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Digital Assets Are More Than Just Cryptocurrency

Bitcoin. Ethereum. Litecoin.
Anyone with a passing knowledge of digital assets will have heard of such highly publicised and liquid digital, or “crypto” currencies. However, the impact of the revolutionary change in technology that ClearToken foresees in the financial markets goes far beyond these headline grabbing tokens.

The technology and protocols underlying such cryptocurrencies is what is driving the expansion of digital asset markets.

Cryptocurrency is the first mainstream example of how assets can be held and transferred on distributed ledger technology (DLT), and the precursor to 24/7 tradable digital securities, real-world and non-financial assets.

Distributed Ledger Technology is Revolutionary for the Financial Markets

Distributed ledger technology effectively decentralises existing financial record-keeping systems.
Instead of requiring a “single source of truth” to be held on centralised ledgers as in traditional markets, which are maintained and administrated at a central bank or central securities depository (CSD), DLT supplies the infrastructure necessary to create a networked database across computers (nodes) which share that purpose.

The truth of the ledger is asserted by the requirement for these nodes in the DLT system to verify changes by consensus. If the records do not match everyone’s records on their copies of the ledger, then the transaction is rejected, and the ledger is not updated. If the information is validated, then the transaction is accepted, and all iterations of the ledger are updated.

This maintains the ledger’s accuracy and as it cannot be altered without consensus, the ledger’s records are trusted as reliable.

Distributed ledgers are not limited to any one asset, as they deal in data.
Any industry where data is collected and used, and needs to be shared and verified, can benefit from DLT. In the financial markets, the use of distributed ledgers can be seen clearly for currency systems, however there is a far greater potential for their use in recording ownership of assets beyond currencies. Ultimately any asset could be digitised, for example: cars, energy, forests, wildlife and more.

A DLT network can be used to enable the rights to a physical asset to be converted to a digital token, or ‘tokenised’, by which all participants on that network are able to buy and sell tokens to adjust their ownership of the building. Through this technology, a physical asset has now become a comparatively liquid asset that can change ownership in real-time.

This fractionalisation of physical assets, is revolutionary for the financial markets.

Traditional vs. Tokenised Markets

Fiat Based
Digital Asset Based
‘Closing bell’ timeframes, coordinated batch-processing windows, and downtime for systems maintenance.
24/7 digital asset markets requires appropriate settlement timing windows and maintenance optimisation.
Cannot be traded fractionally; must be settled in whole amounts.
Fractionalised trading of native assets can be supported in the blockchain environment.
Single-currency accounts; omnibus structure used for netting and settlement individually.
Multi-currency-and-wallet account structure to clear and settle multilaterally and across product lines.
Rely on traditional processing which incurs fees; incapable of accepting payment for the same in cryptoassets.
Blockchain transaction fees factored into trading process, including denomination and clear reflection of balances.
SWIFT messaging and other industry standards; are incapable of writing directly onto a virtual ledger.
Integration is required across the ecosystem as a central player in unifying the clearing process.
Settle in notional amounts, not quantities, e.g. in FX trading.
Solutions will be provided for trades matched either in quantity or notional amount.

Markets Cannot Function on Technology Alone, Intermediation Will Always be Essential

DLT (and Blockchain) will certainly transform the markets as it enables assets to be kept and transferred in a new digitised format. The purist vision of DLT can sound like a simple and single, whole and perfect solution, erasing the need for oversight or intermediary involvement.

However, this is a limited view of how the financial markets operate
The market needs to recognise that DLT and Blockchain alone are not enough to make markets happen. Just as buyers and sellers will always need to find each other on a marketplace, or exchange, the market will always need an independent, integrous intermediatory to fulfil critical risk mitigation functions:

  • Trades and settlement can appear to be instantaneous, however, this is not the case and risk is always present until final settlement occurs.
  • Collateralization and its benefits are absent; trades are currently pre-funded with unknown risk controls and balance sheets.
  • DLT cannot keep a firm from defaulting on its obligations and open positions, nor eradicate the benefits of centralised risk management through margin and default fund contributions.
  • Few market participants have the technological resources to embrace DLT fully, and safely, without third-party support. The technology is incredibly complex and is ever evolving.
  • Technological advancement attracts bad actors in every industry; digital markets are not immune, so third-party infrastructure, support, verification and resilience cannot be eliminated altogether.
  • Market participants will still have due diligence and regulatory obligations (such as KYC) to adhere to across jurisdictions.
  • Governments and regulators are catching up to digital markets and regulated market participants will have to follow their rules .

For all these reasons and more, financial markets, new and old, will always need traditional concepts of market structure, especially clearing houses and custodians to intermediate credit risk between the buying and selling of an asset and to avoid the risks and operational burdens of bilateral trading.

Digital Assets that ClearToken Will Clear

ClearToken is being built to provide all the benefits of centralised clearing in traditional finance and its rigorous risk management function to enable the digital markets to thrive amidst increasing adoption and government regulation. We intend to ultimately handle all digital asset and token instruments (including cryptocurrencies which are the focus of Phase 1 development).

ClearToken forsees three phases digital asset adoption:

Crypto assets are anticipated to grow based on institutional appetite for this new form of capital structure and method for recording data in a public and immutable form. ClearToken is the vital institutional access mechanism with crypto assets also acting as the gateway to delivering the systems and processes required for tokenized securities, real-world and non-financial assets.

Support of fiat-backed stablecoins reflects the interconnectivity between digital and fiat operations in trading digital assets, with emphasis on using innovative yet proven systems that have transparent backing and strong operational frameworks.

Tokenized securities provide potential avenues for growth plus a direct stepping stone to future technical innovation in capital markets – we assume that securities markets will become 24/7, just as derivative markets are already.

This presents a growth opportunity for securities markets: the availability of fractional ownership, low frictional costs and greatly simplified access to global markets via tokenized depository receipts for existing securities.

Particularly attractive to retail investors but will also benefit institutions looking to hedge positions during times of extreme market moves.

The Tokenization of non-financial and real-world assets are a long-term systematic change to how markets and firms conduct business globally. The ability to readily prove ownership of assets hitherto held outside of CSDs will greatly improve their usefulness as collateral and ease with which they are sold, packaged and securitized. We therefore believe a focus on repo, especially given the benefits of CCP clearing of repo under Basel 3, is the correct strategy.

The key element to secondary trading liquidity will be fungibility, facilitating the creation of sufficiently large liquidity pools.