- Digital Assets -

Technically, Digital Assets (DAs) can simply be audio files, pictures, or videos, but the ability to make the items interactive thanks to blockchain technology and smart contracts made them more interesting and scale adoption.

There has been a growing interest in DAs in the last years, which I believe has happened mainly because of the two following reasons. One is the increased awareness of the potential of DLTs (distributed ledger technologies), which has been around for decades but has been fully understood and applied to businesses only in the last years thanks to crypto adoption. In fact, DLTs provide enhanced functionalities compared to traditional systems of recording ownership of assets. They provide a globally acknowledged true source of information on the holdings of the DAs by all members of the network, allowing them to individually verify the validity of ownership and transfers, without needing to trust a central authority or each other. The second reason is the possibility of deploying smart contracts on the blockchain and therefore, making use of DAs for even more various scopes. Will follow a dedicated article on smart contracts.

In 2013, ca 10 BN were traded in DAs, in 2016 with the launch of Ether and Altcoins, ca 17 BN, in 2018, ca 132 BN and, in 2021 ca 1.06 TN and according to data from CoinMarketCap over 8280 different types of DAs are currently being traded.

Definition

We define a DA as something that is represented in a digital form that has an intrinsic or acquired value. It is designed as a store of value or medium of exchange that uses strong cryptography to secure transactions, it controls the creation of digital units and verifies the transfer of assets.

In the diagram below I use the name Tokens because they can be easily associated with DAs and sound less vague. It is a common term applied to a digital entry whereby a person owns or is recorded as owning, a unit or other entitlement through a DLT-based register or other digital infrastructure.

DAs are not only Payment Tokens like BTC and ETH or Altcoins, but they are more than that and and can be used for a variety of purposes.

In fact, besides crypto, other types of DAs include Utility Tokens that can be bought to be used to access some services. A good example is an online gaming company that can use the utility tokens to fund the development of the game. The owner of the token will then be able to use to play or access other services. Finally, Security Tokens that are the most subject to regulations, being very similar to standard securities. Technically, any asset can be tokenised like debt, equity, or other financial instruments and beyond.

Other types of DAs can represent lands, commodities, properties or nothing at all but they are non fungible, hence the name Non Fungible Tokens (an ad hoc article will follow for them).

DAs can also be backed by fiat, so-called stable coins. Such an example is the US stable coin (USDC).

CBDCs

I cannot disregard the Central Bank Digital Currencies (CBDCs ) when talking about DAs. CBDC is a digital form of fiat currency that serves as a method of exchange and store of value. It can be held and transferred electronically by the general public.

Like cash, it earns no interest, is uniquely identifiable, and is universally accessible. In economic terms, it is the equivalent of cash. 70% of banks are exploring CBDCs, in particular, Sweden, Singapore, Korea, China, and countries in the Middle East. The adoption of CBDCs will accelerate the adoption of DAs and will allow central banks to focus more on the regularisation of the different types of assets.

Assets in crypto products have increased in 2020 and 2021. DAs for users have many benefits including tokenised physical asset facilities allowing for easier trading in the secondary markets. They provide for a higher degree of transparency, provenance, and a more accessible inclusive ecosystem thanks to fractional ownership.

EU regulatory perspective

There is currently no EU or global taxonomy for categorising or defining crypto assets.

There is a huge attempt to regulate digital assets. Almost 2 years after the EU commission adopted its Fintech action plan, it proposed in September 2020, a future framework for Markets in Crypto Assets (MICA). The EU recognised the interest in promoting and the universal benefit of crypto assets, including the ease of payment systems for users and access to financial markets for consumers. The commission recognised the lack of harmonisation among the EU member states in crypto assets regulations. For this reason, it has proposed a MICA for issuance and provision of services related to crypto-asset exchanges and trading platforms, addressing investors’ risks, promoting financial stability and, mitigating financial policy risks.

The existing regulations are AMLD6, anti-money laundering 2018 which has been transposed to 2020, domestic law. This regulation brings custodian wallet providers and digital asset exchanges into the scope of AML, focusing on issues that need to have proper AML policies and procedures in place. In addition, it also focuses on some of the providers who would have been required to have a procedure.

The other type of regulation that can capture digital assets from an EU perspective is MiFID2 (Markets in Financial Instruments Directive). Under this directive, some digital assets can be classified as financial instruments and might have reporting requirements.

The key is: DAs are becoming an important asset class in the coming years and therefore, existing regulations that capture AML together with a new framework will hopefully harmonise consistency across the EU and not only.

The ecosystem for the DAs

The following are some of the similarities with the traditional system:

? You have investors,

? You have a founder who sells a product or DA

? You have a custodian,

? You have an asset manager that executes the trading strategy.

The following are the differences:

? You have enablers like miners, node operators, and validators. These are the participants that create digital assets. There are a lot of people that access and validate transactions on the protocols.

? There are public vs. private protocols for DAs. Some DAs are decentralised and sit on public infrastructure, while some are in private infrastructures, where only certain participants are allowed to trade them. From a private infrastructure perspective, it is similar to PE (Private Equity) investments.

Decentralized Finance

I quickly talk about Decentralised Finance (DeFi) here due to its intrinsic correlation to DAs. DeFi is an umbrella term for a variety of financial applications in crypto or blockchain, geared towards disrupting financial intermediaries. DeFi draws on the inspiration from blockchain which allows several entities to hold a copy of a history of transactions, which means it is not controlled by a single central source. DeFi stand out from the standard legacy of service providers since they remove the middle man from the transaction. The underlining technology and platform are vastly different from that of the traditional investment world. It offers financial instruments without relying on intermediaries such as brokerages, exchanges or banks by using smart contracts on a blockchain.

Opportunities for Digital Assets

The following are the opportunities that DAs can serve.

Algorithmic trading - The market does not close and this implies advantages to the volatility of DAs.

Custody - As DAs become mainstream, traditional banks and custodians will look at having a custody arm. The market is currently being disrupted by exchanges having their custody practices. As more assets like traditional stock and debt get tokenised, this will take up a more important role as a custodian business model.

Speed - Given that settlements happen straight away, there is an opportunity to do landing and staking that will generate additional revenues for the business.

Services - From an asset servicing perspective, if more funds start to be traded in DAs, asset traders will need the infrastructure to support their clients, like in tokenising real assets such as land properties commodities.

Funds - Asset managers can use DAs in different ways, like diversifying the risk of their portfolios. DAs could present higher yields or higher returns or investments in more stable assets like stable coins or CBDC (Central Bank Digital Currency).

Fractional ownership - DAs can also be used for hedging or to create liquidity in markets where there is not enough liquidity. Examples can be the real estate market to which only institutional investors have access.

Key takeaway

The key takeaway is that DAs are growing at a rapid pace. All areas of wealth management, finance, law, will need to consider their business models and how they can implement DAs into their strategies.

I believe DAs are a major asset class for the future and it is now time for organisations to consider their business models for when DAs become mainstream. Very soon!

According to Deloitte’s annual global blockchain survey, 90% of respondents believe that DAs will disrupt their industry and serve as an alternative to fiat in the next 5 years.

Thank you for reading and follow me for more on new wealth.

Silvia

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