A presentation by Dr Ian Hunt on his recently published paper, Digital Issuance - An Optimal Model for Digital Assets and Transactions, was followed by a discussion with an expert panel and the members of an invited audience, moderated by Future of Finance co-founder Dominic Hobson.
- Margin pressure exerted by institutional investors and passive investing means asset managers must cut costs but the methods used over the last 30 years – computerisation, outsourcing and offshoring – are no longer sufficient, partly because of rising regulatory costs. The asset management industry needs to move on to a new operating model.
- If the asset management industry fails to adopt a new operating model, it risks being displaced by the Decentralised Finance (DeFi) industry. Despite reputational issues and a recent loss of value, DeFi protocols have experimented successfully with alternative models of capital-raising, trading and investing, and are attracting interest from asset managers.
- A further challenge facing the asset management industry is set by unavoidable generational change. Baby Boomers which saved via pensions, funds and housing are being replaced by Millennials and Gen Z, which are not only digitally native but alienated from all existing financial services providers, as their enthusiasm for tokenised forms of finance proves.
- Tokenisation offers a new operating model. Instead of assets (such as securities) and cash (as payment) being moved between buyers and sellers by a complex eco-system of exchanges, brokers, clearing houses (CCPs), custodians, central securities depositories (CSDs), registrars and paying agents and their computer systems, tokens move between nodes on a network.
- Ultimately, finance is about the transfer of value through time. Its essence can be reduced to flows of value in which an asset is a purchase of future flows of value (an investment by investors) and a liability is a sale of future flows of value (an issue of equity or debt by an issuer). Financial services exist to facilitate exchanges between investors and issuers.
- It follows that intermediaries that facilitate exchanges of futures of flows of value between issuers and investors must add value or they will become vulnerable as forms of transactions costs only. In principle, tokenisation can dispense with intermediaries altogether, with issuers and investors holding self-servicing tokens on their nodes only.
- Tokens differ from conventional financial assets. A conventional equity offers an uncertain promise of capital appreciation and dividend income. A fixed rate bond offers a certain income and a promise of redemption. Mutual funds are more like bonds than equities. What tokens offer is something simpler: a pledge to deliver a particular flow of value in the future.
- These pledges of future flows of value are made by token issuers to token investors. There are two variants. The first is a “native” token that exists in digital form only (as Bitcoin does). The second is a “title” token or a tokenised underlying analogue asset (such as a company share or a building or, in the case of a Stablecoin, cash and near-cash financial assets).
- Fulfilment of pledges of future flows of value can be automated by building intelligence into a token, making it a “smart token”. For example, when the date arrives to make a transfer of value such as a dividend or interest payment or rights issue or redemption, it triggers the token to deliver other tokens of the requisite value to the node of the holder of the pledge.
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