The evolution of digital assets – and their related architecture – will be a product of bottom-up innovation by market participants, and top-down inputs by regulators and lawmakers, similar to prior improvements to how capital markets infrastructure operates. Furthermore, bottom-up developments will come from a combination of legacy financial services organizations, established technology players and newer “digital native” companies entering the market. What these groups have in common is that they are all focused on solving problems that currently stand in the way of digital finance going mainstream in the institutional investment arena.

We look at some of the changes impacting the way digital asset infrastructure is created, something both the technology and financial industries are focusing on in 2023. We also delve into why regulators are closely watching the legal challenges around tokenized versions of financial assets, and explain why parties on both sides of the equation are increasingly interested in the workings of digital custody. Finally, we take a look at how crypto markets fared in last year’s unprecedented inflationary environment.

1. Crypto to mature as a “utility asset”
In 2022, the crypto market saw significant growth as institutional investors entered the market, driving up the price of many cryptocurrencies. This trend was spurred by a growing recognition of the potential for cryptocurrencies to serve as a store of value and a means of payment. As more use cases for crypto and other digital assets are developed, and more people become familiar with the technology, this trend of focusing on utility is likely to continue.
 

2. An increase in “creative destruction”
In periods of rapid change and innovation, new and disruptive technologies displace the established ones. During this era, the crypto market is likely to experience a high degree of volatility, with some cryptocurrencies and digital assets rising to prominence, while others fade away. The lack of regulation in many countries – as well as the relative inexperience of many investors in the crypto market – can make it difficult to navigate the complex and rapidly changing landscape. It is important for those involved in the crypto market to stay informed and adapt quickly to changes in order to remain competitive and successful.
 

3. What is a token, and who owns it?
While cryptocurrencies and tokenized assets both rely on tokens and distributed ledger technology, the key difference between the two types of tokens is what they represent. Cryptocurrencies generally do not have any particular asset backing them, while tokenization of traditional assets is meant to use a token to represent a claim to a particular asset or right that has a verifiable value. From a legal and regulatory perspective, key questions in tokenization are:

• Does the resultant token effectively represent the stated claim?
• Do transfers of such tokens effectively convey the legal rights they represent?
• Finally, is there market infrastructure to support the use of tokens?

4. Token ownership is a real-world issue
According to the Securities and Exchange Commission, client assets must remain “available” to the client, despite custodian default, insolvency, or even if the custodian’s creditors assert a lien against its proprietary assets or liabilities. However, as was evidenced in the Celsius Network bankruptcy in July 2022, most of its customers will be last in line for repayment. In January 2023, a United States bankruptcy judge ruled that Celsius owns most of the cryptocurrency that customers had deposited into its interest-bearing “earn” accounts (as opposed to its “custody” accounts that did not generate interest), impacting an estimated 600,000 accounts, with assets valued at US$4.2 billion.
 

5. Crypto’s “utility” is probably not as an inflation hedge
The finite new supply of Bitcoin on its own does not guarantee protection against consumer price inflation. Swings in Bitcoin demand – and the willingness of holders to add existing Bitcoin supply to the market – dominate. In a similar vein, the determinants of consumer price inflation are far more complex than simply the supply of traditional money. It is perhaps not too surprising, then, that an empirical investigation of the links between Bitcoin and high-frequency inflation measures finds no significant links between the two.