The Reality Behind Buzzwords Series: Blockchain

We’ve all seen the headlines touting blockchain’s industry-disrupting capabilities, but what the asset management industry really needs is a firm understanding of the technology’s practical uses.

Experts from Foreside and Citisoft broke through the hype late last month with the latest edition of Nicsa’s webinar-based “Reality Behind Buzzwords Series,” which clearly defined blockchain, its use in cryptocurrency, and the implications it will have on the industry.

Blockchain, at its core, is a series of immutable records, or blocks, bound together through cryptography and managed by a decentralized group of computers. Gabriel Edelman, Managing Director at Foreside, focused on the digital assets universe within the blockchain investment product landscape, which he divided into three categories: cryptocurrency, initial coin offerings (ICOs), and stablecoins.

“The cryptocurrency everyone’s most familiar with is, of course, Bitcoin,” he said. “Then, there are a variety of ICOs; I’m personally fascinated by countries that are creating their own cryptocurrency, giving access to locals as well as making foreign investments in unique ways. In the last basket, we have stablecoins, or tokens that are pegged to a fiat currency, an asset like gold, or even controlled via an algorithm.”

The Paxos Standard Token (PAX), for example, represents a legal title to a physical bar of gold, “So you’re seeing sort of the digitization of physical things that can be created and then used in financial products,” Edelman said.

Looking at the big picture, Edelman said due diligence in the world of digital assets requires knowing the product in terms of strategy, asset type, and target audience; determining the asset manager’s financial and technical experience; and considering disclosures in regards to fees, the changing regulatory landscape, industry concerns, and the unique nature of digital assets.

Ben Keeler, Managing Director at Citisoft, broke down the realistic opportunities and challenges that blockchain will bring to the asset management industry. 

“There’s certainly opportunity where there is shared truth, specific examples being collateral, repo netting, and really all forms of tri-party reconciliation,” Keeler said. “You can make the argument that distributed ledger technology is a powerful tool to support any case where multiple counterparties are working off of the same sheet.” 

Specifically, Keeler said multinational conglomerates with a lot of moving parts are finding private ledgers useful in supporting internal reporting. In addition, the technology could streamline regulatory reporting and, in the long-term, cause fundamental shifts in how the industry approaches custody services.

From a challenges perspective, Keeler said blockchain is difficult to scale due to limits on the amount of transactions networks can process.

“Exception processing becomes a big issue that needs to be ironed out further,” he said. “Blockchain almost instantaneously publishes records that have been technologically validated to include as part of the chain.”

“But within financial services, the need to correct your work based on new information or updates that come in after a transaction was booked is adding some new wrinkles to distributed ledger technology,” he said.

Some also question whether using blockchain to support day-to-day transactions in the financial services industry is an all-or-nothing proposition. “This is not a ‘get on the train, or you’ll be left behind’ type situation,” Keeler said. “Could it be at some point? Sure. But the value of the tools, to date, have been limited by the question of whether it can be done at scale.”

In the long-term, Edelman said there are several intricacies to consider. Regulation in the blockchain space, for example, is a fragmented area both globally and domestically. Questions also remain around security, lack of standardization, computing power, and how the technology would work with AML regulations. 

“These are all long-term intricacies that are being tackled,” Edelman said. “It’s an ongoing process, but there’s a lot of promise in terms of what’s being developed.”

Note: Although the observations contained in this work represent the best thoughts of the individuals comprising the Nicsa panel, they do not necessarily reflect the views of Nicsa or any of its member organizations. Matters addressed in this work may touch upon legal or regulatory matters, however nothing herein is intended to be or should be construed as legal advice. You should contact your own counsel in order to obtain legal advice regarding these or any other matters.

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