Magazine Issues » September 2021

Digital assets: The crypto conflation

OverpassIn a Funds Europe webinar, experts including the Luxembourg funds regulator discussed how to advance crypto and digital assets’ entry into the mainstream.

Hedge funds and institutional investors are investing in cryptocurrencies and digital assets in greater numbers than ever before. According to Nickel Digital Asset Management, US$43 billion (€37 billion) of bitcoin is held through various close-ended trusts and exchange-traded products (ETPs).

To date, there have been three main impediments for institutional investors wanting to enter these assets – the lack of consistent regulation, supporting infrastructure and service providers with whom investors are familiar.

In a recent Funds Europe webinar, a panel of experts discussed how this is changing and what else might be needed to create a sustainable investment market for crypto and digital assets.

For asset managers, asset servicers and fund administrators, the increased demand for crypto and digital assets raises many questions, said Paul Barker, head of professional development at training company CLT International.

“They want to know what changes they should be making to their operations,” said Barker. “What service providers do they need to appoint? What admin, accountancy, valuation, compliance issues do they have to consider? They also want to know if they have to hire new people and increase their competence in key areas.”

One of the first distinctions to make when discussing digital assets is to separate cryptocurrencies such as bitcoin from security tokens – when real assets are represented as digital tokens held on a distributed ledger.

“There is a general term, ‘digital assets’, that is used as an umbrella term for both cryptoassets and other assets that have similar properties. Consequently, there is often a conflation between cryptocurrencies and tokenisation,” said Adam Belding, chief technology officer at funds transaction network Calastone. “There needs to be more clarity about the difference.”

This is especially important when talking about cryptoassets in the context of a mutual fund or other collective investment vehicle, says Belding. “Bitcoin is a singular asset, whereas a mutual fund has lots of underlying assets, some of which may be cryptoassets.”

Up until recent months, the consensus among the mainstream in the asset management world has been that tokenisation has more potential and is more suitable for institutional investors than cryptocurrencies.

However, according to Luke Dorney, head of sales and partnerships, at Zodia Custody, a digital custody offering developed by Standard Chartered and Northern Trust, this attitude is changing.

“Asset managers are more focused on crypto now,” said Dorney. However, whereas tokenisation of real assets has benefits in terms of liquidity and operational efficiency for institutional investors, it is still at the proof-of-concept stage and there is not yet an established market infrastructure, he added.

In contrast, there is already a market infrastructure for cryptoassets, including a number of crypto custodians, and more institutions are getting involved, said Dorney.

Furthermore, the interest among institutional investors is not linked solely to price. There is also a growing recognition that crypto can be used for collateral and financing or as a means of payment or as a hedging instrument.

The crypto space is one of those comparatively rare instances where market participants, especially on the institutions side, would welcome more regulation.

The regulator’s view
For Karen O’Sullivan, head of innovation, payments, market infrastructures and governance at the Luxembourg regulator Commission de Surveillance du Secteur Financier (CSSF), the emphasis is not so much on the asset itself, but the processes that sit behind the assets. For example, whether or not crypto custodians could meet regulatory anti-money laundering (AML) obligations.

The CSSF has introduced a registration process for virtual asset service providers which is designed to give recognition to the various new entrants to the market, but also to remind them that to be a licensed participant in Luxembourg’s funds market, they must meet the existing rules regardless of the asset class.

Regulators realise that the existing framework will not be enough and there need to be new rules designed specifically for digital assets, something that may be partially addressed by the introduction of the Markets in Crypto Assets (MiCA) regulation proposed by the EU.

But as O’Sullivan pointed out, there also needs to be a harmonised regulatory framework throughout Europe, rather than one where cryptoassets are deemed to be Ucits-compliant in one EU jurisdiction but not in another.

When asked what developments could make the crypto market more sustainable, she also referenced the need for a flexible approach that will “give certainty to the market and the players but won’t impede further innovation in the sector”.

Her call for more harmony was echoed by Dorney, who also called for the development of a post-trade infrastructure that would ensure the safety of assets and would operate in a way comparable to traditional capital markets. For example, crypto trading currently operates on a pre-funding basis, which is the opposite of equities trading.

Calastone’s Belding would like to see a breakthrough use-case for the new operating models inspired by this technology. “Bitcoin and other cryptos becoming more investable is progress, but something to really unlock the potential of this technology would be really exciting,” he said.

Finally, in our webinar held in July, CLT International’s Barker called for a cross-industry working group to discuss the competency standards for crypto. fe

‘Are cryptocurrencies and tokenisation changing the face of asset management?’ is on the funds-europe.com webinars channel.

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