Technology
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.