Crypto Assets, Distributed Finance And Wealth Managers' Menus
Family offices, private banks and wealth managers are considering using the infrastructure of digital assets to run their businesses, or investing in them to make money.
It is hard to avoid the world of cryptocurrencies and other digital assets today. The air is abuzz with talk about bitcoin, smart contracts, non-fungible tokens, tokenisation and decentralised finance. And wealth management as an industry, and as a guardian of client wealth, is being affected by all of these areas in a variety of ways.
Family offices, private banks and wealth managers are considering using the infrastructure of digital assets to run their businesses, or investing in them to make money. Turmoil in established monetary systems – most dramatically with Western powers’ removal of Russia from the SWIFT banking network – puts alternative financial systems under a new, not always comfortable, spotlight. A focus on know-your-client (KYC) background checks and a need for greater compliance rigour, means that the audit trail which peer-to-peer networks are supposed to have has considerable potential. Beyond all this, there’s the hoped-for speed and efficiency of P2P platforms such as blockchain in a world where back-office reconciliation and settlement can still take days.
A nagging question, however, is whether some of these new tech areas are “solutions in search of a problem". Other matters often hinge on how liberal or restrictive national regulators are. Switzerland and Singapore, both important wealth hubs, appear on the more open side, while the UK and the US are somewhere in the middle, and mainland China appears highly restrictive, banning the “mining” of bitcoin. (China went from controlling up to two-thirds of all bitcoin mining in the world in April to not contributing to the industry at all as of July 2021, according to data compiled by the University of Cambridge's Centre for Alternative Finance.)
Overall, however, the tone is one of enthusiasm, tempered with a few question marks.
“In the last six months there has been increasing [wealth industry] interest in cryptos. For example people ask about NFTs, tokenisation and how they can offer digital assets to clients,” Dr Nils Bulling, head of strategic innovation and ecosystem at Avaloq, told this publication. Dr Bulling said conversations about the impact of this category of tech started about three or four years ago.
There is little doubt that the wealth sector is showing lots of interest in the space. A survey of family offices around the world by BNY Mellon Wealth Management, published last week, found that 77 per cent of them have some interest or involvement in cryptocurrencies. Knight Frank, in its annual wealth report, also published last week, noted that 60 per cent of respondents to its survey cited blockchain technology as an increasing opportunity. It found that clients ask for 1 to 5 per cent of their portfolios to be in cryptos. The report’s authors noted that “we are seeing a shift within the banking industry to accepting and managing crypto assets, allowing them to be used as collateral and converting crypto into fiat. It is not a widely marketed service, but banks recognise that the younger generation is going to be using crypto as a currency.”
And there, perhaps, is the key to wealth managers’ thinking. Whatever the scepticism may be among ageing Boomers and some of the Gen X client cohorts, firms need to attract younger clients who appear to accept these new technologies as normal and even exciting. To stay relevant, cryptos have to be on the menu.
Asia and others
It is arguable that one way in which Asia is now setting the pace for innovation – once held by Silicon Valley – is in cryptos. A study by KPMG said that investment in the cryptocurrency and blockchain sector in Singapore jumped more than 10 times in 2021 to a record, with 82 deals worth a combined $1.48 billion, rising from $110 million in 2020 (source: Bloomberg, 7 February, 2022). In Switzerland, the “crypto valley” of Zug is a European powerhouse, as the author was reminded during last week’s visit to Zurich for the annual WealthBriefing External Asset Management awards event.
There were about 1,128 blockchain companies in Switzerland and the neighbouring principality of Liechtenstein at the end of last year (up by 18 per cent (source: swissinfo.ch). The Swiss government implemented the legal basis for distributed ledger technology in 2021 and for listing security tokens on regulated secondary markets. The report said that more than half of the Swiss banks apparently plan to offer digital assets services over the next few years. To take just one example of what is going on, in late February, Swiss digital assets platform SEBA Bank secured a regulatory green light from Abu Dhabi. This also highlights how Gulf jurisdictions, seeking to remain relevant beyond hydrocarbons, are getting into the act.
In the UK, as the country’s financial sector seeks new fields to conquer after Brexit, digital assets are an important part of a wider fintech story. TheCityUK – the umbrella body speaking for much of the London financial sector – said that around 9.8 million people in the UK, equivalent to 19 per cent of the population, owned crypto assets in 2021.
Turning to the US, the market size is expected to grow from $1.6 billion in 2021 to $2.2 billion by 2026, at a compound annual growth rate of 7.1 per cent. It is certainly a good way for California’s Silicon Valley, and other tech clusters such as Boston or Austin to stay on the front foot.
The digital assets space is becoming more mainstream. A 2021 Goldman Sachs survey found that nearly half the family offices it conducts business with want to add digital currencies to their stable of investments, with the closely held firms seeing crypto as a possible hedge for higher inflation and prolonged low interest rates. Almost half of respondents to that Goldman Sachs report said that they are thinking of moving into digital assets such as bitcoin, although most are not currently in this space. Their main reason for caution is that they are sceptical of whether cryptocurrencies are a store of value. (Goldman Sachs polled more than 150 family offices.)
Major institutions, including JP Morgan, Morgan Stanley, Julius Baer, Guggenheim Partners, and others, are involved. SC Ventures, Standard Chartered’s innovation and ventures unit, partnered with Northern Trust to launch Zodia, a cryptocurrency custodian for institutional investors, which was registered with the UK's Financial Conduct Authority in July last year.
Let’s nail down some terms, such as non-fungible tokens (NFTs). Unlike cryptocurrencies such as bitcoin, which are identical units that can be exchanged and are therefore fungible, NFTs are not interchangeable. Each NFT is a unique token on a blockchain which stores information about provenance that can be traced back to the original issuer; therefore it provides collectors with the opportunity of building a digital collection. For this reason, NFTs are popular in applications which require unique digital items, including crypto art, digital collectables and online gaming, where some guarantee of authenticity and ownership history adds value.
The trading volume of NFTs surpassed $13 billion last year, compared with $33 million in 2020 (Source: The Block Research). NFTs are proving a hit with younger wealthy individuals, a fact not lost on art galleries and creators. Arguably, where NFTs grab the interest of investors and commentators most is in the form of crypto art. A recent example includes musician Grimes selling $6 million worth of digital artworks via auction on Nifty Gateway, a marketplace which allows users to buy, sell, display and create a collection of "Nifties." One short video, ‘Death of the Old’ sold for nearly $390,000. However, most of the $6 million in sales came from two pieces – "Earth" and "Mars" – with almost 700 copies being sold.
A famous NFT sale was that of Beeple’s “First 5000 Days” artwork for £50 million at the first digital-only art auction by Christie’s in March 2021. Following the sale, Beeple is now one of most valuable living artists and has taken NFTs from a niche area of the crypto world, to a mainstream phenomenon.
The term “DEFI” applies to distributed finance. DEFI uses emerging technology to remove third parties in financial transactions. Components to remember are stablecoins, software, and hardware that enable the development of applications. “Smart contracts” are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements exist across the blockchain network. The code controls the execution, and transactions are trackable and irreversible. Another term used a great deal is “tokenization.” Crypto tokens are a type of cryptocurrency that represents an asset, such as a private equity investment, or publicly listed stock in a company. Tokens can be used for investment purposes, to store value, or to make purchases.
Tokenization is often spoken about in the alternative assets space as a way to widen access to investors who aren’t ultra-wealthy or large institutions. Tokenization is an important trend and comes in two main forms – tokenization of established assets such as private equity or venture capital, and for “non-bankable assets” such as fine art, Avaloq’s Dr Bulling said. “Generally, banks talk about it but haven’t yet offered it [tokenization] but it might move in the next two or three years,” he said.
David Genn, CEO of Goji, a UK-based technology platform for private asset investments, said that tokenized assets “promise the ability for investors to access private assets more efficiently and in smaller fractions than they currently can. The underlying assets remain the same and regulators treat both the tokenized and standard versions of the asset in the same way.”
“The goal for managers and technology providers is to increase the efficiency of access to private assets for investors. This can be readily done without the need to tokenize the assets which introduces significant additional complexity,” he said.
Current events also give the case for alternative financial structures new edge, Charlie Morris, founder of Byte Tree, said. (The firm provides digital asset data, fundamentals, technicals and crypto research and analysis.)
“Bitcoin sits at the heart of exchanging value between machines, and I am certain that machines will exchange substantially more value ten years from now than they do today. Things are definitely looking up for bitcoin – governments are keen to embrace central bank digital currencies, not just in China, but seemingly everywhere,” he said. “Some for good, and others for bad. Both Russia and Ukraine are contemplating an increasing role for bitcoin in the official payments sector for completely different reasons. Russia wants to work around sanctions, whereas Ukraine wants to liberate its citizens. These should not be disregarded as isolated cases, because the world is becoming a more complex place. Even in Canada, where the truck drivers are expressing their legitimate right to protest, they are being denied access to the banking system. This demonstrates that law-abiding people should protect themselves from involuntary state sanctions,” Morris added.
A question remains about trust – that precious quality in finance. And to that end, an important priority for banks and wealth managers of all kinds is being able to safely store, exchange and validate the crypto assets they own or seek to acquire. That is going to require not just infrastructure, but clearly defined and enforced rules.
(Editor's note: We continue to track how the crypto world influences wealth mangement, both as a business and what clients invest in, and are grateful for insights. Email email@example.com)