Broadening the digital asset marketplace______

Adam Belding, Chief Technology Officer

Calastone’s Chief Technology Officer, Adam Belding, reports on a Funds Europe webinar looking at the next steps in the digital assets marketplace.

What will it take to broaden institutional interest in digital assets – not just as investors but as issuers of tokenised instruments? Is there momentum building for change? What are the stumbling blocks to wider institutional adoption and how can they be overcome?

These were among the themes of a webinar held by Funds Europe in early June entitled ‘Are cryptocurrencies and tokenisation changing the face of asset management?’. I was among the panellists exploring the key changes needed in areas such as market infrastructure and regulation if asset managers are to embrace more fully the opportunities offered by digital assets.

From a Calastone perspective, that means two things: first, what will it take for asset managers to  get comfortable working with digital assets and, second, how can they be encouraged to use the potential of technologies like DLT to optimise the collective investment model through tokenisation of assets and other structures built on them?

On the first point, panellists focused on the area of custody, a primary issue for institutions. Luke Dorney of the digital asset custodian, Zodia, said a lot of things still needed to happen for institutions to enter the market. His focus was the cryptocurrency market, but much of what he said was relevant for the whole world of digital assets.

Crypto custodians have grown up serving the retail market. But institutional involvement will bring about intermediation from brokers and exchanges – plus demands for regulated custodians complying with standards of asset safe-keeping along traditional lines. Approved ‘virtual asset service providers’, he said, are likely to include both fintechs and traditional custodians.

Collective investments, which are Calastone’s area of interest, are a lot more complex of course than bitcoin. The latter is a singular asset. A current-world mutual fund is a collective investment into a pool of underlying assets. The new technologies make it possible to tokenise either the collective investment or the underlying – or do both.

Which brings us on to my second question: how can asset managers be encouraged to seize the potential benefits that DLT offers? One thing is certain: there is increasing awareness that the existing mutual fund model is neither efficient nor cost-effective for investors. This has long been understood but the advent of DLT has acted as a catalyst to make the industry reappraise the way things are done and whether the current situation isn’t just a largely unguided evolution that has occurred over the last few decades.

I was asked how Calastone is preparing for the digital asset world. Our approach in a nutshell is to provide a low-risk pathway that will allow mutual funds to move from the current model to one more optimised without putting businesses at risk. It uses the features offered by newer technologies and tightens the loop between the collective ownership and the physical underlyings. There are a variety of models that have the potential to transform the economics of the industry and open it to new products and investors.

I believe there is powerful momentum now for change, but the mutual fund industry works in a way  that has entrenched itself in business processes and regulatory frameworks that has developed over decades. Progress is required on other fronts to support change – and panellists focused on some of these, particularly the regulatory issue.

Building a regulatory backbone

The starting point is regulatory clarity. Karen O’Sullivan, head of innovation, payments, market infrastructures and governance at the Luxembourg regulator, Commission de Surveillance du Secteur Financier, said crypto assets, for example, were not currently deemed suitable for UCITS funds but there was nothing to prevent alternative funds from holding them.

Given the global nature of digital assets, regulatory harmonisation is important.  Across Europe, for instance, there is currently a patchwork of crypto regulation. However, that is changing. O’Sullivan pointed to the European Commission’s proposed regulation of Markets in Crypto-Assets (MICA), which will put a framework in place to allow the passporting of related services across Europe – all of which bears on a future market in tokens.

The key, she said, was to strike the right balance between regulatory certainty and flexibility: ‘Given the speed with which the market is developing and the number of new assets that are emerging, it’s very important to ensure that when the new regulation is there in two years’ time it is still fit for purpose.’

There is a parallel here with the recent discussions at the G7 concerning global taxes. Across the world, collective investment models are similar but with different nuances on each continent. Whatever comes next in the tokenised world will need to fit into that framework somehow. Some work has been done by the Financial Conduct Authority and others around utility tokens, cash tokens, and security tokens, but there is a long way to go. Until there is something that looks global and is transferable, there will be a continuing barrier to adoption.

Looking ahead, what did panellists hope to see in a year’s time? Both Dorney and O’Sullivan focused on harmonisation, with the development of post-trade structures that underpinned safety and created a market that operated along more traditional lines – with no need to tie up capital for prefunding (an issue for cryptocurrency investors) and no exchange risk.

One other panellist, Paul Barker, Head of Professional Development (Wealth) at the training firm, CLT International, stressed the importance of cross-industry collaboration to improve competencies and promote standardisation. We agree with this view, so we joined the InterWork Alliance as a founding member in 2020, a group built to help build the standards required to make tokenisation a reality.

We are also working with asset managers and asset servicers who, like us, are optimistic about the future direction of digital assets within collective investments. We’re confident of the progress being made on the regulatory side as well, as they begin to narrow their focus onto the enablement of new ways of investing. I very much hope that soon there will be a breakthrough on a use case for the technology and all that is inspired by it – one that not only unlocks the potential of the technology but brings real-world progress for investors. It is overdue.

Adam Belding, Chief Architect

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