Digital Markets – The Future of Finance
Digital assets have the potential to revolutionize finance, but they are poorly understood. A lack of clarity on digital assets creates unrealistic expectations and limits the benefits to the market as a whole. In this post our CEO David Nicol shares our views on what digital assets are, how they add value, and how the market will evolve with them over the next 10 years.
What are we talking about?
“Digital asset” is a catch all term. We live and work in financial markets, so for our purposes here, we are talking about financial assets – securities and contracts – that are managed and represented on digital systems.
I spend a lot of time talking about digital assets and digital markets. I’m going to tell a story about how we got here. If we don’t understand this, then we are not going to understand how digital assets add value, and we will miss a major opportunity to improve markets.
I’d like to go back to 4000 BC… just kidding! This is not going to be one of those preachy posts about the history of money to sell my own book.
Instead, let’s start with the birth of bitcoin in 2008. Or right before that. Financial assets rely on a system of record to tell the world what they are and who owns them. Before 2008 all financial assets relied on a single system of record, managed by a single legal entity. This system (aka ledger) recorded the definition of the asset and who the current owner is. These systems are mainly run by important financial market infrastructure providers, trusted market utility operators who charge a low fee for a record-keeping service. They ensure the ledger is accessible and always correct.
The crypto asset revolution
In 2008, the bitcoin creators proposed a new market infrastructure that used not double entry bookkeeping, but verifiable market-wide bookkeeping. Everyone kept a copy of the updated blockchain as new blocks of transactions are validated with a cryptographic proof and distributed to all parties.
This system turns out to be a terrible way to make payments (slow, expensive, carbon-intensive) but a great way to remove the financial market infrastructure from the transaction. It also sparked the creation of a new type of digital asset: Crypto assets.
Crypto assets use this kind of distributed, cryptographic proof system of record. Their invention coincided with a new normal of open source software and cloud-based tech stacks. This confluence reduced costs to create, work with, and trade crypto assets for everyone, but especially retail (non-institutional) users.
Crypto assets provide huge advantages to users as they can be issued quickly and flexibly, directly to investors. They can use smart contracts, which use logic to automatically execute and/or record events, to interact with other users and services. And they can settle more efficiently, as quickly as T+0 DvP.
Crypto assets have continued to grow in value and interest over the past ten years. We saw the ICO boom in 2016-18, and now the exciting rise of NFTs and web3 assets that will power the much more decentralized future internet. These crypto assets are still in the domain of retail users trading on their own account. Yes, there is a small and growing industry for crypto asset management, but most practitioners are not working at the scale of financial intermediaries and fiduciaries.
This is changing. Institutional asset managers looking to engage millennial and Gen-Z wealth (small now but really focused on the next ten years) and seek alpha from new stores of value are looking to engage with crypto assets. This means proprietary trading and serving as an asset manager.
Regulators and the market as a whole are also looking for crypto markets to engage with regulation. How will things that look and feel like securities but run on crypto rails be regulated? How will market participants in these markets be classified? The next five years will see much more clarity on both questions.
What about the trillions of digital assets that are still managed the “normal” way, with financial market infrastructure and a single system of record? There are retail players in these markets, but most activity comes from institutional market participants. These markets are highly regulated and their participants value safety, security, and efficiency. Can these digital assets benefit from any of the advantages in crypto land?
Yes, they can!
To ensure security, reliability, and (let’s be honest) certain liability, these digital systems of records are often managed and operated by a single organization that operates for the benefit of the market. These infrastructure providers are embracing some decentralization and smart contracts, in a balanced approach to improve market structure while protecting the integrity of regulated financial markets. For example, Primary market issuance solutions are helping issuers and investors connect more directly, issuing assets on digital-native systems of records, and coding the assets to interact with the market automatically. Smart contracts and accessible systems of record allow assets to interact with the market more intelligently. Digital assets can also move and settle quicker, and the market is ready for new forms of digital settlement.
Why you? Why now?
I can hear it now: Aren’t you guys just building a bond trading system? What’s with the digital asset focus?
Well, we come from an institutional client-base and a deep understanding of how markets evolve. We are seeing two trends that are deeply important for all markets, and we are building technology to serve the future of markets.
First, we are seeing institutional use of digital assets and digital systems of records. Digital bonds, digital notes, etc. These digital assets require markets that can support their smart contract intelligence and help them interact with the market for information sharing or mobility.
Second, we are seeing institutions engage more earnestly with crypto asset markets. They are looking for market infrastructure that can support crypto assets, but still tick the boxes for compliance, regulation, and certainty of results.
LedgerEdge is delivering on these opportunities. We are working with the very best customers in the business, and we are seeing the birth of digital markets at the institutional end of the spectrum. We couldn’t be more excited about the future.
By David Nicol, CEO, LedgerEdge