Digital assets go mainstream

Ken Lo June 28, 2021 09:05

If you think digital assets are just a passing fad, chances are you are likely to miss out on many potential investment opportunities. Digital assets are moving mainstream, evidenced by increased global adoption by both retail and institutional investors. Below are just a few examples.

• While the S&P 500 index yielded a 1.5x increase for the past two years, the price of Bitcoin soared by roughly five times and the daily trading volume skyrocketed by 10x to USD66.4 billion during the same period.

• Coinbase, one of the world’s largest crypto exchange which was recently listed, witnessed a 95x increase in its valuation since 2018.

• Goldman Sachs, DBS and other major financial institutions now offer digital assets to their wealth management clients.

• Grayscale Investment, the world’s largest digital currency asset manager, doubled its AUM from USD20.6 billion to USD40.6 billion in five months since the start of 2021.

Digital assets are becoming an important driver for future economic growth, and cryptocurrencies are just a fraction of the digital assets space. In the coming few months, I’ll examine and help you understand in this monthly column some of the basics of digital asset classes, blockchain technology as well as recent capital markets innovations.

Cryptocurrencies, Blockchain, and Digital Assets: A Primer

Is Bitcoin the only cryptocurrency? Bitcoin represented 64.5% of the entire cryptocurrency market at the start of 2020 but is now about 44.3%. Ethereum (ETH) is now the second-largest coin in terms of market capitalisation. You might also have heard about DOGE coin, the meme coin made famous by Elon Musk with a photo of a Shiba Inu. Each digital asset is created with unique proposition, but Bitcoin was the first to use blockchain technology to manage trading and ownership.

What can blockchain do? Blockchain is a decentralised ledger where the users do not have to trust the counterparties but merely the technology that verifies the transaction. Also, because of blockchain’s immutability, all participants can audit the whole string of transactions. Blockchain is not a new technology and was first outlined in 2011 by two researchers who wanted to implement a system where document timestamps could not be tampered with. It now has proven solutions in trade finance, payment and supply chain management. Below are some examples:

• Barclays co-operated with a fintech start-up, Wave, to issue blockchain-based letters of credit and guaranteed USD100,000 worth of dairy products for a food cooperative organisation.

• JP Morgan created a blockchain-based cross-border payment rail, JPM coin, potentially settling USD6 trillion of its wholesale payments across 100 countries around the clock

• ZA Tech launched their poultry farming management using blockchain technology to trace the upbringing and transporting of the chicken.

• Central banks across the globe, including the HKMA, are probing the feasibility of circulating central bank digital currencies (CBDCs) to ease the cost of managing fiat and to facilitate better data analytics.

Any other digital asset types? Asset-backed tokens such as non-fungible tokens (NFTs) and utility tokens have also become popular. NFTs solve the piracy and profit-sharing problem in the art space, while utility tokens captivate audiences with perks and privileges.

Blockchain Enables STOs

Blockchain applications in capital markets have opened new opportunities in the institutional space. Initial Coin Offerings, ICOs, were the pioneers of blockchain applications in the capital markets. While the ICO hype was quickly suppressed due to many high-profile scams, the potential for revolutionising how fundraising is done through blockchain technology did not fade away. Instead, industry players and global regulators have improved the integrity and compliance of the digital asset space, giving birth to Security Token Offerings, STOs.

The West has been fast in adopting STOs, with several tokens listed and traded on licensed exchanges. Some early examples of STOs include St. Regis Aspencoin (a single-asset real estate investment trust owning the St. Regis Resort in Aspen, Colorado), tZERO (equity shares of a US digital exchange), Blockchain Capital (a blockchain-focused venture capital fund with a portfolio invested in assets such as Coinbase and Bitgo).

As existing capital raising processes entail high costs and entry barriers, blockchain can address the inefficiencies with key benefits such as fractionalization, immutability and smart contract automation. Below are some benefits from both the issuers’ and the investors’ viewpoints.

(1) An additional fundraising channel and an alternative asset class. With fractionalization, STOs effectively lower the high threshold in private market sectors such as real estate and private equity. The once institution-only opportunities have now become accessible to a much larger investor community.

(2) More flexibility and creativity in product structuring. The flexibility of a token to represent not only economic rights, but other rights ranging from property access to loyalty program memberships, enables much room for product innovation. A token can permit the issuer more flexibility to combine financial assets such as equity and debt as well as to mobilize intangible assets such as IP rights, data ownership and collectibles.

(3) Enhanced liquidity through secondary exchanges. The fact that a token can be listed on exchanges for secondary liquidity gives a significant edge to illiquid assets. There has been ongoing development of licensed exchanges across the world, covering a variety of sectors.

The Path Ahead: Adoption and Partnerships

Despite the promising outlook for issuers and investors, much work remains to be done. Blockchain tech and digital assets require adoption on a wider scale to unleash the full potential. We believe digital assets may be one of the pivotal economic drivers in this century and are committed to contributing to the community knowledge base as this investment class continues to evolve.

In the next column, we will discuss in more details the global STO landscape and the opportunities in Hong Kong and the Greater Bay Area.

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Ken Lo

The writer is Co-Founder and Chief Strategy Officer at HKbitEX, a regulated digital asset trading platform for professional investors, as well as an adjunct assistant professor for the Master of Fintech Program at the Chinese University of Hong Kong.