The future of capital markets
For many years, parts of the financial markets have been burdened by unnecessary restrictions resulting in inefficiencies in the free allocation of capital. The upcoming broad applications of digital assets promise to change that. This article serves as an introduction to the topic of digital assets and describes some of the associated opportunities and challenges for retail investors, institutional investors, and financial service providers. Traditional markets have long faced obstacles due to limitations in the availability of asset classes, difficulty of cross-border transfers and minimum capital requirements, to name a few. Given the possibilities and universal applicability of digital assets, all market players have at least an interest in familiarizing themselves with the subject and perhaps even developing a strategy for the capital markets of tomorrow.
Similar to ‘Blockchain’, ‘Digital Assets’ is yet another term that is sometimes misused as a buzzword. Nonetheless, understanding the implications of digital assets is essential as they will undoubtedly play a huge role in the future. It all started with Bitcoin and its underlying technology enabling the creation and transfer of digital value without intermediaries. Several years later, Ethereum, an asset management platform, was introduced. Since then, Ethereum has evolved into the world’s largest blockchain ecosystem. The German Federal Government, along with the Federal Ministry of Finance and the BaFin (Federal Financial Supervisory Authority), have introduced several laws and regulations in recent years with the aim of laying a solid foundation for digital assets. One of these regulations specifies how institutions should store digital assets in their custody. In addition, the Law on Electronic Securities and, more recently, the Law on the Location of Funds have been introduced. While Germany is not quite ahead of the pack, with smaller countries like Switzerland being even more nimble and progressive, the German state is making progress in building a solid regulatory base for the markets for commodities. capital of tomorrow. This is especially noteworthy given the struggles Germany has faced with digitization in the past: the slow digitization of schools and universities and the mess of paperwork at vaccination centers are just two examples.
At the same time, Europe as a whole is also making great strides. While the aforementioned legal and regulatory initiatives are being implemented in Germany, Europe as a whole is looking to introduce MiCA (Markets in Crypto-Assets) regulation. MiCA represents universal regulatory work advancing with a speed and determination rarely seen in the European bureaucracy, which 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 uniform applicable regulations. for the 450 million citizens of the EU. This is especially noteworthy given the struggle that regulators in the United States have had to determine which agencies have jurisdiction over crypto assets. Of course, some aspects of the MiCA regulations are not dealt with optimally. However, given the speed at which this regulation is being implemented and its universal relevance, it may well be worth it given that businesses need security and protection before they want to invest.
One thing is certain, German laws as well as upcoming European regulations reduce risks for businesses, enabling them to make better financial decisions for the future. Additionally, the legitimacy offered by government regulation signifies the importance of topics such as blockchain and digital assets, especially for the financial industry.
Digital asset use cases
But what exactly are digital assets? At its core, digital assets are digital representations of all kinds of objects and their associated value. They allow the issuance and transfer of ownership without the need for paper documents. It may not be obvious anymore, but even today when you buy stocks through a Germany-based broker or online bank, a paper document with a notary’s stamp is kept for you somewhere in a safe. – strong on German soil. This traditional way of executing such transactions has inefficiencies. For example, issuing traditional securities costs time and money, and cross-border transactions are usually very complicated. These inefficiencies result in high fees and lead to delays, as transactions cannot be executed or finalized almost instantly.
Widespread adoption of digital assets will lead to easier and faster issuance of new securities, while cross-border transactions will be streamlined. These advantages apply to existing types of securities, such as bonds, fund units and, in a few years, stocks. Beyond simply improving the efficiency of existing types of titles, digital assets will allow the creation of whole new types of titles.
Here are a few examples: Startups in Germany have started working on building digital assets based on real estate. Finexity, Exporo and others allow retail investors, who otherwise could not participate in the real estate market due to a lack of capital, to invest in real estate. Digital assets allow investors with as little as, say, 5,000 EUR to invest in real estate. In addition, investors can divide their investment between several different objects, which allows a diversification of their investment. One problem with this approach is that it could be viewed as a loan capital investment. Market participants concerned about inflation, 3.8% in Germany and almost 5% in the United States, might rightly be skeptical of debt capital investments. Equity instruments will address these concerns when they are introduced. We will likely see companies introduce such instruments in the fall of this year, providing investors with excellent protection against inflation. Digitized real estate is just the first step, other companies are striving to offer investable stocks of old, artwork and other real estate assets. Not just as debt capital investments, but also as inflation-resistant equity instruments.
Therefore, digital assets make new categories of investment possible and accessible even to retail investors. In addition to stocks, portions of large sets of assets representative of companies, digital assets will enable targeted, inflation-resistant investments in individual real assets. From 2022, this use of digital assets, which currently focuses on real estate, antiques and art, will be applied to industrial goods, making them accessible to investors.
Industry 4.0 funding
The concept of leasing is well known, but who besides institutional investors and automakers can profit from the returns generated by thousands of leased vehicles? Currently, no one. From 2022, unique industrial goods will be made investable by private investors: industrial installations, machines, tractors, etc. The way it works is that these assets usually come with a significant upfront cost and continued consumption of resources – an operating cost. At the same time, they create a production which in turn creates profit. Simply put, this allows for an investment opportunity, similar to how leasing works, but open to retail investors. Manufacturers of industrial equipment will be able to continue producing their equipment without being limited by capital limitations. The companies that use the machines no longer buy them for a large initial sum, but rather pay for their use. This model is also called “pay-per-use”. In this model, the capital market finances the initial purchase of the machine through digital assets and investors realize returns each time the machine is used. CashOnLedger is already working on this concept, starting with tractors, but with the intention to soon extend to all types of industrial goods, making them investable.
Digital assets are the future. The diversity of types of investable assets will increase considerably in the years to come. Companies in the financial sector, but also in industry, must familiarize themselves with the new opportunities to take advantage of this next stage of digitization. Currently, there are already projects and prototypes, but in a few years, thousands of digital assets will be available to everyone.
Conclusion – The Diverse World of Digital Assets
The financial sector should not underestimate these future developments, but rather seize the challenges and opportunities of the coming digital transformation and start developing a strategy. Competition from cryptocurrency exchanges is increasing rapidly, and as Coinbase has shown, they have the necessary funds in their war chests to rapidly develop and execute successful business models. In addition, these platforms rapidly extend the range of assets to which their clients have access. As more traditional assets are digitized, these platforms, in addition to cryptocurrencies, will start offering digital stocks, token real estate, art and more to their customers. users. Institutional and retail investors are likely to use the platform offering the widest variety of services and assets. Legacy financial service providers will therefore need to adapt to this new world of digital assets to avoid losing their relevance.
When it comes to the uses of digital assets, this is only scratching the surface. There are many other categories of these that would be well beyond the scope of this article. Decentralized protocols, utility tokens, non-fungible tokens, DeFi protocols, etc. The digital future promises to allow for extreme diversity in capital markets.
Authors: Teacher. Dr Philipp Sandner founded the Frankfurt School Blockchain Center (FSBC). From 2018 to 2020, he was ranked in the “top 30” economists of the Frankfurter Allgemeine Zeitung (FAZ), a major German newspaper. Since 2017 he has been a member of the FinTech Council of the Federal Ministry of Finance in Germany. He is also a board member of Avaloq Ventures and the Blockchain Founders Group, a Liechtenstein-based venture capital firm specializing in blockchain startups. Benjamin schaub is a project manager for INTAS.tech, a digital asset consulting firm.