State of Digital Assets, Oct 2020

The following content is my personal opinion and does not reflect the views or position of Accenture or Accenture Federal Services (AFS).

Intro

Over the last few months I've noticed a significant increase in attention towards the digital asset space - central banks issuing whitepapers and conducting pilots for sovereign digital currency, corporate treasuries allocating to cryptoassets, government agencies issuing new guidance and bringing enforcement actions against major industry participants, DeFi total value locked exceeding $10B and financial media resurrecting the bitcoin ticker. While these events happen independently, they are all tied together in the broader macro transition from an analog/electronic financial world to a more open, cohesive, digital financial ecosystem. There are multiple external factors driving each one of these independent events, which in summation, are driving the digital asset industry forward. I am writing to convey my thoughts on the state of the digital asset industry, its possible future directions and to evoke discussion and/or feedback from the broader digital asset community.

To organize my thoughts, I will address the digital asset industry in separate sectors based on their current market presence. I am defining market presence as a combination of in-production use and general public conversation. To set a common understanding, in my personal view, the "digital asset" umbrella contains both permissionless and permissioned networks and technology. Some of the sectors within digital assets are cryptoassets, central bank digital currencies (CBDCs), stablecoins and tokenized securities. To differentiate assets from the underlying networks, capitalized (Bitcoin/Ethereum) refers to the networks while lowercase (bitcoin/ether) refer to the cryptoassets running upon the networks. Along with these core "asset" sectors, there are the supporting digital asset services - analytics, custody, broad financial services (such as lending and borrowing) and others. Both these asset and service sectors can be broken down further and in more detail but to be concise, I will speak to these asset sectors at a high level.

Cryptoassets

In August 2020, Michael Saylor entered what he refers to as "the hornets nest" when he announced his company, MicroStrategy, was investing its treasury's assets into bitcoin to maintain purchasing power and combat monetary inflation. I believe Michael has eliminated the reputation risk of a publicly traded corporation holding bitcoin on its balance sheet and I expect a majority of Fortune 500 companies to adopt this treasury allocation strategy in the future. As part of Michael's recent crypto podcast roadshow, he spoke about the impact steel and aluminum had to the architecture and aerospace industries and how this analogy could apply to financial services. Before steel, society was limited to a maximum height of buildings using just wood. With steel, skyscrapers were created, along with the majority of New York City and most major metro areas. With aluminum, the aviation industry was enabled at the mass scale we know today.

Are Bitcoin and Ethereum the steel and aluminum of the next generation's financial services? Will Bitcoin underpin a more sturdy and trustworthy financial services infrastructure with its publicly verifiable blockchain network which has been functioning for 10+ years? Will Ethereum enable more efficient financial services to be delivered to a broader audience than any bank currently can? Perhaps "DeFi" is the seedling of these more efficient financial services upon Ethereum. Actions such as PayPal's recent announcement of cryptoassets being offered for investing and payments could be the beginnings of this steel and aluminum adoption in traditional financial services.

As I see these new components of financial services being adopted, I have concerns surrounding the paradigm shift of a brand new infrastructure. The first concern regards the ability to protect consumers from unknown risks inherent to new technology that only requires an internet connection to access. Unlike many previous technologies, permissionless blockchain infrastructure testing requires real assets and monetary value. There will be funds lost to technical errors, software failures, security breaches and lack of education. My second concern regards regulators and lawmakers prioritizing, gaining insights and becoming comfortable with these new entities who do not use a centralized ledger or order book to facilitate financial services. New tools, market monitoring techniques and guidance will likely be required. The United States regulators, along with their global counterparts, have publicly issued significant guidance which enables companies to better design their products and services with the new steel and aluminum if they choose. I believe it may take new laws passed by government leaders to provide concrete regulatory certainty for the industry.

Related to regulation, the current DeFi boom, while creating new products and excitement in the space, is running a very real risk of violating significant KYC/AML and BSA laws, likely more so than securities violations. I expect DeFi to follow in the steps of the ICO boom in that the more egregious offenders will receive legal actions in the coming years. It is critical to eliminate the nefarious actors taking advantage of a new technology to scam consumers or conduct illegal actions. I hope the regulatory and consumer protection agencies of our society will strike the balance between allowing innovation and protecting consumers.

Finally, the live price feed, communicated in the cryptoassets of the financial protocols, allows for open market speculation on these new technologies. I would urge market participants to find underlying metrics in order to analyze these technologies by more than just price action. Keep in mind that these are networks, with living ecosystems containing some of the most intelligent individuals in finance, technology and engineering driving progress. Many valuation models have been put forward and I expect more view points, models and theories to emerge as the markets mature. Price is just one aspect of the ecosystem.

Stablecoins

The growth of stablecoin market size shows that there is a demand for dollars in the crypto token form. Not only has the total market value increased significantly (USDC market cap growing from ~$500M to ~$3B since COVID-19 struck in March 2020) but the infrastructure supporting these stablecoins have expanded from Ethereum to alternative smart contract networks. This diversification of infrastructure provides a more resilient overall network and more options for end users. While there are many theories to explain the rapid growth, the core objective of tokenization and tying to a real world asset has significant traction. In the short term, I expect the definition of "stablecoin" to be deconstructed and develop multiple segments based on design and the asset being represented by a crypto token. For example, Paxos has a crypto token which is backed by and redeemable for an ounce of gold. This could be considered a "stablecoin" in that the crypto token is designed to be stable with the price of the underlying gold, mitigating the systematic risk of the cryptoasset (bitcoin, ether and others) market while enabling more efficient trading and composability within the Ethereum ecosystem.

It would not be surprising if a major commercial bank or fintech firm issues a stablecoin which follows the USDC model of a crypto token representing a 1:1 redeemable value with a fiat currency. Looking forward, I expect stablecoins to have a some direct relationship (either competition, complimentary or cannibalization) with CBDCs at the retail layer.

CBDCs

As the CBDC drum beat continues to grow louder, I look across the global landscape and see a wide variety of models and approaches. At this early point, I simply believe every central bank will be required to issue a natively digital form of its sovereign money or it risks being displaced in the global financial markets. This displacement risk quickly becomes a national security risk. Similarly to how previous national infrastructure projects required partnerships between public and private enterprise, it is likely the CBDC projects will involve both public and private entities working together.

Each country with a central bank will have the opportunity to encode its believes and values in its new form of money. We may end up in a world where people could choose which country or economic zone they wish to contribute to GDP based on its money's design. Then again, some people may have no choice and be subject to a strict, closed, surveillance state money. I believe that one of the mental models to help frame the CBDC topic is that money is becoming a product. Central banks must upgrade their products because in an open market, usually the best product wins.

Tokenized Securities

Securities ownership has evolved from paper certificates, to electronic communication networks with CUSIPs/ISINs and will likely continue this evolutionary trend as technology moves forward. Recent events, such as the SEC Chairman's statements on equity tokenization, blockchain-based bond issuance by the World Bank and growing infrastructure around the use case, suggests we are on a path to complete financial asset (equity and debt) tokenization. I see the two main drivers of this evolution being the market participants, who desire more efficient trading and regulators, who desire more transparency and compliance.

Placing a financial asset in a programmable digital wrapper could enable more efficiency, transparency, compliance and new functionality. A concrete example of this - an equity or bond could be programmed to know who is allowed to own it, who it owes cashflows to, when to execute those cash payments and what other securities it can join with to form a synthetic index. The entire history of ownership could be made available to authorized stakeholders with an instant query. A recent job posting from Nasdaq for blockchain talent, along with regulator guidance, suggests it is a matter of time before this new tokenization standard is implemented and possibly required.

Closing

I want to thank you for reading my personal views on the current state of digital assets and would encourage you to comment on areas I have addressed and areas I did not address. I am excited to learn from the broad and diverse expertise in this exciting industry.