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:
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.
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.
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.
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.
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:
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.
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.
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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