How Blockchain, Digital Assets Change Wealth Management

Tom Burroughes Group Editor 28 February 2023

How Blockchain, Digital Assets Change Wealth Management

We talk to a UK-based investment firm focusing on areas being affected heavily by regulation – blockchain and digital assets fall into that category.

The world of distributed ledger technology, aka blockchain, continues to attract wealth managers’ attention because of its ability to handle data more efficiently and securely. Not necessarily the most “glamorous” side of modern finance, it is nevertheless one of the most important. In the US, for example, the market size is expected to grow from $1.6 billion in 2021 to $2.2 billion by 2026, at a compound annual growth rate of 7.1 per cent. At the end of 2021, there were 1,128 blockchain companies in Switzerland and the neighbouring principality of Liechtenstein.

This news service recently spoke to Michael Cherepnin, director at EJF Capital, a UK-based organisation that invests in highly regulated sectors. The firm, which held $3.9 billion of assets under management at the end of 2022, was founded in Washington DC in 2005. 

WealthBriefing: Blockchain technology has a variety of uses that go far beyond its connection to cryptocurrencies. What in your view are the areas it is most suitable for in the wealth and banking areas, and why?
Cherepnin: At its core, blockchain technology can provide the ability for anyone to transfer value anywhere in the world, akin to the way the Internet allows the transfer of information. Therefore, we see that one of the most natural and immediate real-world applications of blockchain lies in financial services, within capital markets and banking. In a nutshell, blockchain can eloquently solve multiple longstanding issues plaguing the industry by making financial transactions faster, cheaper, and more secure. Those features are enabled by all participants in each transaction managing, sharing, and synchronising data across a decentralised network that can only be altered by consensus.

In our opinion, one of the most interesting use cases of blockchain in the wealth management space is tokenization i.e., the process of creating a digital representation (i.e. token) of real-world assets – such as loans, real estate or art – on a database. Once broadly adopted, we believe that tokenization has the potential to democratise certain investments by lowering investment sizes, diversifying investment opportunities and allowing investors to gain exposure to previously inaccessible investments.

In the banking space, blockchain can improve efficiency and reduce costs of traditional trading and other capital markets' transactions. For example, securities, foreign exchange and loan transactions currently take up to three days to clear and settle in most financial markets. With the use of blockchain, transactions can settle intraday leading to lower execution costs and less counterparty risk, thus resulting in efficiency gains for banks.

Another notable use case of blockchain is payments, where this technology can address not only speed and cost issues, but may also provide a better way to prevent fraud and money laundering. Blockchain-enabled solutions vary in nature, but two notable examples are stablecoins (i.e. digital assets designed to maintain a stable value relative to fiat currency and issued by a private company) and central bank digital currencies (issued by the government).

What sort of challenges in wealth management do you think blockchain tech is most likely to help solve?
With the generational shift, Gen Y and Millennials are expected to hold 50 per cent of the wealth globally by 2030. Importantly, this population is technologically savvy and expects digital ease and convenience in managing their investments. That is why technology in a broad sense is important to the sector. As it relates to blockchain specifically, it can help wealth managers to onboard and KYC clients quicker, move funds with immediate access, and provide access to previously unavailable asset classes.

Wealth management is a client-centric sector, and client onboarding can often be a challenging task, with KYC and AML procedures consuming a lot of time and effort. Through blockchain the entire process can be streamlined with smart contract functionality, allowing wealth managers to focus on providing best-in-class services to clients.

A faster and cheaper payment settlement alternative could lower counterparty risks and risk management costs, as well as allow 24/7 system availability. With the growing competitive pressure from new fintech entrants, these benefits of blockchain technology can prove to be important differentiators for wealth managers.

Lastly, asset tokenization can provide numerous new opportunities for alternative investments that were previously inaccessible to some wealth management clients.

Where is demand coming from for blockchain in the financial sector, from where you sit?
Blockchain has broad applications within the financial services ecosystem with multiple tangible use cases for various constituencies.

For example, asset managers are implementing blockchain into their business models by creating new revenue-generating products as we have seen with Fidelity’s announcement that it is to offer digital assets to its retirement clients, WisdomTree’s blockchain-enabled funds have already been approved by the SEC, and the brokerage formed in partnership between Citadel, Virtu, Schwab and leading market-makers.

Similarly, as the often most-trusted onramps to the global economy for consumers, regulated banks are increasingly evaluating ways of providing revenue-generating services to their customers, and many have invested in or are building blockchain-enabled products. One example is JP Morgan which has long been using its internal blockchain platform called Onyx to facilitate wholesale payments for clients.

Equally important, financial market infrastructure incumbents such as the London Stock Exchange Group and Nasdaq are also incorporating blockchain into their back offices to realise potential cost savings and operational efficiencies – for example in the post-trade part of the transaction lifecycle.

In your view, what are the most popular misconceptions about technology?
There are two terms that are often used interchangeably but they represent very different things – blockchain technology and crypto.

Blockchain is merely a specific implementation of distributed ledger technology, a decentralised database managed, shared, and synchronised across various participants. Blockchain technology brings three notable improvements relative to traditional data transfer protocols: near instant settlement, significantly lower processing costs, and greater security and permissioned transparency. In simple terms, this technology can be cheaper, faster, and safer.

Crypto, on the other hand, refers to investing, trading or lending in various digital assets called “tokens,” some of which are yet to prove their intrinsic value and are used for speculative trading. Unlike tokenized assets, crypto tokens are not linked to real world assets such as securities, loans, or real estate. The utility of crypto tokens is often derived from powering the blockchain as a reward or a collateral for processing transactions, thus their value is derived from the value of the underlying ledger.

The critical distinction, in our mind, is that crypto represents a different asset class, similar to equities, bonds or commodities, while blockchain represents the underlying technology that has multiple specific use cases within and outside financial services, similarly to cloud computing and artificial intelligence.

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