Is the Financial Industry Ready for the Radical Shift in Digital Assets?by Rebecca Oi November 20, 2023
The world of financial services is undergoing a profound transformation driven by the convergence of data and emerging technologies.
During the “Digital Assets: Connecting the Dots” keynote session at the London Stock Exchange Group’s Open Day as part of the Singapore Fintech Festival Innovation Crawl, Dr Peter T. Golder, Managing Director and Head of Group Digital Assets at LSEG, delved into the transformative impact of digital assets on the financial sector.
In a time when the financial industry is facing unprecedented challenges and opportunities, Peter’s insights shed light on the pivotal role that digital assets play in connecting the dots and forging a new path forward.
Understanding digital assets
Digital assets, often perceived as abstract concepts in the digital world, have gained significant attention and traction in the financial sector.
“A digital asset is a programmable security or value representation enabled through blockchain smart contracts. Unlike traditional securities, these digital assets can embed logic, enabling automation of processes related to cash flows, pricing, and more,” explained Peter.
This abstraction allows for a broader classification of digital assets, ranging from cryptocurrencies to asset-backed securities. It’s important to distinguish between native digital assets, those created directly on a blockchain, and traditional securities that have been tokenised and converted into digital form.
Peter added that regardless of their origin, the key feature of digital assets is their programmability, driven by smart contracts.
The paradigm shift
Introducing digital assets brings about a paradigm shift in the financial services industry. While traditional processes rely on manual interventions, the programmable nature of digital assets allows for automation, enabling faster, more efficient, and cost-effective operations.
“This shift prompts the industry to reevaluate business models and embrace innovation to stay competitive,” Peter said.
He added that one of the primary drivers of this change is the potential for business models to evolve within the industry. This transformation can address common industry challenges, such as capital efficiency.
By tokenising assets and utilising blockchain technology, optimising capital deployment across the entire value chain becomes possible. This optimisation opens up opportunities for new and more efficient business methods.
The three-horizon framework
Innovation often follows a trajectory marked by three horizons: short-term, mid-term, and long-term. These horizons represent different timelines and focus areas for change.
What’s common across all these horizons is the potential for second-order implications. While the initial technology might seem exciting, unforeseen consequences and opportunities often have a lasting impact.
“In the context of digital assets, one such implication is the potential for collateral management. Tokenised securities can facilitate collateral movement on an intraday basis, a significant advancement in capital efficiency,” Peter pointed out.
This newfound flexibility in handling collateral management has the potential to revolutionise the industry, making it more agile and cost-effective.
The future blueprint
As we look toward the future, the blueprint for the financial services industry is becoming more apparent. Digital Market Infrastructure (DMI) is poised to play a crucial role.
DMI, as a service, offers a common infrastructure layer that connects various participants in the financial ecosystem. This infrastructure provides a foundation for innovation and collaboration.
“DMI encompasses foundational capabilities, including trading technology, data and analytics, blockchain, stablecoins, and smart contracts,” Peter elaborated.
“These components create a horizontal stack supporting various asset classes and solutions. This approach reduces the need for siloed infrastructure, making it more accessible and cost-effective for market participants.”
One of the most significant benefits of this transformation is democratising access to different asset classes. The programmability of digital assets, combined with data-driven decision-making, enables investors to access previously inaccessible markets.
Whether it’s private market investments or exotic trades, the ability to automate due diligence and execute complex transactions becomes a reality.
The network effect amplifies the value of the ecosystem. The more participants join, the more valuable the network becomes, creating a self-reinforcing cycle.
This network completeness is crucial for the success of digital market infrastructure, as it enhances liquidity and expands opportunities for all participants.
The coalition of the willing
Peter’s analogy of the “tragedy of the commons” is a compelling backdrop for the industry’s current state. While the benefits of a unified approach to digital assets are evident, individual organisations often hesitate to take the first step. The challenge lies in assembling a coalition of the willing, where entities come together with a shared purpose and vision.
This collective effort is not merely a technological endeavour but a cultural shift. It requires organisations to step out of their comfort zones and embrace innovation as a means of mutual progress.
As the industry grapples with this challenge, it must also address the question of incentives. What motivates firms to participate in this coalition, and how can these incentives be aligned to ensure everyone benefits?
Navigating risk aversion
Innovation and risk aversion are often at odds in the financial industry. Peter recognises this inherent tension and underscores the importance of thinking differently about innovation.
The industry’s common enemies, or the forces of darkness, might be the catalyst for change. It’s essential to identify the obstacles that hinder progress and collectively work towards overcoming them.
Peter said that one of the fundamental issues lies in defining the “right” problem to solve. With multiple stakeholders in the industry, each with their own perspective, reaching a consensus can be challenging.
Yet, it is this alignment of objectives that will drive meaningful innovation. The industry can make substantial progress by starting with a common foundation and gradually expanding initiatives in the coming years.
Asset classes and methods
Digital assets encompass various asset classes and methods. Whether it’s equities, fixed income, or other assets, the industry must approach them strategically.
A portfolio approach that considers different asset classes and methods is essential. This approach prevents overcommitment to a single strategy and enhances adaptability.
Uncertainty is a constant in emerging technology, and agility is critical to navigating it successfully.
Peter’s emphasis on the absurdity of certainty highlights the need for flexibility and the ability to pivot when unforeseen circumstances arise. The digital asset landscape is dynamic, and the industry must be prepared for unexpected changes.
The power of concentration
Concentration is an influential factor in determining success. Peter’s reference to the S&P 500 and tech giants like Google illustrates that only a few key players drive the most returns.
This concentration of success highlights the need for a strategic approach to digital asset ecosystems.
When building these ecosystems, it’s crucial to focus on what truly matters and not become overwhelmed by the sheer volume of possibilities. The industry can achieve more significant results by concentrating on the most impactful areas.
Ecosystem development is a gradual process. It begins with alignment within specific asset classes and expands to create asset-class-agnostic infrastructure.
Collaboration and support among organisations are crucial elements in ecosystem development. Psychological safety, where organisations collectively embrace innovation, reduces individual risk and encourages participation.
“Digital assets must transcend jurisdictional boundaries to become truly global,” emphasised Peter. “Technology should adapt to local regulations without stifling innovation. This challenge calls for a delicate balance between innovation and compliance.”
He added that a jurisdiction-agnostic approach allows for seamless connectivity across markets and ensures that the benefits of digital assets are not confined to specific regions.
Fractionalisation is a mechanism to lower the cost of asset ownership. However, it introduces complexities regarding ownership and exposure.
“Participants in the digital asset space must carefully consider whether they genuinely own the underlying assets or hold exposure through intermediaries,” advised Peter. “Understanding these implications is vital to making informed decisions.”
As we navigate this evolving landscape, it becomes evident that the financial world’s transformation goes beyond technology; it’s about reinventing business models, fostering regulatory collaboration, and redefining liquidity.
It’s about finding common ground, building ecosystems, and ensuring this revolution benefits all participants.
While this journey has challenges and uncertainties, there is also immense potential for growth, efficiency, and inclusivity. The financial services sector must adapt, embracing digital assets and the opportunities they present.
In the end, Peter’s insights remind us that the future of finance is not solely about technology or regulation—it’s about our ability to connect the dots, innovate, and collectively steer the industry toward a more dynamic and resilient future.
The digital age of financial services is upon us, and it is up to industry leaders, stakeholders, and innovators to shape it into a model that serves the needs of all.