Written by 11:45 Member, Sustainable Finance

Digital Assets and Distributed Ledger Technology in the Financial Industry

The latest Deloitte whitepaper explores perspectives, opportunities and application areas for digital assets and DLT in the financial industry. Learn how the digital transformation of asset trading is working and what impact digital assets such as digital coins and tokens have on banks, capital markets and asset managers. In addition, we delve into the custody of digital assets and analyze its importance in implementation and future processes.

Asset trading is undergoing a twofold transformation: on the one hand, the trading processes themselves are changing; on the other hand, the digital transformation is also changing the way in which these processes are carried out. Digital assets are defined as digital representations of value enabled by these technological advances.

To gain a better understanding of digital assets, it is first necessary to distinguish between the different types of the same. Two types of digital assets have similar characteristics to currencies: digital coins and digital tokens. Digital coins can be used as a means of payment, with their value determined either independently or based on an existing currency. They are divided into three main subcategories: Cryptocurrencies, Stablecoins and CBDCs (Central Bank Digital Currencies). The boundaries here are blurred in places.

Digital tokens, on the other hand, refer to assets that confer on the holder full, partial, or potential ownership of another asset, the right to use a service, or the right to execute. These tokens are created through program code, known as smart contracts, on a public blockchain or approved distributed ledger. The four main representatives are: Utility Token, Security Token, Governance Token, and non-fungible Token.

Digital assets only gained importance in the wake of the 2008 financial crisis

After many people lost trust in centralized financial intermediaries, “Bitcoin” was created in early 2009 as the first decentralized cryptocurrency based on distributed ledger technology. The demand for the decentralized, anonymous or pseudonymous cryptocurrency grew steadily, prompting many other cryptocurrencies such as Diem or Ether to enter the game, albeit with different design features. Since 2017, the market for cryptocurrencies has more than tripled to date due to the rapid increase in demand.

Due to the high volatility of cryptocurrencies, stablecoins, which are pegged to stable assets such as fiat currencies or gold, have become a less volatile digital coin option. More and more national banks, central banks and asset managers around the world are recognizing the market relevance of offering digital assets such as stablecoins or Central Bank Digital Currencies (CBDCs). Prestigious players such as JP Morgan and Goldman Sachs were among the first banks to launch their own stablecoins, and China’s central bank issued CBDCs to test a digital renminbi/yuan. In line with these global developments, the ECB also recently launched a pilot project to test the technical implementation options for a digital euro.

In recent years, regulatory requirements for digital asset players have been both relaxed and specified in greater detail. As evidenced by the relaxation of laws related to the issuance, trading, and storage of digital assets, many financial institutions are betting that blockchain-based systems will become the preferred technology of the future. Among the accelerators of this trend in Germany are the licenses issued by BaFin for the custody of digital assets and the recently introduced Electronic Securities Act (eWpG), which allows securities to be issued without the mandatory physical certificate.

The digital asset ecosystem is extremely complex in terms of the variety of offerings and technology platforms, e.g. digital ledger technology (DLT). This presents financial intermediaries with the challenge of deciding which instrument they will use transparently in the future.

Digital assets and distributed ledger technology: Exploiting the potential

Deloitte observes the emergence of new products as well as an increasing digitalization and modernization of existing financial products based on DLT and blockchain technology. This promises to make investments more attractive for (digital) investors.

To secure a leading position and competitive advantage in this emerging industry, financial services providers must be among the pioneers and start developing the necessary infrastructure for issuing, trading and investing in digital assets and currencies today. It is critical that investors gain confidence in the new roles that market participants will play in the digital asset environment; success will depend on existing safeguards and regulation of certain new market roles. It will take the continued support of regulators to allow this new sector of financial products and interactions to grow and mature.

The key to success will be to increase the liquidity of digital assets on a certain number of marketplaces that currently face higher costs and lack of transparency.

Firms will need to find a solution to rising intermediate costs while the two different systems run in parallel. The transaction costs per trade of the “new” asset model will initially be very high. As more participants join the market and economies of scale can be achieved, the cost per transaction will decrease. The only way to achieve cost efficiencies is to create a new settlement and payment infrastructure for digital assets with a high level of automation and increase the number of trades settled while shutting down the old, outdated settlement and payment system.

Text: Deloitte
Picture: Unsplash

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