We are on the cusp of a revolution that will transform financial markets as we know it. The approval of spot Bitcoin exchange-traded funds (ETFs) in the US in January set the pace for US investors to gain exposure to an asset class on the rise. While UK retail investors face regulatory and practical hurdles that prevent them from investing directly in US spot Bitcoin ETFs, UK institutional investors can get access.
A recent survey from EY-Parthenon of 250 institutions found that 45% of institutions with more than US$500 billion in assets under management (AUM) would allocate 1% of their portfolios to digital assets. This is a marked departure from a few years ago, when most institutions wouldn’t touch the space..
A number of things have changed since then, making the digital asset industry increasingly appealing for institutional investors. Perhaps the most crucial is the evolving regulations.
The regulatory landscape for digital assets is quickly evolving, albeit slower than the technology that’s driving the industry forward. Regulators worldwide are moving to providing clarity around crypto activities and building frameworks that would include, and even integrate, crypto-based products with those in broader financial markets.
The UK’s Financial Conduct Authority (FCA) has registered more than 40 crypto firms that operate within the anti-money laundering and counter-terrorism legislation. The FCA is also working with the government on its proposal to regulate stablecoins, and a wider regime for regulating crypto assets.
As stablecoins become more acceptable to institutions, we could see them delve further into the issuance of fully digital bonds and on-chain financing of assets denominated in fiat currency. Although fragmented global regulation is one of the risks that could offset these products in a cross-border setting, there’s reason to believe that countries will collaborate to create unified frameworks. The International Organisation of Securities Commissions (IOSCO) is working with 27 countries on a regulatory agenda for crypto and DeFi.
More inclusive regulations pave the way for more traditional finance (TradFi) firms to build infrastructure for digital assets. Further, these regulations now allow TradFi firms to participate in growing narratives that define the industry, like RWA tokenisation.
Tokenisation provides the opportunity to introduce new financial products through digital representations of conventional assets, while creating liquidity by allowing for fractional trading in illiquid assets. It also offers the added benefit of operational efficiencies through programmable smart contracts that complement the existing infrastructure of TradFi platforms.
A great example of RWA tokenisation is Money Market Funds (MMFs) which offer stability and yield to institutions, given the underlying investments are short-term debt products, and they also eliminate single bank or stablecoin provider counterparty risk. Learn more about investing in MMFs through Archax.
Another area that institutions are playing close attention to is the issuance of bonds as tokenised assets on the blockchain, which provides the benefit of improved transparency and faster settlement times.
Perhaps, the most notable example of how far institutions have come on the path to tokenising RWAs is JPMorgan’s Onyx blockchain, which has processed over $1 trillion worth of intraday repo transactions. The firm also launched a tokenised collateral network (TCN) in October, with BlackRock and Barclays as early adopters.
The first transaction on the TCN involved BlackRock tokenising shares in its Money Market Fund and pledging them as collateral with Barclays for a derivatives contract. More recently, JPMorgan plans to open its permissioned Onyx blockchain to allow third parties to deploy apps, and enable others to tokenise assets on its network.
With institutions in search of instant settlement and more liquid markets for trading traditional financial assets, it is unsurprising that a large number of firms are looking into tokenising commodities. Tokenised gold, which is an on-chain representation of the physical precious metal, has surpassed $1 billion in combined market cap.
Santander Bank has also launched a pilot to issue loans to Argentinian farmers that were collateralised with tokenised agricultural commodities including soybeans, corn, and wheat.
Tokenisation is undoubtedly an area that institutions will look to explore, but as the industry grows, there will be other places that institutional offerings can play a larger role.
Decentralised finance (DeFi) has grown into its own sub-industry within the crypto space, with smart contracts running high-level functions that are usually carried out by financial intermediaries. It’s hard to imagine a world where traditional financial firms don’t deploy their own decentralised versions of their existing borrowing and lending platforms.
Custody and infrastructure will also likely play a big role in the wave of institutional adoption, with a tri-party custodial solution collaboration between Binance and Sygnum being one noteworthy example.
As regulatory clarity improves, institutions could potentially lay the foundations for the new landscape of digital assets, with mature market infrastructure and experienced participants being a big part of the shift in the tide.