As the Benefits of Digital Assets Become Harder to Ignore, What’s the Path Forward?

In October, the payments platform Square brought renewed attention to digital assets when it bought 4,709 bitcoins, which represented about 1% of the company’s total assets at the end of the second quarter. The significance of this move should not be overlooked: Square’s move points to a potential looming trend about how digital assets will reshape financial services, especially in the midst of the current economic conditions brought by the global pandemic.

The 2008 financial crisis sparked tremendous change in the industry, including the rise of fintech and the creation of bitcoin as an alternative form of currency, free from the restraints of the traditional financial system. However, as time went on, traditional financial companies became more interested in bitcoin’s underlying distributed ledger technology (DLT), blockchain, which has a number of use cases outside of cryptocurrencies. And with central banks worldwide continuing to develop their own digital currencies, DLT opens the door for greater efficiency in the financial system.

As financial institutions such as Fidelity Investments and JP Morgan continue to invest in and expand use cases for their respective blockchain technology capabilities, it’s become clear there is some existing infrastructure in place today that could pave the way for greater adoption of digital assets within the larger financial services ecosystem. One particular area of interest where digital assets could have a substantial impact is trade settlements.

Implementing digital assets could enable broker-dealers to free up billions in capital to better assist clients while also reducing their own risk. However, we must align the willingness of US regulators, banks, and industry utilities—such as the Depository Trust and Clearing Corporation (DTCC)—to invest in the technology needed to bring more efficiency to financial markets in the long run.

Central Banks Leading the Charge

To get a sense for the potential impact of digital assets on the financial services industry, we can first examine a couple of the building blocks in place today. One of the more crucial demonstrations is how some central banks worldwide are developing their own digital currencies.

When the social media giant Facebook announced plans for its own digital currency, Libra, a handful of central banks suddenly revealed their plans to do the same. China is particularly bullish on the digital yuan, and recently began a public test with 50,000 citizens using 10 million yuan (about $1.5 million) at 3,000 participating merchants in Shenzhen.

Countries such as England, France, Singapore, and Switzerland are also exploring ways to create the infrastructure needed to support distributed ledger assets. What those countries are attempting to do now is attract capital and business to their countries by pursuing more progressive digital currency strategies.

US Removing the Regulatory Shroud

Here in the US, regulators have increasingly expressed more progressive views towards digital assets at both a federal and state level.

The Securities and Exchange Commission’s outgoing-chairman, Jay Clayton, recently said the SEC is open to the existence of a tokenized ETF if done the right way, and if such a product improves efficiency in the current system.

Over the summer, the Office of the Comptroller of the Currency authorized the custody of digital assets by national banks in a fiduciary or non-fiduciary capacity. However, to date, no bank has offered this capability. That might be due to the lack of clarity around what exactly banks are allowed to do.

On the state level, we’ve witnessed more progress. In September, Kraken Financial became the first cryptocurrency firm to become a US bank, thanks to approval from the Wyoming Banking Board. In fact, the state’s governor, Mark Gordon, is at the forefront of a push to turn Wyoming into a leader in the industry.

And finally, Congress flirted with the creation of a US digital dollar under the ABC Act, which would have authorized the Federal Reserve to create “FedAccounts,” or Digital Dollar Account Wallets during the pandemic-driven economic stimulus packages earlier this year. However, that measure was not included in the final bill, although it continues as a topic of conversation.

These are just a few glimpses into the future of digital assets…but where is that future headed?

Future Use-Case: The T+0 Settlement?

If the US regulatory environment continues to trend in a positive direction, one future use case for a digital asset environment is trade settlements.

Today in America, most trades settle in two days as a result of advancement in technology and electronic trading. What once took three to five days now takes two or less.

However, in a digital asset environment, those same trades could clear in one day with an expectation that settlement could occur instantly in the not-too-distant future. A settlement cycle can be shortened because of the existence of cryptographically verifiable data, allowing the digital asset and the digital fiat currency needed to settle the trade atomically. That, in turn, would benefit the broker-dealer by opening up more capital on a balance sheet.

Ultimately, we would be applying traditional financial services to both native digital assets, as well as tokenized versions of assets that exist off-chain.

Moving Forward

Whether our industry will move forward to achieve the aforementioned settlement speed will depend on a couple of key factors.

While building blocks are in place for the rise of digital assets in the US and worldwide, there are some potential obstacles to think about. US regulatory bodies have expressed more comfort with digital assets; however, historically, Congress has been slow to keep pace with innovation in the financial services industry. A lack of understanding on their part could stymie progress.

Another consideration is the potential for financial institutions to drag their feet on investing in the required technology upgrades to support digital assets, especially given the current economic climate.

And yet, the benefits of digital assets could potentially bring to our industry are too great to ignore. What we need is a firm commitment to progress—to continue building on the existing foundation, financial institutions and regulators will need to work together to makes these possibilities a reality in the near future.

Lisa Iagatta is director of account management at Tegra118and is responsible for North American client relationships for several Tegra118 solutions. She also serves as chair of Isitc, where she is responsible for the strategic direction and growth of the independent non-profit financial services organization in North America.