In this article, Legal and General Investment Management (LGIM) Chief Technology Officer Derrick Hastie, KPMG Director of Wealth and Asset Management Consulting (and Digital Transformation Specialist) Paul Came, KPMG Director of Financial Services Coverage (and Crypto/Digital Assets Specialist) Ian Taylor, and State Street Digital Head of Client Engagement Luke Brereton share their reactions to some of the major trends identified in State Street’s 2022-2023 Digital Assets and Investment Study.

The study is a survey of 300 investment institutions, including asset managers, asset owners and insurers, assessing their current holdings of digital and crypto assets, as well as their preparedness for and approaches to incorporating digital technologies such as blockchain, distributed ledger technology (DLT) and smart contracts into their operating models.

Theme 1: Pivot in tone from crypto to digital assets
One notable element of the survey results that resonates with prevailing market sentiment is that respondents’ interest appeared to be cooling on Bitcoin and other cryptocurrency assets, relative to the ability of blockchain and distributed ledger technology (DLT) to create digital token versions of more traditional asset classes.

Hastie said this tallied with LGIM’s view of the market. “We don’t hold any cryptocurrencies,” he added. “But the focus on tokenization does align to LGIM’s approach in this space.

“We see value in the digital tokenization of more traditional assets, and the opportunity for tokenized assets to be part of our portfolios in the future.”

KPMG’s Came agreed, claiming institutional asset managers were instinctively “wary” of cryptocurrencies and, despite some moves into the space in recent years, remained so in light of events like the FTX bankruptcy, as well as the absence of effective or common regulatory standards.

“Asset managers have, however, been consistently positive on tokenized traditional assets,” he said. “Many see DLT as a technology that can solve some of the biggest industry problems – be that fees and costs, closing distance from the end investor, and complexity in the current operating models.”

But, according to Came, the industry and its regulators would need to work together to start setting standards for any new digital infrastructure and ensuring new operating models and technology platforms are efficient and interoperable, citing advances in digital custody as an example of this beginning to happen.

He also said the main areas of demand from KPMG’s clients were for tokenization of blue chip shares and bonds, and stablecoins for facilitating payments through digital architecture.

Similarly, State Street’s Brereton said the growing focus on “the broader application of this technology across financial markets” shown by the survey results “resonate with what our clients have been talking to us about during the latter half of 2022.”

Theme 2: Firms are gearing up the skill set to be ready for advent of digital assets
One thing that was clear from the survey is the investment in technology infrastructure, workforce expertise and industry partnerships that investment institutions are making in anticipation of digital finance going mainstream. The results showed a majority of respondents building specialist teams with expertise in this area. A majority also claimed to have conducted blockchain-based trades of tokenized assets, or be in a position to do so if necessary.

“The numbers seem about right for this stage in the technology adoption cycle,” said Hastie. “In terms of preparedness, two years ago, we built a blockchain solution for a key insurance client, and the learnings have been tremendous. However, in terms of day-to-day operations, the teams have had limited exposure in handling tokenized assets, and we would be looking for key partners to work with us and help build out our operating models, which would ultimately inform our longer term technology strategy.”

One change Came said he’s seen among larger financial services clients in recent years is the transition from having innovation leads looking at digital technology as part of their wider remit, to having senior staff or teams dedicated to digital assets specifically.

“Furthermore, acquisitions of firms that operate in the digital asset and blockchain ecosystem by large financial services firms has increased in recent times,” he added.

Came also noted the number of respondents (11%) who claimed to be pioneers who had traded digital token versions of mainstream assets was “surprising,” pointing out that the most common coding languages that the majority of asset managers’ IT people have expertise in are not like Solidity, the language smart contracts for financial transactions are typically written in.

Brereton said he’s seeing great progress in this space too. “Investors in cryptocurrencies to one side, over the last couple of years we have seen clients build in-house expertise in the field, to the point where many now have a dedicated team tasked with developing and executing a digital assets strategy,” he said.

Theme 3: The winning use cases for the application of DLT are still emerging, but the industry generally expects efficiency gains
Respondents saw a variety of ways for digital assets and their underlying technology to work for the benefit of their organizations, with a third or more citing distribution, asset issuance, asset servicing and smart contract generation among the most important services they would like provided in a digital finance environment. But improved operational efficiency and reduced operating costs were a common theme in the ways they expected these areas to improve their businesses.

“We see the principle advantages being efficiency gains, new forms of liquidity and new distribution opportunities,” said LGIM’s Hastie.

He also highlighted data from the survey indicating respondents were split on the imminence of mainstream digital tokenization and trading, with many believing it is still a decade or more away.

“In terms of timeline, it’s closer than most people think, but there are still a few key pieces of the puzzle missing before we believe this will be commonplace,” said Hastie. “Our sense is that we will first see adoption in more illiquid assets and niche small markets, where tokenization will have a meaningful efficiency gain.”

But, as KPMG’s Taylor noted, “There are a great deal of uncertainties still with respect to regulation, data and technology standards, end client appetite, level of investment and collaboration required to achieve this. However, in the medium to longer term horizon, we believe all assets will be tokenized and on a blockchain of some design.”

He pointed to “several bond issuances on blockchain by banks” as one of the “faster moving areas” in digital finance, adding that, as far as traditional asset managers go, many are looking at real and private assets like real estate, physical infrastructure assets, infrastructure, private debt, etc., as a starting place.

“However, one thing that needs to be addressed there is, what is the advantage for the real estate/physical asset owner of getting investment via the blockchain, rather than to a consortium of private investors?” Taylor added.

He also addressed data from the survey indicating institutions are uncertain as to whether traditional wrappers will retain their status as primary investment vehicles for investors.

“Longer term, therefore, the bigger benefit for asset managers is likely to be tokenization of ‘funds’ – which may no longer be actual funds – and the underlying assets,” said Taylor.

“In a world where most assets are tokenized, will the mutual fund still be the dominant investment vehicle? Many think not, and that we are moving towards an era where mass personalization at lower cost bases could be a realistic product offering,” he added.

As State Street’s Brereton concluded: “We are now seeing an emergence of transformational use cases aimed at cost reduction, simplifying or codifying operational complexity, infrastructure underpinning transformation change, and potential new revenue streams opening up, with an emerging focus on tokenization of funds, both on the illiquid and liquid ends of the spectrum.

“The technology has the potential to impact just about every part of the financial services value chain, and while it does not change the underlying risk characteristics of a given asset, it can aid in the development of secondary markets and close the gap between issuers and the end investor.”