Convergence Takes Shape in the Digital Asset Market
Despite recent shake-ups in the crypto and digital assets market, investor appetite for digital assets remains strong. This includes cryptocurrencies, DLT-based securities (such as tokenized securities, to include digital bonds, and non-traditional assets like art), and DLT native securities. As the market continues to evolve, we anticipate increasing levels of convergence between digital assets and the underlying DLT infrastructure that supports their trading.
SIX Digital Exchange (SDX), a leading blockchain-based financial market infrastructure, examines how this convergence could impact the digital asset universe.
The March into Digital Assets Continues
Market volatility, to include the fallout from FTX default, has not deterred investors from embracing the broader digital assets ecosystem. According to a recent SIX Future of Finance Digital Assets Buy-Side report (May 2023), approximately 70% of respondents expect to include digital assets in their portfolios within the next 12 months, compared to just 10% today. Institutional investors are progressively diversifying their returns by adding alternative and digital assets to their portfolios. However, the speed of adoption differs between cryptocurrencies and digital securities. While cryptocurrencies are consolidating around a $1 trillion market cap (reaching peaks of $3 trillion), regulated digital securities in token form hover around the $1 billion mark at best(1).
While the cryptocurrency market is dominated by retail and small institutional investors, the institutional security token market is still in the experimental stages of development. Despite evolving at different speeds, we anticipate greater convergence between these two digital asset classes driven by growing technology interoperability and greater regulatory clarity and oversight.
The Building Blocks to Support Digital Assets Exist Already
The underlying blockchain technology supporting the issuance and creation of cryptocurrencies and digital securities is largely identical. The key differences lie in the details of how on-chain assets behave and how they are regulated and legislated. However, the market infrastructure surrounding them has created two parallel tracks, making it challenging to progress towards institutional maturity.
From a technological perspective, transactions involving regulated digital securities often operate on private blockchains managed by banks or financial market infrastructures (FMIs) with controlled network membership and rules of engagement. In contrast, cryptocurrencies and other public-chain native digital assets have lifecycles on more open, albeit less regulatory compliant, peer-to-peer public chains. In technical terms, selected intermediaries such as issuance platforms or DeFi companies can transparently purchase these assets using public chain rails.
We anticipate a future where private blockchain implementations will eventually assume some public blockchain characteristics. But how?
Interoperability Is a Must
Firstly, achieving interoperability between public and private blockchains is essential for the convergence of digital assets and the DLT infrastructure. Seamless asset replication and trading on different platforms rely on this interoperability. SDX, in collaboration with industry peers, is working to actively improve connectivity between different distributed ledger technology (DLT) protocols and networks. A notable development in this regard is R3's recent announcement of a new open-source project called Harmonia, in partnership with Adhara, under the umbrella of the Hyperledger Foundation. This initiative is expected to expedite the creation of interoperability protocols specifically designed for regulated networks and institutions. Leveraging these technological advancements, SDX is committed to facilitating interoperability across multiple DLT networks, thereby promoting seamless integration within the digital asset ecosystem.
Additionally, SDX and several other financial institutions are collaborating with SWIFT on experiments to test how firms can use their existing SWIFT infrastructure to transfer tokenized value over various public and private blockchain networks.
Regulation as a Convergence Enabler
Regulation also plays a crucial role in driving convergence. As the market matures and becomes more regulated, traditional financial service providers will continue to enter the digital asset space, offering custody and other services. Regulatory frameworks like the EU's MICA rules and the EU DLT Pilot regime provide oversight for previously unregulated crypto-assets and encourage the adoption of DLT systems for trading and settlement. This convergence of regulation and technology narrows the gap between cryptocurrencies and digital securities, ultimately creating a more unified and compliant digital asset market.
Digital Asset Markets Pivot Closer Together
Looking ahead, we envisage a global digital asset agnostic settlement infrastructure operating on both public and private blockchains for all digital assets. In this agnostic environment, valuable assets such as money, securities, commodities, real estate, art, property rights, and collectibles will be available on various blockchains in differing token forms. Value is tokenized, and 24/7 availability, transferability, and exchangeability become key features. Asset owners, corporates, and beneficial owners will directly access digital assets, relying on banks and intermediaries to manage their assets, offer financial products, and provide related services like legal and tax support. Each of these players will be integral participants in the network.
So, why haven't we reached this point yet? The need for orderly interactions among network participants, appropriate risk measures, and membership requirements are standard expectations in such an environment. We have already discussed technology and regulation earlier. To support this growth, providers must offer comprehensive services that bridge different technology silos and asset classes as the underlying foundations (technology and regulation) naturally evolve.
SDX strategically focuses on digital securities, Web3, and alternative assets, recognizing that each market will evolve at its own pace. With its private blockchain implementation for regulated digital securities and its Web3 Services business for public chain-based assets, SDX is well-positioned to drive the convergence of digital assets in the market. Working with partners and clients, SDX aims to make the vision of blockchain's real benefits in financial services a reality.
(1): Coindesk – April 4, 2023 – Bitcoin’s huge surge pushes crypto market cap to $1.19 T, the highest since June