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The Blockchain Comeback: How Institutions Effectively Use Digital Assets

This blog post first appeared in Forbes.

A wave of skepticism hardly hit the crypto assets market in 2018, especially observable by a massive drop in ICO volumes. This sharp decline was mainly due to offerings of poor quality and a lack of regulatory oversight. 2019 will be a transition year on the way to a regulated market of tokenized assets. Security tokens are at the core of the rebound and three major disruptions are accelerating the redefinition of financial markets:

The digitization of existing assets

One of the main reasons which caused investors to lose interests in ICOs and cryptocurrencies was the lack of oversight on that new fund-raising method and the poor quality of the assets they received in return of their investments. To overcome that deeply-rooted problem, the trend is to turn towards known and well-recognized asset classes like tokenization of securities and add the efficiency and safety potential of decentralized ledger technologies.

An evolving infrastructure for digital assets

Supporting the digitalization of existing assets, a strong and reliable infrastructure is needed to provide a seamless experience for the end-user, namely individual and institutional investors wanting to diversify their asset allocation. Since the beginning of 2019, an upsurge of established global financial exchanges announced a handful of projects aiming at developing the trading of digital assets in a regulated environment. With different levels of progress, all major players have at least announced collaborations with technical experts and companies to develop deeper knowledge in this ground-breaking technology advancement.

A more transparent regulatory framework

There is a need for regulatory approval in all jurisdictions and broader market acceptance from all existing players in the industry. From the regulatory perspective, a major shift towards digital assets can be observed at the moment. But at its current state, it won’t happen before 2020. The Swiss legislator, considered to be one of the first to rule on that matter, will soon vote on such legislation. However, even if successful, the ruling will take effect on January 1st, 2020.

Today’s insufficient market infrastructure level

Currently, the market infrastructure still needs to overcome psychological and technological hurdles to trigger interest from institutional investors. Three main reasons explain the lack of trust in the existing market infrastructure: insufficient market readiness, lack of education of market players and investor related factors. Insufficient market infrastructure and market readiness can be defined by the limited integration between traditional money and digital assets, a low level of liquidity and transparency of current digital assets and no enterprise-grade custody solution available, making the investor itself bear the responsibility of holding the asset, or having to rely on relatively inexperienced custodians with low volume capabilities. The lack of education of market players is characterized by the recent development of decentralized ledgers and not enough time for established market players to adopt that technology to-date. Furthermore, there is no standard for security tokens. Lastly, investor related factors are comprised partly from a disjointed and inconsistent investor experience with crypto asset-based exchanges with renowned names having experienced systematic technical problems or having been hacked. Also, the lack of institutional grade investment products hindered the attractiveness of digital assets to meet the needs of sophisticated investment strategies.

What assets to be tokenized, only cash, shares and real estate?

In theory, all existing asset classes can be put into digital certificates “tokens”. From listed and unlisted equity, bonds, real estate, luxury goods and investment funds, every asset class already has been tokenized, but not in all cases was it proven to be an improvement of existing processes or adding any kind of value. One central criterion is that it’s only useful to tokenize assets, which can be after only be transferred via blockchain. With the current state of legislation, it does not bring value to tokenize tangible assets such as real estate and luxury goods since both asset classes can still be sold outside of the blockchain or any other exchange. However, the digitalization of intangible asset classes such as debt, equity and derivatives can already benefit from smart contract characteristics in managing the entire asset lifecycle such as issuance, electronic voting rights, dividend payments and automated shareholder registers.

Following are the Finoa research results on potential developments of digital asset classes for the upcoming 8 years:

Tokenized Economy

Source: https://finoa.io/#research

A clear trend can be observed that intangibles will cover most of the projected market volume with more than 95% of the total if we include “Other financial Assets” as intangibles.

Traditional & new players competing for the market share

Competition between the existing exchanges and newcomers will be key to determine the future of the digital assets’ providers. On one side, existing market leaders have the most potential to grasp the largest market share. With an existing base of trusted customers including the largest institutional firms, an established brand image and a proven ability to scale, only a technological change is required to address the new market of digital assets. Since they are and will remain regulatory compliant, exchanges will set the standards for security tokens to be listed, as they already do, increasing investors’ confidence and broad market acceptance. On the other side, new market players are entering the space with disrupting technologies and more flexibility to adapt quickly to changing market conditions. However, even with a more efficient technology, new actors are facing structural problems to set foot in the industry. First, regulatory conditions like exchange and broker-dealer licenses are needed to operate in most countries. In addition, distribution and connections to financial institutions are still lacking to gain broader market presence, acceptance and confidence.

The first half of 2019 has and will continue to witness traditional market players entering the digital assets space at a fast pace. Singapore’s SGX partnered with Nasdaq to develop a blockchain settlement system. In Europe, Deutsche Boerse and SIX also partnered with technology companies to integrate digital assets in their offering starting this year already.

Newly established companies are starting to get traction in the security tokens space with names like Coinbase Prime to create an institutional trading platform or t-Zero which offers a regulated platform for security token offerings. Also, daura and Sygnum joined forces with Deutsche Boerse and Swisscom to build a tokenized ecosystem with a focus on issuance of security tokens.

Dependent on regulatory approval

To conclude, digital assets show a great potential for the future of the financial service industry. To support its successful development, customers and institutional players will soon decide on whom to partner with for new security tokens issuance. Furthermore, the regulatory approval will be the most time costly condition to get the ecosystem up and running. 2020 will be a transition year for the development of the market infrastructure for security tokens. Momentum will build up in 2021 and 2022 before going to a generalized market acceptance and towards a more tokenized economy.

Oliver Bussmann is Founder and CEO of Bussmann Advisory; ex-chief information officer at UBS and SAP.

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4 Major Blockchain Trends to Watch for in 2019

This blog post first appeared in Forbes.

With 2019 right around the corner, the time has come to reflect on the events of 2018, but more importantly, to consider what the next year holds. With a groaning bear market dampening the crypto hype, it is easy to forget that blockchain technology continues to hold much promise.

While some may lament the entry of regulators in 2018, clamping down on ICO projects, and putting in place strict frameworks for compliance, these are signs of a market maturing. Speculators aside, industry experts knew the Wild West of Crypto was only a transitionary phase, and as it draws towards its close, the time has come to focus on holistic, sustainable growth with real, tangible benefits.

Trend #1: The arrival of Security Tokens

 

As 2018 marched along and the utility token market saw a slowdown, industry has been rife with talk of the arrival of security tokens. This is for good reason.

The market has long-waited for the grand entrance of institutional investors – but they have not yet significantly entered the market. This has partially been attributed to the core offerings of ICOs. Utility tokens offering usability are simply not substantial enough to investors, who are used to buying stakes in companies.

Enter security tokens. The familiarity of the IPO world coupled with the benefits of blockchain is an offering that promises to redefine the IPO business. The idea of programmable equity brings possibilities of immense liquidity and efficiency at lower costs. Coupled with access to global pools of capital, 24/7, opportunities abound.

However, it is still a promise, as the market infrastructure for listing and trading security and asset tokens is still in the works. But the change is coming, with 2018 seeing major crypto exchanges applying for brokerage licenses in preparation. With the market still nascent – we expect to see the opening of exchanges with security token trading functionalities in 2019. However, it is likely in the early stages that liquidity will be limited.

The success of security tokens is contingent on digital asset exchanges being up and running. Alongside crypto exchanges like Coinbase, Binance and Lykke seeking regulatory clearance for security tokens, we also see traditional players like Nasdaq, London Stock Exchange and the Swiss Stock Exchange developing digital asset platforms, signs indicating that market infrastructure will be in place by the second half of 2019. As processes stabilize and regulatory concerns are addressed, we will see the launch of several STO projects towards the end of 2019, with major activity and more liquidity in early 2020.

Trend #2: The rise of Alternative Asset Classes – move from crypto to digital assets

 

With several indicators pointing towards the possibility of a global slowdown especially in the equity and bond markets in the coming year, investors are on the lookout for alternative asset classes. With the developing market for security tokens, there are immense possibilities in the tokenization of well-performing assets that previously lacked liquidity. Consider healthy Small-Medium Enterprises (SMEs) and Real Estate Assets, that tend to have robust returns, but lack wide market access.

While they may not be able to afford public market listing, opening up to global markets of investors could provide an infusion of capital that could help scale their businesses. With over 90% of companies in operation globally listed as SMEs, the potential for growth is significant.

Trend #3: The creation of Decentralized Ecosystem Platforms and new business models

 

Of all the methods to harness the power of blockchain, one that has piqued interest across borders and industries is the possibility to develop B2B2C ecosystems. A McKinsey study from 2017 reported the importance of ecosystems in the future, suggesting that new ecosystems would emerge in place of many traditional industries with over $50 trillion in revenue by 2025. Not unlike e-commerce in the nineties, the vast potential for growth and disruption with decentralized P2P ecosystems is yet to be discovered.

In enabling efficient peer-to-peer transactions through shared APIs, the potential of a smart contract-powered decentralized ecosystem is vast. This also involves the construction of new business models, in a frame of cooperative competition, with competitors coming together to build up ecosystems that connect various players through the lifecycle of any product and the end-to-end delivery of services.

While this concept has already seen some implementation in 2018, the experiments have brought learnings rather than success. The experiments have helped identify complications in implementation, such as the need for a business governance model that allows all ecosystem players to have a voice without any single leader.

The learnings from unproductive experiments open up the gates for more progress in 2019, with innovative new decentralized ecosystems being developed by the end of the year.

Trend #4: The real winners – Hybrid Models

 

It is more and more widely accepted that blockchain is here to stay. Even as the technology turns toward the trough of disillusionment on Gartner’s hype cycle, comes the investment in technology development and greater regulatory clarity.

At the end of 2018, blockchain remains the darling of the tech-savvy, but is still perceived as a vague, not-quite-understood, new entrant to the tech conservative. The true winners of 2019 will be companies that are able to bridge the crypto and fiat worlds, enabling digital links between the two. This linkage is a necessity across industries, from storage, trading, asset management of digital assets to real world applications of technology for the bystander, such as voting and land-registry.

The end of 2018 also marks the end of the crypto-hype, and we welcome the next phase of development of digital assets as we move up the slope of enlightenment and toward the plateau of productivity.

 

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