Sponsored by Citi.
GC: When we use the phrase ‘digital assets’, Bitcoin and cryptocurrencies often first come to mind, but how broad is this term in what it means for the future of capital markets?
Ryan Marsh: Digital assets refers to the technology that is used to secure the assets, so it is a broad term for any cryptographically-secured asset on distributed ledger technology (DLT). The main types include cryptocurrencies, CBDCs [central bank digital currencies], stable coins, security-backed tokens, asset-backed tokens and NFTs [non-fungible tokens]. Essentially, it is a basket of different asset classes secured by a common technology.
A lot of the news we read is about cryptocurrencies, and if you look at the market cap of digital assets that’s where it currently lies. However over time, there will be a significant opportunity to digitally transform traditional assets where they could become more easily accessible to investors, and reduce costs associated with the investment lifecycle.
Ryan Marsh, Citi Securities Services’ global head of DLT & digital innovation
GC: Of these types of digital assets, where do you see the most potential in the capital markets in the short-term?
RM: If we look at the most liquid assets today, they are public securities such as equities and bonds that are supported by developed and regulated market infrastructure such as stock exchanges and central securities depositories (CSDs). That’s the space where we, as custodians traditionally service and where most of our transactional activity is. These securities are not only liquid but also relatively low cost to transact. Some might say that a T+2 settlement cycle is inefficient but it is significantly more efficient than transactions in alternative assets. Alternative assets such as private equity and real estate are generally paper-based and not as accessible, and certainly not serviced within those traditional infrastructures or timeframes. Take a piece of private equity or land that sits as a certificate or title deed in a vault somewhere for example – if we can digitise those and fractionalise them then that really does have the potential to democratise investments in these assets and increase liquidity.
Those are the two paradigms that we have today. If we can start to digitise both these types of assets, then they not only become much more accessible, but we can also reduce the cost of the investment lifecycle as the investment lifecycle becomes shorter and more automated. Because of the minimum size of alternatives assets investments, however, lower value investors currently don’t have access to them, so that’s where we will see some early adoption.
Whether it’s a bond, equity, piece of real estate or a cryptocurrency, once digitised, it can all be serviced in a common type of infrastructure whether that’s an exchange, CSD or a public peer to peer network. If it operates on DLT, it enables atomic, immutable and automated movement of assets that should reduce the cost of Investments.
I believe cryptocurrency market cap is going to be overtaken fairly quickly by alternative assets and eventually securities as well.
GC: What does custody look like for digital assets?
RM: Think about what custody is in this context: it is the ability to safely manage and store private keys that control the assets. A digital asset is an asset secured by a cryptographic key, now that’s effectively a digital bearer instrument. The holder of that key has full control of the asset.
Custody is the ability to safely store these cryptographic keys on behalf of the client. That’s clearly a big change from where we are today, but if you take a step back, this is really just a continuation of the evolution of custody. If you go back to pre- 1970s, custody was all about holding physical certificates in bank vaults for clients. Then it evolved to controlling immobilised assets in CSD accounts and then dematerialised assets in CSD accounts – now it’s about controlling the flow of assets across the internet by managing these digital keys.
Custodians that can safely manage private keys can safekeep any asset, whether that’s cryptocurrency, securities, a piece of real estate or NFT. All those assets are going to be stored by similar processes for managing those keys.
One of my predictions is that in 10 years’ time, a custodian will have a much wider range of assets in its possession, including things like NFTs. NFTs are a really interesting development – it’s an example of taking an asset that’s intangible in the past – such as a piece of intellectual property, like art – digitising it and protecting it by cryptographically securing it with a key ensuring that it cannot be accessed or copied without access to the key.
GC: The capital markets of the future certainly sounds different through digitising all sorts of products, how deep can it go?
RM: You can apply the logic to everything. There are conversations about how we as individuals are managing our identity for example. We have all this information on social media relating to you and you have little control over it and how it is used. There are initiatives underway such as the creation of a digital ID that you have full control over via a digital key and an entity can only access it when you allow them. In the future, even digital identities could be safekept by custodians.
There’s a whole new world of asset classes that could emerge, so it’s a really exciting evolution. It’s not just about technical capabilities, because we need to have a way of safely managing those keys, but because everything is online, there also needs to be an increased focus on cyber security risk.
We also need to know how these assets behave. For example, if you look at crypto, there are processes like AirDrops and staking that are unique to those assets. Different assets have their unique attributes and custodians have to deal with those as well as safely storing the keys and providing traditional services such as connectivity, credit, lending and market expertise.
GC: Are you engaging with clients on this evolution or is it more of a ‘build it and they will come’?
RM: Clients are interested and keen to partner on use cases and ultimately building solutions together. Traditionally, the service providers have been ahead of the investors in this space, but we are increasingly seeing this gap being closed. This is the future of custody and we are partnering closely with clients to provide access and reduce any barriers by ensuring that our solutions are backward compatible to minimise changes for our clients.
GC: What are these barriers for clients when it comes to this new digital asset ecosystem?
RM: There are three significant challenges: fragmentation, technical complexity and network adoption. With fragmentation, we are seeing a lot of new marketplaces emerging that will support different assets, standards and processes in those markets. So, you’ve got fragmentation of marketplaces, technologies and processes, and that can get quite overwhelming when actors are investing and servicing clients globally.
With technical complexity, this space has evolved so quickly over 10 years. Two years ago, people were saying these networks can’t process more than 100 transactions per second, and now we are talking about networks that can support 60,000 transactions per second. The challenge is keeping up with the speed of this evolution and integrating this alongside legacy technology and processes that will remain relevant for a number of years.
What we have quickly realised is that it is our job as a service provider to solve for these challenges, it shouldn’t be a barrier for our clients. Our goal is to ensure we build the necessary connections into these new marketplaces, adapt to those processes and the features of those new assets, and integrate all of these fragmented processes alongside our existing technology and processes. This way, clients will be able to access this new digital asset ecosystem via a single service layer and be assured of its compatibility with existing protocols. They won’t need to worry about connectivity or differing standards. We see this as a key differentiator of Citi’s service offering.
The journey itself will be another evolution and our goal is to reduce those barriers in the early days to support the wider adoption of digital assets so that clients can start to enjoy the benefits.
The third challenge is scaling up these networks. What I’ve mentioned earlier is us helping those networks evolve. Citi has a local custody presence in more than 60 countries and we are leveraging this globality to partner with exchanges, CSDs, new market places and clients to allow them to select the right use cases. This will ultimately encourage adoption in those networks, deal with fragmentation and the technical complexity.