State Street says digital currency is in ‘polar vortex’ as it eyes real assets

“This is the first time bitcoin and other cryptocurrencies have gone through such an inflationary environment. It is the fourth crypto winter and the most severe given wider adoption – we are referring to it as a polar vortex,” Mr Ahmad told The Australian Financial Review during a visit to Sydney from his base in Singapore.

Mr Ahmad said it was important to separate the current market volatility in cryptocurrencies from the desire to create market infrastructure that could eliminate counterparty risks by allowing instant peer-to-peer transfers.

Asset tokenization

Crypto’s institutional applications contrast with retail investors chasing capital gains in speculative coins that lack utility in the real world.

Mr Ahmad reckons the bitcoin and ethereum collapse this year, which has infected traditional markets, will lead to institutional interest in “asset tokenisation” gathering pace as global standards develop, which global investment banks are lobbying for.

“But as far as an asset class is concerned, we think [crypto] is here to stay. There is going to be an evolution of the players and the protocols in the market.”

He reckons the World Economic Forum’s forecast for tokenised asset markets to reach $US24 trillion by 2027 could still play out because banks will want to use blockchain-based trading to unlock liquidity and create new markets.

State Street holds about $US43 trillion ($62 trillion) in assets under custody. Even if 2 per cent of these are tokenised into a digital form to trade on blockchains, “that will have a significant impact in terms of infrastructure requirements – and those changes are already starting to happen”.

“We think regulatory harmony could create an environment where we see an explosion of tokenised instruments into the market,” he said.

Even though crypto exchanges are jostling to create venues for tokenised assets to trade, no liquidity pools or secondary markets have emerged yet. But with regulators and banks working on standards, State Street expects new markets to be established by the end of the decade.

Push for common standards

Bodies such as the International Organization of Securities Commissions (IOSCO), the International Digital Asset Exchange Association (IDAXA), Global Digital Finance (GDF) and the International Token Standardization Association (ITSA), backed by large German banks and exchanges, are among those pushing for common standards.

ITSA has proposed “international token identification numbers” as a standard to identify cryptographic tokens, and an “international token classification” to point to inherent characteristics of tokens, including purpose, issuer type and the regulatory frameworks that apply to them.

Singapore, Switzerland, Luxembourg and Germany are considering regulations to allow assets to be issued “on chain”.

Australia’s Treasury will soon start a process of “token mapping” to determine local definitions and treatments. The Digital Finance CRC, created a year ago with funding from the Reserve Bank, National Australia Bank and Macquarie, has embarked on a research program to examine digitization of real-world assets and Australia’s response.

‘Reimagine financial markets’

“As an industry, we are looking to ensure standards emerge because this is a great opportunity for us to reimagine financial markets,” Mr Ahmad said.

Benefits to banks could include reducing regulatory capital. He points to State Street Digital’s work with Vanguard in the US foreign exchange forward market, where it typically takes days to exchange collateral. A new platform allows collateral to be exchanged every 15 minutes, reducing “risk weighted assets”. This could be applied in fixed income markets.

Within 10 years, crypto will be creating liquidity for pre-IPO stocks, and could give retail investors “fractionalized” access to bonds.

Mr Ahmad said tokenised carbon exchanges would provide investors with more transparency on carbon assets as crypto technology underpins those markets.

“This is starting to emerge and questioning the status quo for market infrastructure, including the need for central securities depositories, where these assets have typically been issued.”

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