Blockchain is more about the creation of an ecosystem than it is about a technology – and a key part of creating that ecosystem is interoperability: ensuring that different systems can talk with each other. The problem, however, is that most conversations around blockchain and interoperability in the asset management industry start at a very high level and then quickly get into the weeds of technical complexities, never grounding the discussion in the practical realities of the industry and specific use cases. We need a more practical way forward.
The asset management industry is incredibly complex. It comprises a diverse network of retail and institutional investors, asset types, and intermediaries, and, in between, structures designed to facilitate collective ownership, such as funds – which themselves present a complex web of global trading venues, currencies, and regulatory considerations. So the issue is not unique to blockchain. We have the problem now: separate representations of the same thing on different systems. For example, the distributor has a representation of the holdings in a fund they hold on behalf of their investors on their own system, and the transfer agent has their own separate representation of the same information.
But the asset management industry has navigated challenges of interoperability for decades, developing systems and processes that, despite their inefficiencies, mostly function. The introduction of blockchain technology and tokenisation of assets, while promising, does not magically resolve these challenges. Linking two blockchains together is no different in terms of a technical challenge than trying to link different financial technology systems as they have existed for the last 50 years. Security, synchronisation, resilience, and ACID considerations are all the same. Even distributed transaction coordination itself is a set of messages, all with possible failure modes, so the model can still break if there is just one technology architecture attempting to be the one “superchain”.
The biggest challenge of all is that there is not one chain. We still have many conversations with people who talk about “the chain” as if there is only one. This comes up a lot when talking about “digital money” or a central bank digital currency (CDBC). The reality is that were the Bank of England to create GBP CDBC, it would need to decide which chains to make it available on, or it would need to create its own infrastructure, and then work out how to bridge that to whatever blockchains or other infrastructure needed access.
Even if everything were run on some variant of one blockchain, interoperability would still be a live issue. We hear the story a lot that if everything runs on Ethereum and the Ethereum Virtual Machine (EVM – the computation engine for Ethereum), this will all somehow just work, but that is not correct. There is nothing built into Ethereum blockchains that means they can interoperate with each other without additional work. There is some usefulness in both having the same tooling and technology interfaces, but that is all it is.
Take, for example, the idea that smart contracts will enable automation of corporate actions, like dividend distributions. This does not just happen. There needs to be an infrastructure made up of smart contracts that would collaborate to enable this. The actual dividend rate would still be calculated elsewhere, and then there would need to be some means of paying out the cash, and possibly reinvesting. This is complex business logic, no matter what software you implement it in. Even if entirely implemented on one Ethereum based blockchain, there would need to be an agreed standard on how all this would work.
You not only have to consider the various processes and systems that comprise the asset management ecosystem, but also the dynamic nature of assets themselves. Tokens, and the assets they represent, are not generic, inert things; they have specific attributes and behaviours, necessitating a representation that can encapsulate these characteristics across different blockchains. This requires not only a technical solution but a conceptual framework that can accommodate the idiosyncrasies of assets and asset management within a blockchain environment.
The path forward requires a shift in perspective from top-down to bottom-up. Rather than thinking about interoperability in the abstract, with a generic idea of a token, you need to start with what exactly you want interoperability for. The big three questions you need to answer if you want to build an interoperable asset tokenisation ecosystem are: what is the specific use case – what are you actually trying to do? What does my token represent? And which blockchain(s) need to interact? Once you’ve answered those questions, you have a bounded problem that you can actually figure out and develop a solution for.
It might start as a technical exercise, but by building something for a specific use case, you will find reusable elements – general standards, common identifiers, ways of referencing things – that are more generally applicable to a wider ecosystem of asset tokenisation. You can then start building out from there.
This is how we’ve approached interoperability at Calastone. We have built our network on interoperability so thinking about how we allow access to data and functionality is at the heart of what we do. Our Digital Investment DLT network is built with the idea of interoperability at its heart, but covering the broad range of functions required to manage a collective investment product, as our system does, is complex. We are on a journey to understand what becomes possible with the Investor Register, ABOR, IBOR, and CBOR all on when network, and one aspect of this journey is to consider how integration with the existing ecosystem for asset management and capital markets, as well as the new one of tokenisation and DeFi, will work, but always keeping at its heart the question of what business outcome we are trying to achieve.
This approach underscores the importance of interoperability not as an abstract ideal but as a practical necessity. By focusing on specific use cases the asset management industry will be able to navigate the complexities of blockchain integration and interoperability more effectively, addressing the immediate challenges of asset tokenisation while paving the way for a more interconnected and efficient future in asset management.
First published in Ledger Insights April 2024: https://www.ledgerinsights.com/unlocking-the-future-solving-interoperability-in-asset-tokenisation/
