Digital assets have faced a lot of criticism lately, but what’s the real state of the market?
As a fairly nascent market, attitudes towards digital assets differ across borders, businesses and even between friends and colleagues.
Differences in attitudes across geographies “are driven by regulatory stance,” says Bradley Duke, co-CEO at ETC Group. “In Europe, German and Swiss regulators really stand head and shoulders above everybody else in terms of being proactive in constructing a regulatory framework that crypto can operate within.” As a result, market participants are far more comfortable engaging with the asset class as they feel that “the regulator is looking out for them,” Duke explains.
In the UK, the FCA originally took a hesitant stance on crypto and, as a result, regulation is lagging behind European competitors. ETC Group already has crypto products listed on SIX, Euronext Paris and Euronext Amsterdam — but not the London Stock Exchange. “Wherever the regulator is, the markets follow,” Duke affirms, “including the clearing houses.”
Regulation
In many jurisdictions regulation has been lagging behind the digital asset industry from the outset, in part because regulators didn’t expect the market to take off as much as it has. A panellist at Citi’s Digital Money Symposium this year addressed policymakers’ wait-and-see approach, which they explained has caused regulations to often be out of date by the time they go live.
This lack of preparation may be a factor in some participants’ hesitancy to engage with these asset classes — a lack of solid infrastructure, inconsistent guidelines and changing standards don’t spark confidence. In terms of governance the industry can seem, at times, like the Wild West.
“A lot needs to be done around regulation,” says Solene Khy, head of product management and product strategy for digital assets at Murex. Crypto-native custodians who have considered regulation from the start “shouldn’t be afraid of what’s coming,” she reassures, but those who haven’t “will probably not be part of the future landscape” unless they make fundamental changes to their operations.
But there’s hope on the horizon: the European Parliament recently approved the EU’s Markets in Crypto-Assets regulation (MiCA), which aims to protect consumers and improve financial stability around the asset class. This is particularly prescient following the numerous scandals around crypto assets in recent months. However, “the onus is not exclusively on regulators,” says Vikas Srivastava, chief revenue officer at Integral. “Technology providers from other parts of the financial markets need to step into the fold and bring over their tried and tested solutions.” As digital assets continue to become a staple of portfolios, “there is a strong business case for market participants to show their customers and prospects they are taking measures with technology to shore up their offerings.”
Custody
“Custody is the main challenge in the digital asset space today,” Khy states. Between crypto-native centralised exchanges, crypto-specialist custody firms and tech providers offering the tools for clients to build custom custody services, there are several options on the market for organisations to choose from. Banks, too, are looking to take advantage of growing interest, expanding their existing custody channels and partnering with crypto-native technology firms to appeal to existing and new clients. However, there’s still “a lack of traditional trusted and regulated custodians that can securely store digital keys,” she adds.
This isn’t helped by the fact that the use cases of digital assets are continually diversifying, with custodians under pressure to be able to service the asset class in all its forms. Additionally, according to David Newns, head of SIX Digital Exchange, investors now “expect their custodians to also support services such as trading, post trade and asset servicing.”
As a result, and following the Credit Suisse and Silicon Valley Bank incidents coupled with the 2022 crypto exchange crashes, “both incumbent and new investors are opting for multiple custodians to diversify counterparty risk,” Newns says.
NFTs and hype cycles
The lifecycles of various digital assets tend to follow a consistent route. A product will become popular, seeing enthusiastic support from celebrities and cultural figures, before people begin to question the rationale behind it and it fades (or crashes) out of the zeitgeist.
One such example of this is non-fungible tokens (NFTs), which have faced a fair amount of ridicule over the last few years. From criticisms around their impact on art to technical questions about the unenforceability of copyright, from stilted celebrity endorsements to comparisons with pyramid schemes, buzz around them seems to have faded.
Several celebrities have been criticised or had legal action taken against them after promoting various digital assets, many of which used unregistered bounty programmes to draw in customers. Such incidents deal the digital asset ecosystem another reputational blow, framing them as risky, unreliable and sketchy.
Even large institutions can end up on the wrong side of the fence when it comes to jumping onto the latest trend; the UK government abandoned its plans to produce an NFT through the Royal Mint less than a year after the scheme was announced.
However, ETC Group co-CEO Bradley Duke argues that NFTs are broadly misunderstood. “Everyone thinks of NFTs as an ape smoking a cigarette,” he says, stating that NFT technology has been “tarred” by the reputation it gained from this narrow use case.
In reality, NFTs are “the missing piece of the puzzle,” Duke suggests. More than a [vessel] for ‘art’, they confer “real, provable and enforceable” ownership — “like a deed to a house” for any form of digital asset. This use of NFTs will become increasingly important as the world becomes more digital he predicts, and the technology should not be written off after the initial “speculative bubble” has burst.
Excessive emissions
Digital assets do not have the best track record in terms of their ESG credentials. Environmentally, it’s a well-known fact that crypto mining uses colossal amounts of energy. The process “consumes as much energy as a country like Argentina or Australia per year,” states Daragh Tracey, senior strategy manager at Fenergo.
As concerns around the climate, and the impact that cryptocurrencies are having on it, have escalated over recent years, the industry has begun to take steps to reduce its environmental impact. Ethereum moved from proof of work to the more energy-efficient proof of stake in September 2022, which reduces emissions by a staggering 99.992 per cent. The move, which Tracey affirms was a “massive technical challenge”, broke through to mainstream media and provided hope for the more ESG-conscious investor that crypto may become a viable, ethical investment.
Whether the rest of the market will follow suit remains to be seen, but Ethereum’s landmark shift is certainly a step in the right direction.
Open to all?
Digital assets have been seen by some as exclusionary, rarified investments available only to the elite, playthings of the rich and famous — perhaps unsurprising, given that one Bitcoin is worth more than US $3000. On the other hand, meme stock, easily accessible platforms like Robin Hood and celebrity endorsements have significantly chipped away at this image, presenting digital assets as something that anyone, with or without previous industry experience, can get involved with.
So will digital assets be just as available as traditional assets — and will that happen anytime soon?
“The thing about crypto is that you just have to have a phone. You just have to have a device that’s connected to the internet, and you can be part of the story,” says ETC Group’s Duke. He argues that digital assets are “an exciting innovation with some real social upliftment opportunities,” and an impact that can go far beyond the diversification of a portfolio.
He highlights the role that crypto can play in less economically stable jurisdictions: “it can be a lifeline,” he explains, allowing those in countries “with rampant inflation or a failed banking system,” or who are unbanked or underbanked, to connect to the global economy.
Rather than a personal, returns-based approach, many are enthusiastic about digital assets and cryptocurrency “because they see the banking system is broken, exclusionary and expensive, and they have a vision of how the world can be,” Duke says. Taking a different perspective on the asset class could go a long way to rectify some of the reputational damage the market has faced.
The next big thing?
Security tokens and central bank digital currencies seem to be one of the next big trends in digital assets, emerging from the chaos as pillars of hope, if not complete certainty, that digital assets could be a safe investment. With clear regulation frameworks and the backing of trusted institutions, they offer some sense of reliability and trustworthiness to investors who have been disappointed one too many times.
That being said, numerous failures in the digital asset world — exchange collapses, criminal allegations and personal losses — haven’t prompted a complete loss of faith. Earlier this year, a report from management intelligence platform Acuiti reported that 75 per cent senior executives active in crypto derivatives trading were ‘quite’ or ‘very’ optimistic about the digital asset market over the next quarter, with only 14 per cent expecting FTX’s 2022 collapse to reduce industrial participation in cryptocurrency markets.
The financial industry is committed to making digital assets work. Although it requires trial and error, and failures are inevitable, progress is being made. Driven by market participants, and now with the support of regulators and policymakers, the development of digital assets and their custody marches on.
