By Serra Angel Wei, Founder & CEO at Aegis Custody
As institutional investors increase their digital asset positions, we have witnessed a renewed push for the digitization of traditional assets, such as green energy bonds, accounts receivables and physical art. Behind this digital transformation is the realization that representing traditional assets as digital ownership certificates provides a number of benefits, such as a reduction in transaction costs and the creation of liquid markets.
But challenges remain. Regulation remains inconsistent, and there is the question of investor trust. This is where regulated trust companies can play a key role. By providing infrastructure for the entire digitized asset ecosystem, they can ensure that investors have access to a consistent supply of high-quality, vetted assets, while, at the same time, leveraging their existing custody services.
The current state of digitized traditional assets
Asset digitization is made possible by smart contracts built on distributed ledger technology (DLT) like the Ethereum blockchain. Immutable and transparent, Ethereum enables the creation of digital certificates and a record of all transactions relating to them. Smart contracts, in particular, have enabled the transition of traditional financial processes, such as asset servicing and ownership transfer, to automated digital processes that require no intermediaries.
A number of traditional asset types are already being digitized. For example, real estate in the United States, wine in Switzerland, whiskey in Singapore, bonds in Malaysia and stocks for foreign investors looking for exposure to U.S. markets. The non-fungible token (NFT) boom around digital art, video and in-game collectibles is the most well-known use case.
What makes asset digitization so attractive is the sheer size of traditional asset markets, their inherent illiquidity, and their reliance on documentation. The $300 trillion real estate and $250 trillion private debt markets are two such examples. Both are traditionally illiquid markets that require numerous third parties and expensive paperwork to transact. The $7 trillion trade finance market is another example.
On the regulatory front, there is inconsistency at best around the world. Switzerland has taken the lead with respect to tokenized securities, while the United States has formed a digital asset working group to “ensure collaboration between regulators and the private sector.” Most other players lump digitized assets together with traditional securities and, thus, require similar approvals. Thailand, Russia, and UAE, on the other hand, currently have no regulation in place.
Hurdles remain for investors
The big question on the minds of investors is centered around the issue of trust. Do they have legal assurance that ownership of a digitized asset equals ownership of the physical asset? For example, if an investor buys a digital certificate representing a property, are they the legal owner? It is an important question, and one that has far-reaching consequences for the digitized asset market.
DLTs like Ethereum, while inherently immutable and transparent, can provide a verified ownership history of the digitized asset, but they cannot verify whether there is a real, legally owned physical asset behind it. In other words, DLTs can act as the System of Record (SOR) for the digital certificates but not for the physical assets.
There is also the question of storing digitized assets, particularly in the wake of the recent NFT boom. With some NFTs worth six figures or more, securely storing them has become a priority for seasoned institutional investors.
Regulated trust companies have solutions
Trust companies have traditionally been the best way for investors to hold traditional financial assets. They leverage segregated trust accounts operating under regulatory scrutiny to separate investor assets from their own. This ensures that in the event of the liquidation of the trust company, there is no impact on investor assets. The same logic can be applied to digital assets like cryptocurrencies or digitized traditional assets.
With respect to NFT storage, trust companies can step in to provide robust security and insurance for all digital assets under custody. Going a step further, this process may allow investors to then collateralize their digital assets for loans and mortgages.
Beyond basic custodial services, however, trust companies have the potential to provide the infrastructure for the entire digitized asset ecosystem. On the supply side, they can leverage their existing due diligence expertise to conduct KYC/AML verification of asset owners looking to digitize their assets, which is a key part of the authentication of traditional assets.
Once the asset has been digitized and the digital ownership certificate issued on DLT, trust companies can store both the traditional asset and digital certificate in transparent trust accounts. This establishes a legal connection between the two assets, meaning that investors can trust that they do in fact own the traditional asset.
With the assets in custody, smart contracts can facilitate and automate a number of traditional financial functions. Ownership transfer can be completed without the assets needing to leave custody, while asset servicing activities such as dividends and interest payout can be handled automatically.
By enabling the issuance of authentic, asset-backed digital certificates, trust companies are in the unique position of being able to connect asset owners with investors. They can build asset digitization and investment platforms that ensure the consistent supply of high-quality investment instruments, ranging from trade finance assets to green energy bonds, for investors.
What the future looks like
With trust companies providing the trusted and compliant infrastructure for the ecosystem, the digitization of traditional assets offers a number of advantages. To start, previously illiquid markets like real estate can be made liquid. An ownership stake in a property can be converted to cash easily with a few clicks once a buyer is found. Investors can also get access to a diverse range of alternative investment opportunities that were previously unavailable.
Asset owners, on the other hand, can unlock the working capital of their assets. Accounts receivable and capital advance assets, for example, can be digitized and sold to investors in exchange for cash. Traditionally, this has been an expensive and time-consuming process.
Asset management will become more efficient as a wide variety of assets can be tracked from one place. Legal ownership transfer can be done frictionlessly simply by transferring the digital asset, and, as mentioned, most servicing activities can be automated. It is also possible to digitize and manage non-financial assets such as recipes and company secrets.
And as digital transformation progresses, innovators will continue to find new ways to unlock opportunities for both asset owners and investors. Smart contracts will evolve to automate even more traditional financial processes, new investment instruments will emerge, and the hundreds of trillions of locked capital will be freed.
With DLT and smart contracts enabling the digitization of any traditional asset, the time is now for the digital transformation of traditional finance. Trust and transparency, however, are slowing forward progress. Trust companies, with their existing due diligence expertise and regulated custodial services, hold the keys to the future of digital asset investment. They can provide the infrastructure for the entire ecosystem so that investors can get access to new asset markets and asset owners can finance their illiquid assets.
About the author:
Based in San Francisco, Serra Angel Wei is a cryptocurrency finance executive, investor and entrepreneur. With a blend of skills across traditional and blockchain-based finance, she has over 10 years of investment, research and private equity experience. She founded Aegis Custody in 2018 to solve the problem of illiquidity as a barrier to value creation.
Prior to Aegis Custody, Ms. Wei was a crypto investor at Passport Capital, where she helped build an Asian digital asset strategy desk to bridge the gap between cryptocurrency and institutional finance. Her particular strategic focus was on blockchain funds of funds (FoF) and direct ICO investments.
In 2015, Ms. Wei founded Serra Advisors LP , a boutique investment bank that provided cross-border investment advisory and M&A services for clients in China and the United States. The firm’s synergy VC/Growth Fund evolved from an advisory model to help Chinese companies gain a full-fledged US-based investment partner.
Before Serra Advisors LP, Ms. Wei was an equity research analyst in the technology group at Goldman Sachs. Whilst there, she worked for a US$5 billion crossover fund called QVT Financial LP and was responsible for research and investments in global technology sectors.
Ms. Wei holds an MBA from Stanford University Graduate School of Business.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
