About Digital Assets
In the past, both public and private asset classes were only accessible to high-net-worth individuals who were experienced. This meant that trading was an exclusive market where barriers to entry were high. Contrastingly, the creation of digital assets allowed for a sense of inclusion as individuals with a “know-how” of the market began to discover a new way of trading.
To delve into the topic of digital assets, the FIA Asia 2022 conference titled “Digital Assets. The Next Currency” discussed the implications of the industry and the likely direction that the market will take.
This article will surmise the key points derived from the conference and flash out key challenges faced by the digital space.
Scouting The Digital Landscape
While rules and regulations have improved in comparison to 1 to 2 years ago, institutional investors are looking for clarity in regulations. In general, the purposes of digital assets remain rather ambiguous as they can be used to gain access to a larger variety of product options, diversify portfolios, or be used for risk mitigation.
To address the security concerns and the lack of structuring mechanisms, ideas and suggestions were put forth:
Zero-Knowledge Proof
“There are ways to implement technological solutions to improve borrowing efficiency… for example, using zero-knowledge proofs which is a security feature. Essentially, what it does is provide visibility of an asset without knowing what the asset is. With that, clients can sign a loan on a covenant, and if that is breached the key is transported. This process enables credit risk proofs and clients don’t have to manage as much.”
- FIA Conference 2022. Adam Farthing, Chief Risk Officer, B2C2 Japan
In the above example, the zero-knowledge proof protocol is where one party proves to another party that a given statement is true while the prover avoids conveying any additional information apart from the fact that the statement is indeed true. (Refer to these slides for a thorough explanation). In cryptocurrency, it is commonly used as a form of authentication on unidentified or uncertain grounds.
The addition of these forms of security measures will structure the digital asset markets with regulated access. When coupled with other security layers, the flow of money into and out of the industry will become safer.
Project Guardian
“Through Project Guardian, it differentiates crypto speculations from the digital asset innovative space. The utilization of technology is demonstrated using trust anchors, which can be used by regulated financial institutions to set up controls for entities, while clients are also able to verify their exchanges and trades”.
- FIA Conference 2022. Alan Lim, Head, Fintech Infrastructure Office, Monetary Authority of Singapore
Project Guardian is an initiative launched by the Monetary Authority of Singapore and published to the public on 19 October 2022. The initiative aims to “test the feasibility of asset tokenization and DeFi while managing risks to financial stability and integrity”.
In the conference, Mr. Alan Lim proceeds to explain that Project Guardian involves 3 main motives.
1) The first, is to understand if the tokenization of assets will help to reduce settlement risks.
2) Second, assuming that the market exists, and tokenization is the norm, how can MAS help to prevent fragmentation among industry traders?
3) Lastly, between the extremes of centralization and decentralization, how can MAS be involved in the digital space to position the market somewhere in the middle? The organization does not always side with decentralization as the direction per se, but rather, it seeks to find a more direct way to achieve efficiencies without the need for an intermediary.
The trust anchor, in simplified terms, is a digital identity equivalent to a verifiable ID or license for cars. The use of this anchor allows firms to operate with the same level of sophistication or worthiness as a verified and authenticated ID. Ultimately, the study, creation, and use of these protocols are meant to prevent market manipulation.
XSGD as the tokenized Singapore Dollar is a prime example of the implementations suggested in Project Guardian. The token is managed with trust anchors for users to verify their credentials and this form of authentication can be scaled across different venues. (Used for other products).
Assessing Risks
When retail investors lose all their money, they are often trading in a form of digital asset that is a high-risk, non-liquid product. But it is important to note that there is a spectrum of cryptocurrencies, and some remain more liquid than others.
Currently, cryptocurrency resides on a slippery slope between stable and non-stable conditions. This is shown by the FTX collapse, where a tweet about the FT token created a domino effect in other parts of the digital space. Yet, there remains a certain proportion of self-management that could protect traders from volatility, for example, one could manage risks by adjusting how much capital is deployed to the exchanges. Otherwise, setting up measures such as semi-custodians or counterparties is another option.
Where does Regulatory Responsibility End?
With the new form of gaming tokens from Korea, new coins that don’t exist on exchanges are traded amongst fellow traders. These signs show that when regulators limit speculations by use of regulations, people may move to semi-gray areas or where there is the least friction.
Henceforth, based on a consultation paper by MAS early this year, the research seeks to examine consumer protection and the amount of disclosure required. Secondly, the research also seeks to elaborate on fund securing or the use of segregating funds. MAS maintains the stance that when volatility occurs, investors can lose all their money to false or misleading information. Therefore, regulations are always about informing the public of risks.
Regulatory responsibility is served with the objective of creating an ecosystem of trustworthy exchanges, adequate disclosure regimes, and transparency from private brokerages.
“Every Industry goes through a maturity phase, the interest rates increase, the market blows up and the industry is faced with a crisis, is it a structural problem, cryptocurrency problem, or an innovation problem…. How can we recenter KYC to be more efficient and how should we approach the segregation of assets, for example in water funds or sinking funds”
- FIA Conference 2022.
Overview and Summary
With 24/7 trading and the cloud, cryptocurrency is open to the access of everyone.
Among the panelists, it is hoped that one-day, several positive objectives can be achieved:
1. Trade can become digitalized through digital tokens and there is no transferring agent. (A digital native.)
2. There is no differentiation between public and private assets.
3. There are sufficient shared standards or one that is internationally welcomed.
4. Sufficient KYC
5. Customer sophistication
6. Counter-Financing
7. Verified Authentication
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