation that there are more efficient and sustainable ways to do business. The pandemic served as a mega-catalyst for the adoption of new technology. A great example is video-conferencing and online collaboration tools, which reduced the impact on our environment by reducing unnecessary 2-3 days roundtrip to Asia and the US and one-day roundtrips to other European cities. 

And 2020 has not only changed our day-to-day lives. It also accelerated the change in economic and monetary infrastructure. The way we are recording ownership of assets like money, stocks, bonds, real estate, and fund shares is in a transition phase. At the time of writing, blockchain-based systems record over $1 trillion worth of assets, and the pace is increasing fast.

As an extension of my last year's predictions, I want to shed some light on the developments I envision in 2021:

Predictions on blockchain native money:

1. Central bank digital currency (CBDC) will continue to raise

• CBDC is a reality today. China’s latest trial, called Digital currency electronic payment (DECP), included over 100,000 Shenzhen citizens. In 2021 China will go live with its digital means of payment and replace their current monetary system over the coming years. I expect a significant impact on Asian & African countries, who will think twice which currency to use for settling trades. 

• Europe has realised the need for CBDC as well. The European Central Bank (ECB) has consulted with businesses and citizens to understand what they expect from the digital euro. Christine Lagard has recently acknowledged that the Euro area's demand for CBDC is high and that the ECB is planning to introduce it within the next five years. The Swiss Central Bank has even secured trademarks for an electronic Swiss Franc following a successful case study. In 2021 we will see further pressure coming from China and stable coin providers, which will push the ECB to focus on a quicker implementation not to loose their monetary control to private institutions.

2. Private banks, e-money providers, and transfer agents will start exploring stable coins to improve internal and intrabank efficiency

• Why should you employ three people to implement an error-prone six-eye principle when the blockchain can take care of the account keeping automatically? In simple words: The blockchain ensures that third parties or hackers cannot manipulate your record-keeping while maintaining transparency and being audit-proof: The end of endless reconciliations. Banks are currently under heavy pressure. Negative interest rates and high regulatory overhead eat up their margins. If they don't innovate, we will see further heavy consolidation. In 2021 banks will realise that using a blockchain solution will drastically cut their cost and open up a new customer market. In 2021 the US will be leading the stablecoin development with the Office of the Comptroller of the Currency (US Agency) recently announcing that their use is officially allowed by federally chartered banks.

3. FinTechs working on self-stabilising digital money pegged to a currency will become competitive

• Many FinTechs do not want to wait for private and central banks to move, creating their own DLT-native stable coins. The most promising example so far is MakerDAO’s stable coin DAI, which recently crossed $1 bn in circulation. Institutional adoption is still far away. But for somebody holding digital assets or digitised fund shares, a stablecoin could be a working solution to create short term liquidity. DAI is an over-collateralised stable coin tracking the US Dollar. When you submit 100 USD worth of digital assets as collateral, you can borrow up to $65 DAI in return. Many cryptocurrency exchanges already accept DAI, but other use-cases are still to be found. Be aware that if your collateral's underlying value sinks below a certain collateralisation ratio, you will be liquidated and usually incur a loss. In 2021 collateral-backed as well as algorithmic stable coins will further gain in traction.

Predictions on assets on the blockchain:

4. $20bn of investment fund volume will be issued through DLT-registries. Multiple DLT-only transfer agents will start operating in Europe and the US

• Many technology companies (FundsDLT, iZnes, Calastone & Securitize) are working hard to get their transfer agency licence or already have them. ScalingFunds collaborates with existing transfer agents, central administrators, and custodian banks, supplying them with the technology to compete against the uprising DLT-only newcomers. However, it is fair to say that there are other differences between these players. Some of them are focused only on the US or EU, and others specialise in different fund segments (listed vs. private market). 2021 will be a big year for fund managers who will issue $25 bn in digital fund shares. This will be the kick-off for a transition rally, leaving the old system onto a DLT-based one. In 2022, we will see a growth factor of 3-5x every year.

5. European legislators will further strengthen the use of DLT in the investment fund industry

The German eWpG legislation (electronic securities act) will further strengthen the use case of DLT for funds in Germany. Recently announced additions to the Luxembourg regulation only clarify that DLT systems are allowed to register shares, as it was already possible throughout the last years. In 2021, changes in European Regulations will open the market and reduce the oligopolistic power of clearinghouses, enabling new players to emerge in a promising market.

6. Digital Assets will become a part of most institutional money managers

Generation X, Millennials, and even a few Zoomers are starting to invest, nearly all of which were growing up with the internet. The willingness to go through complicated processes to put your money to work is ever decreasing. Fintechs like Robinhood and Trade Republic are expanding at an incredible speed, but they are just touching the surface of what is possible with technology today. Although neo-brokers improve usability and accessibility, they are not changing anything about the antiquated securities systems underneath, which are in place since the 1970s. In 2018 Global Custodian estimated fee savings of $27 bn by changing the underlying financial infrastructure to DLT-based systems, and this is considered a conservative number. In 2021, financial infrastructure companies working on replacing the legacy rails of finance will receive record funding from strategic investors and VCs. The majority of global fund managers will have a senior management person responsible for digital assets. Mathew McDermott is an excellent example from Goldman Sachs, who shares my view that “In the next five to 10 years, you could see a financial system where all assets and liabilities are native to a blockchain, with all transactions natively happening on chain”

Predictions on blockchain technology:

7. Public blockchains will gain the upper hand over private ones

Many have advocated for private blockchains like Hyperledger or R3 for professional use cases instead of public blockchains like Ethereum. Why this is the case is still unclear. Is it scalability or privacy? A public blockchain can achieve both as well. Scalability: With a variety of emerging layer 2 systems, Ethereum is on the right track. Think of these as multiple transactions that are not synced immediately with the main blockchain, but only once enough of them are collected. If most blockchain users adopt these so-called rollups, we can achieve 1,000-4,000 TPS (transactions per second). With the pending upgrade to Ethereum 2.0, 100,000 TPS are possible. For comparison, credit card networks can process 5,000 TPS. Privacy: One class of layer 2 systems uses zero-knowledge proofs (ZK snarks rollup), which allow sensitive information such as account balances or transaction volume to remain private. In 2021, we will see an incredible push in blockchain scalability and privacy, leaving little arguments for private over public blockchains.

Summary

2021 will undoubtedly be a new beginning, and I am incredibly excited to be part of the technological shift which thousands of software engineers and financial professionals worldwide are pushing forward. After dedicating several years to innovative financial services technology at ScalingFunds, I cannot wait when most assets and money transition from legacy banking rails to a blockchain-powered and digital-first financial infrastructure. Just imagine real-time investment transaction, instant cross-border delivery-vs-payment procedures and their benefits to global market activities. We all know it is coming, and many things are already possible on a small scale today. Retrospectively, 2021 will be seen as the year where the digital age for finance finally took off. 

If you want to be part of this exciting journey as well, please reach out to us!

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