How to make the digital asset markets grow – Are the commercial opportunities in digital assets compelling enough to overcome the fear of disruption?
- Future of Finance
- Apr 16, 2024
- 11 min read
Updated: Jul 10
A Future of Finance interview with Gilbert Verdian, CEO of Quant.
Tokenised assets markets, though rich in the promise of cost savings and higher returns on investment, remain disappointingly small. However, the obstacles to the scaling of the digital asset markets are increasingly well-understood, and gradually being cleared. Legacy laws and regulations are proving more workable than expected, and being adapted where they are not. Experiments by regulators, central banks and private sector firms, sometimes in regulatory sandboxes and sometimes at BIS Innovation Centres, may not have bred a new caste of blockchain giants but they have proved that the technology works and legal and regulatory constraints are not fatal. Established intermediaries are losing their scepticism and fear of disintermediation and exploring the opportunities to profit. Whole new infrastructures, such a unified ledger or single programmable platform, are being conceived. Ways of putting central and commercial bank money on blockchain are being found. So it feels like the time is ripe for a business such as Quant, whose founders recognised at the beginning of the Initial Coin Offering (ICO) bubble in 2015-17 that the digital assets industry was creating potentially existential problems for itself in its lack of alignment with existing regulations, its failure to develop regulated forms of digital money on-chain to complete the cash leg of transactions and the determination of competing blockchain protocols to monopolise activity rather than capitalise on the network effects of making digital assets portable between blockchains. Since its foundation in 2015, Quant has focused on adapting blockchain technology to meet the needs of regulated banks, asset managers and insurers, and reassure the regulators and central banks that supervise them, by developing tools that enable blockchain protocols and traditional systems to interoperate successfully. Dominic Hobson, co-founder of Future of Finance, spoke to Gilbert Verdian, CEO of Quant.
Key Insights
Incumbent financial institutions did initially retard progress towards large and liquid digital asset markets, by investing in a discovery process rather than commercial opportunities, but appreciation of the cost savings and the revenue and profit gains available from investing in and trading digital assets is now widespread, as the enthusiasm for spot Bitcoin ETFs showed.
The criticism that most tokenisations so far have limited benefits because they are asset-backed rather than digitally native under-estimates the value of bundling and unbundling tokenised assets into new instruments and fails to recognise that tokenisation has yet to impact the global bond and equity markets in a significant way at all.
Asset managers are in a powerful position to drive progress towards tokenisation because they have much to gain from reduced costs of investment and increased diversification of returns, and the downward pressure they are experiencing on ad valorem fees mean they also have strong incentives to push the investment banks to offer them alternatives.
Policymakers and regulators are also in a powerful position to encourage adoption of tokenised assets by working with the private sector to devise legal and regulatory regimes that encourage the issuance of digital assets and attract institutional investors to purchase them, creating a virtuous circle that catalyses the growth of digital assets everywhere.
Transcript
47:36 Dominic Hobson: The fourth and final topic I’d like to discuss with you in our list of obstacles to the growth of large and liquid digital asset markets is the risks and the opportunities in disruption – a major technological disruption taking place in the financial services industry. And I find when I talk to incumbent financial institutions, they talk to me a lot about their fear of disruption. But a cynic, and as a journalist, of course I’m a professional cynic, would argue that these intermediaries of the existing flows are actually highly adept at self-preservation. They can very easily plead they lack the budget, that there’s no business case for investing in this new technology, that the return on the investment is way too far in the future. And of course, they have all these inescapable regulatory obligations and legal barriers to getting involved. They take part in various collaborative projects, they run Proofs of Concept [PoC]of their own, they run pilot tests, sometimes with central banks and others, which enables them to kind of feign interest in making progress, while actually trapping progress in a sort of endless cul-de-sac of projects which really don’t lead to anything going into production at the end of day. Now, again, are cynics like me right about this? And if I am, what can be done about this sort of institutionalised cunctation on the part of incumbents? I mean, feel free to disagree with me, but that’s how it looks from where I am.
49:13 Gilbert Verdian: Yes, I think that was the case up until about two years ago, and maybe last year in 2023. Everyone participated in things just to understand what-does-that-mean. But I think what has arisen out of all that experimentation is the understanding of new revenue, new forms of asset classes, and evolution of what they’re doing today, but also the ability to take out friction and risk and cost into what they’re doing as institutions. And that gives them opportunity. So the business cases are adding up. If you do spend ‘x’ million today, in terms of implementing a new form of payment rail, a new form of settlement engine, a new form of tokenisation, they’re seeing direct bottom-line growth to their target revenues, because you’re able to take a whole bunch of cost out and a whole bunch of friction that has been pretty impossible to disrupt for an institution just because of that cost of running the existing infrastructure. And they’re seeing the opportunity to differentiate with new forms of products, which gives them new forms of revenue, because it’s driven by investors. They want new instruments, they want new assets and new asset classes to invest in. They want a new experience in terms of how they’re investing, and they want access to better liquidity, and they want access to better markets and different types of funds, different jurisdictions. So we’re seeing the light bulbs go on in most institutions where they’re seeing new revenue and new opportunity, which they didn’t have before. So they are getting behind that now, and they are investing time and money and resources into building this today. And it’s in conjunction with the change in regulation and the change in market appetite, where you’re bringing things that were unregulated into a regulated space. So it gives them the incentive to take that leap and to make that step and make those investment decisions today, because it will pay off in the medium and long term. And we’re already seeing that. I mean, the ETFs [Exchange Traded Funds] that were launched, I don’t think there were ETFs in history that had that much volume and liquidity being put into them in that short amount of time. So we’re seeing a very market-driven approach to respond to this.
52:02 Dominic Hobson: I’ll come back to the opportunities point you made in a second. Before I do, I might just continue in my cynical vein, not least, but you brought up those ETFs which have been launched which strike me as being a typical product of the incumbent institutions. In the sense that you’re doing this at one remove, you’re not really going the whole hog. There is this bias towards what I call asset-backed digital assets, where the asset continues to exist in analogue form, the entire paraphernalia of the supporting institutions, the custodians, the fund accountants, the transfer agents, the management companies – and this is true of both the funds and the securities industry, by the way- carry on existing, whereas the real benefits of this lie in purely native digital assets being issued, where a lot of the intermediation disappears. It becomes, to go back to your phrase, a question of programmability, of being able to automate those functions and the cost they represent and thereby either reduce them or eliminate them altogether. Am I stuck in my cynical theme here in saying that actually I’m not surprised that incumbents are going down the asset-backed route because it’s much less risky for them, but the benefits are much lower as a result of it. Do we have to go down this path or could we jump straight to a fully native digital asset future?
53:34 Gilbert Verdian: I think they’re starting with something that’s asset backed – tokenising existing funds that are exchanged, listed and easily traded on a regulated stock exchange, for example. But if you look at the nature of other instruments, there’s many that exist that have no asset options. Futures, forward rate agreements, contracts, derivatives, for example, those are still in their existing form running on legacy systems. What’s stopping institutions tokenising those and trading those using the benefits of digital finance and programmability for settlement and coding that into the asset, but bundling and unbundling those with other assets and other instruments. So we still haven’t touched upon the rest of the capital markets yet. We still haven’t touched upon the rest of the money supply yet. I mean, we’ve only just looked at CBDCs [Central Bank Digital Currencies], and commercial banks have only just started looking at tokenising bank deposits. But what about yields? What about interest-bearing accounts? What about gilts [gilt-edged securities, or government bonds], as you said earlier, Dominic? There’s many forms of instruments that are highly tradeable, highly sought after. And they can be tokenised, either bundled with the top-level asset that exists, or unbundled and parcelled into a different instrument itself. So we don’t know. We’re at the beginning of this journey, but we’re keen to see where this goes, because it really is transforming the core of how we transact on all markets being capital and long capital.
55:29 Dominic Hobson: I promised to come back to the opportunities for the incumbent service providers, because that’s obviously an incentive for them to change. That’s the greed as opposed to the fear factor which might cause them to change. And we do see a lot of opportunities being put in front of them. The emphasis often is on collateral mobility as an obvious use-case, and the benefits from that are potentially very substantial if you can start to mobilise collateral, which is presently trapped in various traditional finance silos, and use it on a global scale. We also see a lot of emphasis put on under-served asset classes like real estate and privately managed assets. And all that appears to make sense. Yet when I look at my lists of fund token and security token issues, I see that activity is actually concentrated among a relatively small group of progressive institutions. It’s focused on a relatively small number of asset classes. A lot of bonds in there, corporate bonds in there, for example. You touched on this in your last answer there. We haven’t yet begun to tackle the global bond, equity and fund markets at scale. If were to try and switch the attention of the industry towards those ginormous, hundreds of trillions, presently invested through those vehicles, how would we go about it and who would need to drive that? Is it the issuers or the investors?
57:00 Gilbert Verdian: As Larry Fink said. from BlackRock, tokenisation is securitisation on steroids and it is quite foundational. We’ve seen that the market has started with something that’s light touch, easily accepted by regulators and not heavily regulated – so, corporate bonds. And ESG [Environmental, Social and Governance] has been a good example. So they’re looking at something from an experimentation perspective – what they can do easily today. And as they’re progressing in their thinking and the maturity of regulation, they will start looking at other instruments. We are at the beginning of this journey. There’s no way to know which one is next and where we’re heading. But I think if we look back in ten years’ time, the majority of different instruments are going to co-exist in tokenised and non-tokenised form. Things will be, in terms of tradeable goods, things will be bundled and unbundled as different instruments. Futures will be done, tokenised and non-tokenised. Forward rate agreements, contracts, derivatives, all these different types of asset classes will exist in both forms until … It’s market driven. Until investors decide, `Actually, I prefer to invest only in tokenised assets because it gives me better velocity, safer custody, it’s easier for me to transact and easier for me to convert from a liquidity or treasury management perspective.’ So it will be down to investor choice again. But I think issuers will provide the opportunity to tokenise different types of asset classes, different types of instruments, or offer them in their existing form. And the market will decide.
59:14 Dominic Hobson: Do you think the buy side should be doing more here? What do I mean by the buy-side? I think I mean end-investors. They have a responsibility to earn a higher return on their capital. I think I do mean issuers. They have a countervailing responsibility to pay less for capital. But above all, I think I mean institutional asset managers, they are potentially the primary beneficiaries of a radical change of business. Are they doing enough to drive progress towards fully tokenised digital asset markets?
59:49 Gilbert Verdian: We’ve been talking to a lot of asset managers. We’ve met the IA, the Investment Association [the asset managers’ trade association in the UK] and their members numerous times about this. I think asset managers are quite progressive. They are looking at …They all have the same challenges. How do you reduce cost? How do you give better returns to the funds that they’re managing, to their investors? And what else can you do to earn more revenue for the fund, for investors? So I think they’re very active in exploring opportunities and it is very, again, market-driven. And they are seeing the dollar signs, right? So they’re seeing the opportunity to fractionalise and tokenise, and they’re seeing the opportunity to purchase those for better returns and to settle those with better liquidity with tokenised money. So it is early and we’re seeing funds experimenting with tokenisation. We’re seeing asset managers start to look at buying tokenised parcels of assets rather than the traditional asset itself. But they can do more. I mean, they have a say, they are part of the financial system and their investors are demanding better returns. So they do have the ability to encourage their investment banks and their commercial banks to do more, the issuers to provide alternative options for them and to reduce cost in terms of running the fund and giving better returns back to their investors.
01:01:36 Dominic Hobson: My last question is this. If you had a visit from the tooth fairy or whoever, and they granted you one wish, that you could persuade a leading government in the United States or the United Kingdom to do one thing to help the digital asset markets progress towards size and liquidity, what would that one thing be?
01:02:05 Gilbert Verdian: I think it comes back to the first discussion we had around having the policymakers and the lawmakers aligned by enabling the right regulation and the right legal framework to foster growth in that industry, by adopting a new form of digital finance for that jurisdiction. And that will cover – it’s an umbrella term – digital finance, and that will cover everything from tokenised assets to tokenised money. And by having that, you can see a catalyst of that jurisdiction growing and investment pouring in, because you’re seeing that implemented clearly for all the institutions to understand what rules they have to follow, what opportunities arise out of those rules, and for that jurisdiction, like the UK, for example, to be the preferred venue for all forms of digital finance globally. So if I were to wave that magic wand, I would make that joined up legal and regulatory change with private sector input on what they need and making it a big milestone to enable that huge growth. And we’re seeing that happen in small pieces and in different parts of the system, but it needs a big bang moment, so to speak, for that to occur.
01:03:42 Dominic Hobson: Gilbert Verdian, CEO of Quant, thank you very much for taking the time to share your knowledge and your insights with the members of Future of Finance.
01:03:49 Gilbert Verdian: Dominic, thank you. It’s great to chat.