The extreme volatility of cryptocurrencies has long been a major concern. Investors’ nervousness has risen in recent times as the future of digital currencies remains uncertain all the while the crypto crash lingers on.
However, the technology behind cryptocurrencies, blockchain and (more importantly) other digital assets is gathering greater adoption by regulated financial institutions around the world. Digital ledger technology (DLT) – the umbrella term under which blockchain also functions – has gained visibility and is now being developed for several applications. The financial system, having switched to electronic trading a few decades ago, is set to witness another significant transformation through the use of DLT.
The fund industry has undoubtedly seen massive growth in terms of the number of funds and total assets under management in the last decade. Despite this, fund houses still rely on long complex chains of distribution which make building investor relationships and controlling distribution costs difficult.
However, the industry has seen the light, acknowledging the transformative potential of blockchain technology in the sector since it enables digitisation and tokenisation of funds whereby helping to reduce inefficiencies in fund distribution.
Asset managers using blockchains
The YouTube link above is an example of how Vanguard, the second biggest asset manager in the world (with $8trillion undermanagement), is using blockchain technology. Warren Pennington, from Vanguard, explains how blockchain technology is being used to help manage its vast array of index funds: “…blockchain at its core is a supercomputer that we can all use at the same time allowing many parties to all be connected in real time.”
Blockchains can certainly create opportunities for both asset management firms and investors. Whilst asset managers can go to investors and expand their distribution networks, investors can now also subscribe to a native digital or tokenised asset via an online distributed ledger. The fund tokens can then be held in digital wallets that are owned and operated by the investor, thus moving the industry closer to a self-service style model.
Oliver Portenseigne, CEO of FundsDLT (established in 2016 and owned by Clearstream, Credit Suisse Asset Management, the Luxembourg Stock Exchange and Natixis Investment Managers), believes: “The immediate result of greater blockchain adoption in wealth and asset management is simply cheaper, easier and faster services. Financial inclusion is therefore improved as this will attract larger numbers of potential clients to wealth managers, who before may have been perceived as out of reach”.
Furthermore, blockchains offer the potential to reduce transaction costs, provide automation and real-time visibility, and enhance reporting. They will also streamline AML/ KYC processes because tokens’ ownership can be linked to the digital identity of the investor, therefore building proof of beneficial ownership with AML/KYC controls incorporated into the smart contract.
Taking a look at how DLT and tokenisation will transform the fund distribution value chain, Paul Daly (Head of Distribution Products and Solutions) and Carole Michel (Fund Distribution Senior Global Product Manager) at BNP Paribas Securities Services, have concurred: “This technology will give birth to new types of services such as consolidation in case of interoperability between blockchain platforms, storage of private keys, signature of orders to validate the value on the chain, and structuration of data in the security token.”
Confirming this approach also in an interview with CoinDesk, Tyrone Lobban (head of Onyx Digital Assets at JPMorgan) has explained the bank’s institutional-grade DeFi plans, pointing out how much value in tokenised assets is ready to be used at the appropriate time.
“Over time, we think tokenising U.S. Treasurys or money market fund shares, for example, means these could all potentially be used as collateral in DeFi pools,” and adding, “The overall goal is to bring these trillions of dollars of assets into DeFi, so that we can use these new mechanisms for trading, borrowing [and] lending, but with the scale of institutional assets.”
Hoping that DeFi developers would leverage the yield-generating potential of non-crypto assets, JPMorgan incorporates the tokenisation of traditional assets to a greater scale. Through two complementary components, one of which is JPMorgan’s blockchain-based collateral settlement system, Onyx Digital Assets hopes to bring bank-grade DeFi to realisation. Project Guardian, which tests institutional-friendly DeFi using permissioned liquidity pools that comprise tokenised bonds and deposits, is the second part.
Furthermore, tokenisation offers a real opportunity to improve the asset management industry since it allows for the digital representation of funds and the underlying assets on a blockchain or DLT. According to a study by BNY Mellon “almost all institutional investors (91%) are interested in investing in tokenized products”.
Speaking to Connect Forum, Edward Glyn, head of global market at Calastone, reported: “This tokenised product would provide the same exposure but be issued and operated throughout a technical ecosystem where every player also has access, input, and oversight.”
From the investors’ perspective, this means more personalised low-cost investing, real-time investing, clear and fair pricing, transparency, access to a bigger pool of assets and a user experience equal to the challenger banks and lifestyle apps.
On the other hand, investment managers see this as a radical enhancing of the supply chain, improved transparency and analytics, simpler fund issuance, and the possibility of greater alpha generation by removing tens of basis points off management costs.
As a step towards tokenisation, AllianceBernstein joins hands with specialists in blockchain technology, Allfunds Blockchain – the collaboration between the two aimed at integrating blockchain technology into the financial service ecosystem. The Allfunds Group, a leading B2B WealthTech platform for the funds industry with €1.4 trillion in assets under management, offers fully integrated solutions for both asset management firms and distributors. Within this is a standalone company, Allfunds Blockchain, which generates a unique environment of security, privacy and data governance amongst financial institutions and enables new capabilities for programming and automating processes via smart contracts.
AllianceBernstein (with $779billion in assets under management) offers research and diversified investment services to institutional investors, individuals and private wealth clients worldwide. The integrative collaboration creating mutual benefits between these two is, without doubt, an important example of how blockchain is influencing the asset management industry. Another is the recent acquisition of a stake in digital securities exchange, Archax, by Abrdn.
Following through on the £508billion asset manager’s ambitions to enter the digital assets market, the Edinburgh-based fund group has become the largest external shareholder in Archax although, prior to this, BlackRock (the world’s largest asset manager), had partnered with Coinbase Global to offer digital assets to institutional investors.
So, whilst it is quite impossible to mention all since the list is inexhaustible, the above demonstrates how tokenisation is still impacting the asset management industry.
Looking ahead, tokenisation would enable the industry to develop a secondary market where the value encapsulated in a token can be transferred almost instantly in a traceable process that can handle small amounts of capital and settle in real time. This would not only simplify operations, reduce costs and provide real-time data, but would also be of value to clients with illiquid funds.
Furthermore, the use of blockchains and/or DLTs offers compliance staff and regulators much needed greater transparency while potentially reducing counterparty risk.