08/04/2021 by Future of Finance 0 Comments
Rising institutional interest in crypto-currencies could herald the greatest change in financial markets for centuries
There are many reasons why established financial institutions are starting to trade and invest in crypto-currencies but their interest is certainly driving the development of services which match what they expect to find in the traditional foreign exchange (FX) and securities markets. Substitutes for the traditional means by which counterparty credit and settlement risk are mitigated are already in use. Service providers are seeking regulated status, and commercial law is catching up with day-to-day market realities. Traditional providers need to start thinking about how they can best adapt their existing services to what might turn out to be an epochal form of change.
The cryptocurrency market infrastructure is ill-equipped to accommodate the surge of institutional interest in the asset class, in terms of liquidity sourcing, documentation, regulatory certainty, transaction costs and execution, clearing, settlement and credit counterparties.
However, the pioneers are forcing service providers to develop broking custody and financing solutions to overcome the barriers to further institutional investment in cryptocurrencies and, eventually, security tokens.
Tokenisation to a blockchain network of cryptocurrencies held in digital wallets by independent custodians is making it possible to access liquidity seamlessly from both centralised exchanges and decentralised pools and settle transactions promptly on a fully-funded basis.
Institutions accessing cryptocurrencies via tokenisation platforms must adjust their expectations of custody (it is the private keys to the assets, not the assets themselves, which are safekept), asset servicing (entitlements are written into the assets through smart contracts) and custody risks (these are covered by a combination of economic incentives and insurance rather than bank balance sheets).
The trade and post-trade services developed for cryptocurrencies are likely to be applied to security tokens as well. Although security tokens are unlikely to displace existing securities issues, new issues of debt and equity can be expected to take tokenised form. The first such issues are now imminent.
Questions to be addressed at the next discussion
1. To what extent are buy-side institutions (as opposed to trading firms) investing in cryptocurrencies?
2. In which jurisdictions has law caught up with market realities?
3. In which jurisdictions has regulation caught up with market realities?
4. In what ways are prime brokers responding to the tokenisation opportunity?
5. In what ways are global custodians responding to the tokenisation opportunity?
6. How are developments in the DeFi markets influencing the evolution of tokenisation platforms?
7. Is there a risk that blockchain networks will not inter-operate?
8. Are the counterparty credit management techniques developed by cryptocurrency firms being adapted for the security token markets?
9. Are public distributed security token debt issues being prepared for launch?
10. Will the functions of existing financial institutions be unbundled?