Digital assets trade processing: The roadblocks and the road ahead

Institutional investors’ interest in digital assets is on the rise, but hinges on the introduction of regulations, standards and technologies that reduce friction in trade processing, ensuring fluid movement of securities between accounts and institutions.

A survey of 271 institutional investors conducted last year by Celent found that 91% of the respondents were interested in investing in tokenized products. Of the 271 respondents, 41% said they already hold digital assets, while an additional 15% said they plan to hold digital assets in their portfolios in the next two to five years.

It’s worth noting in light of events such as the collapse of cryptocurrency exchange FTX in November 2022 that securities are not cryptocurrencies—while people often conflate the two, the viability of securities remains promising despite the volatility of crypto. And while there is investor interest in digital assets, natively, digital assets need to be incorporated into the full trade lifecycle from trade execution through post-trade activities. The incorporation of digital assets to support collateral needs will further drive adoption.

The broad adoption of digital assets involves what some industry observers refer to as “a journey of trust and innovation”. This means developing an understanding of what new technology should be adopted, and calls for extensive collaboration between fintech firms and providers of digital asset services—from banks to exchanges, market infrastructure providers and other industry participants.

Investor concerns

Yet even as interest and adoption grows, there are a several areas of investor concern.

• Security: Studies and anecdotal evidence suggest security is a top line priority. Investors fear being hacked and having their assets stolen, or any other breach of security. Some of the early digital asset pioneers have focused on putting in place a faster, more secure digital asset infrastructure in response to increased scrutiny among retail investors.
• Guidance: An abundance of caution and hesitation around releasing definitive guidelines and standards has led various industry parties to voice frustration about the lack of a roadmap, particularly when it comes to regulation. This absence of regulatory guidance and clarity about oversight continues to hinder investors’ ability to fully commit to the asset class.
• Oversight: In the US, for example, it is not clear which regulatory body will oversee digital assets. Further engagement from the Commodity Futures Trading Commission (CFTC), the US Securities and Exchange Commission (SEC) and state regulatory agencies should help the industry advance and grow.
• Technology: Another major question surrounding digital asset adoption is the role and integration of technology. Many industry participants believe adoption of digital assets by asset managers likely will be enabled by blockchain technology. As they see it, blockchain can facilitate the creation of digital cash representations through “coins” or digital tokens that represent physical or digital assets as well as fully native digital assets.

These concerns require attention in the coming months and years to ensure widespread adoption is both achievable and secure for investor peace of mind.

The opportunity

One of the most exciting developments around the future of digital assets is the opportunity around operational efficiency. Many see the transition to shortened settlement times as the future of transactions, with continued progress being made toward reducing settlement cycles from the current T+2 or T+3 scheme to faster T+1 settlements.

So where does technology fit in? Blockchain’s structure has the power to remove friction in the transfer of digital assets, as the immutable nature of blockchain transactions and enhanced audit capabilities will enable firms to generate “operational alpha” by eliminating reconciliation requirements. The increased efficiency that is expected to come from doing away with reconciliation requirements will likely boost profitability. Industry research suggests that if investors want to prepare for the future of shorter settlement cycles and the related compression of post-trade timeframes, they shouldn’t wait to begin investing in the appropriate infrastructure—the time is now.

To get there, a wide range of industry participants—including custodians of digital assets—will need to work together to define top investor priorities and how to address them. Some industry participants have already laid the groundwork with the introduction of the first digital asset custody platform and guidance that could help serve as a roadmap for an industry looking to understand and address investor needs.

Last year, the Alternative Investment Management Association (Aima) teamed up with major digital asset custodians and industry experts to compile and publish highly sought-after guidance on key considerations for investors in their digital asset strategy. BNY Mellon also helped pave the way with the launch of a digital asset custody platform in 2022, going live with select clients in the US to hold and transfer digital assets within the bank’s platform. These two developments underscore the industry’s push to formalize both the guidance and infrastructure around digital assets’ market growth.

Notably, asset managers view the asset servicing and custody market as highly fragmented. Nearly three-quarters of the respondents in the October survey expressed a desire for one integrated provider for all digital asset needs. This is a huge opportunity to create a more cohesive and unified digital asset framework going forward, leveraging the joint expertise across the securities landscape.

Another issue that will need to be addressed by market participants—digital asset custodians and those involved with digital trading, settlement and post-trade activities—is the standardization of documentation, processes, technology and best practices. Achieving that goal will call for close collaboration with industry associations.

To build the framework needed to drive investors’ interest in digital assets, ISITC has canvassed its membership to encourage various industry stakeholders to communicate with each other on key issues, notably to understand which roadblocks threaten to slow wider adoption of digital assets by investors.

Kristin Hochstein is chair of ISITC, an industry trade group focused on developing standards and best practices in financial services operations. This article was written in collaboration with Dianne O’Boyle and Jason Ward, who head ISITC’s Digital Asset Working Group.