For many years, certain parts of the financial markets have been burdened by unnecessary restrictions that create inefficiencies in the free allocation of capital. The imminent widespread adoption of digital assets promises to change that. This article serves as an introduction to digital assets and describes some of the associated opportunities and challenges for retail investors, institutional investors, and financial services providers. Legacy markets have long faced obstacles related to limited asset class availability, difficulties with cross-border remittances, and minimum capital requirements, to name a few. Given the possibilities and universal applicability of digital assets, all market participants can benefit from at least familiarizing themselves with the topic and possibly even developing a strategy for tomorrow’s capital markets.
Similar to “blockchain,” “digital assets” is another term that is sometimes misused as a buzzword. However, it is important to understand the impact of digital assets as they will undoubtedly play a huge role in the future. It all started with Bitcoin and the underlying technology that enables the creation and transfer of digital assets without intermediaries. A few years later, Ethereum, an asset management platform, was launched. Since then, Ethereum has become the largest blockchain ecosystem in the world. The German government, along with the Federal Ministry of Finance and the Federal Financial Supervisory Authority (BaFin), has enacted several laws and regulations in recent years to provide a solid foundation for digital assets. One of these regulations specifies how institutions should keep digital assets in their custody. In addition, the Electronic Securities Act and, more recently, the Fund Location Act have been introduced. While Germany is not quite leading the way, as smaller countries like Switzerland are even more agile and progressive, the German government is making progress in building a solid regulatory foundation for tomorrow’s capital markets. This is particularly noteworthy given Germany’s past struggles with digitization: the slow digitization of schools and universities and the paper chaos in vaccination offices are just two examples.
At the same time, Europe as a whole is also making great strides. While the above legal and regulatory initiatives are being implemented in Germany, Europe as a whole is striving to implement the Markets in Crypto-Assets (MiCA) regulations. MiCA represents a universal regulatory effort that is moving forward with a speed and determination rarely seen in European bureaucracy, and will likely be enacted by the European Commission towards the end of 2022. This regulatory framework covers all possible types of blockchain-based assets and applies a uniform regime that applies to all 450 million EU citizens. This is particularly noteworthy given how difficult regulators in the United States have struggled to determine which authorities have jurisdiction over crypto assets. Of course, there are some aspects of the MiCA regulation that are being handled suboptimally. However, given the speed at which this regulation is being implemented and its universal relevance, it may well be worth it, as companies need certainty and protection before they are willing to make investments.
One thing is certain: the German laws and the upcoming European regulations reduce risks for companies and allow them to make better financial decisions for the future. In addition, the legitimacy provided by government regulation underscores the importance of issues like blockchain and digital assets, especially for the financial sector.
Use cases for digital assets
But what exactly are digital assets? At their core, digital assets are digital representations of all types of objects and the value associated with them. They enable the issuance and transfer of property without the need for paper documents. It may no longer be self-evident, but even today, if you buy shares through a broker or online bank based in Germany, a paper document with a notary’s stamp is kept for you somewhere in a vault on German soil. There are inefficiencies in this conventional way of handling such transactions. For example, issuing conventional securities costs time and money, and cross-border trading is usually very complicated. These inefficiencies result in high fees and cause delays because transactions cannot be executed or completed anywhere near immediately.
The widespread adoption of digital assets will lead to easier and faster issuance of new securities, while simplifying cross-border transactions. These benefits also apply to existing types of securities such as bonds, fund shares, and in a few years, equities. In addition to improving the efficiency of existing types of securities, digital assets will also enable the creation of entirely new types of securities.
Here are a few examples: Startups in Germany have begun creating digital assets based on real estate. Finexity, Exporo, and others are enabling retail investors who otherwise cannot participate in the real estate market due to lack of capital to invest in real estate. Digital assets allow investors to invest in real estate with as little as EUR 5,000. In addition, investors can divide their investment among several different properties, which allows them to diversify their investment. One problem with this approach is that it could be considered a debt investment. Market participants concerned about inflation, which is at 3.8% in Germany and nearly 5% in the U.S., may be justifiably skeptical about debt investments. Equity instruments will address these concerns when they are introduced. It is likely that companies will introduce such instruments this fall, offering investors excellent protection against inflation. Digitized real estate is just the first step; other companies are working to offer investable shares in classic cars, art and other tangible assets. Not only as debt investments, but also as inflation-protected equity instruments.
So digital assets are making new asset classes possible and even accessible to small investors. In addition to equities, parts of large asset bundles that are representative of companies, digital assets enable targeted, inflation-protected investments in individual real assets. From 2022, this use of digital assets, currently focused on real estate, classic cars and art, will be transferred to industrial assets and make them accessible to investors.
Financing Industry 4.0
The concept of leasing is well known, but who – aside from institutional investors and automakers – can benefit from the returns that thousands of leased vehicles generate? Currently, no one. Starting in 2022, individual industrial assets will be made investable for retail investors: Industrial equipment, machinery, tractors and more. The way it works is that these assets typically have high upfront costs and ongoing consumption of resources – operating costs. At the same time, they generate production, which in turn generates a profit. Simply put, this provides an investment opportunity similar to leasing, but open to small investors. Industrial equipment manufacturers can continue to produce their equipment without being bound by capital limits. The companies that use the machines no longer buy them for a large amount up front, but pay for their use. This model is also known as “pay-per-use.” In this model, the capital market finances the initial purchase of the machine through digital assets and investors receive a return each time the machine is used. The company CashOnLedger is already working on this concept. It is starting with tractors, but plans to soon expand it to all kinds of industrial assets and make them investable.
Digital assets are the future. The variety of investable asset types will increase significantly in the coming years. Companies in the financial sector, but also in industry, should familiarize themselves with the new possibilities in order to benefit from this next stage of digitalization. Currently, there are already some projects and prototypes, but in a few years there will be thousands of digital assets accessible to everyone.
Conclusion – The diverse world of digital assets.
The financial sector should not underestimate these future developments, but embrace the challenges and opportunities of the coming digital transformation and start developing a strategy. Competition from cryptocurrency exchanges is growing rapidly, and as Coinbase has shown, they have the necessary funds in their war chests to develop and quickly implement successful business models. In addition, these platforms are rapidly expanding the range of assets to which their customers have access. As more and more traditional assets go digital, these platforms will offer their users digital stocks, tokenized real estate, art, and more, in addition to cryptocurrencies. Institutional and retail investors will likely use the platform that offers the widest variety of services and assets. Legacy financial services providers will therefore have to adapt to this new world of digital assets in order not to lose relevance.
As for the use of digital assets, this is just a small sample. There are many other categories that are far beyond the scope of this article. Decentralized protocols, utility tokens, non-fungible tokens, DeFi protocols, and more. The digital future promises to enable extreme diversity in capital markets.
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). From 2018 to 2021, he was ranked as one of the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belonged to the “Top 40 under 40” — a ranking by the German business magazine Capital. Since 2017, he has been a member of the FinTech Council of the Federal Ministry of Finance in Germany. He is also on the Board of Directors of FiveT Fintech Fund, 21e6 Capital and Blockchain Founders Group — companies active in venture capital financing for blockchain startups and crypto asset management. The expertise of Prof. Sandner includes blockchain technology in general, crypto assets such as Bitcoin and Ethereum, decentralized finance (DeFi), the digital euro, tokenization of assets and rights and digital identity. You can contact him via mail (email@example.com), via LinkedIn (https://www.linkedin.com/in/philippsandner/), or follow him on Twitter (@philippsandner).
Benjamin Schaub is a senior consultant at INTAS.tech. His interests include the development and integration of blockchain use cases in the financial industry as well as crypto custody. You can contact him via email (firstname.lastname@example.org) and via LinkedIn (https://www.linkedin.com/in/benjamin-schaub/).
About the Frankfurt School Blockchain Center
The Frankfurt School Blockchain Center is a think tank and research center that explores the impact of blockchain technology, crypto-assets, and distributed ledger technology (DLT) on companies and their business models. In addition to prototyping, it serves as a platform for managers, startups, technology and industry experts to share knowledge and best practices. The Blockchain Center also provides new research impetus and develops training for students and executives. It focuses on the areas of banking, finance, mobility and “Industry 4.0”.
INTAS.tech is a blockchain consulting company founded by Frankfurt School and Plutoneo Consulting, specifically tailored to the needs of financial companies. INTAS.tech focuses on the integration and management of digital assets, as well as the strategic assessment of blockchain deployment opportunities and their implementation.
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