Digital assets could unlock a range of untapped opportunities in financial services and enable firms to deliver new value to their customers. But challenges persist that need to be resolved first.
Just as banknotes morphed into commercial bank deposits, and physical security certificates into security accounts held at custodians, the emergence of digital assets is yet another stage in the industry’s evolution.
What began life in the so-called cypherpunk universe of decentralised finance, digital assets are poised to unleash unprecedented change on the fabric of social and economic relationships.
What are digital assets?
In Defining Digital Assets, a recent report published by the SWIFT Institute, Alistair Milne, Professor at the Loughborough University School of Business and Economics, defines digital assets as “virtual records of value directly held on and transferred across a shared cryptographically secured ledger.”
As the report explains, digital assets come in many different forms and can either be permissionless or permissioned. Permissionless digital assets –including cryptocurrencies and non-fungible tokens –can be held and exchanged by anyone with internet access, although these remain largely unregulated and don’t use financial intermediaries.
Permissioned digital assets, on the other hand – such as Central Bank Digital Currencies (CBDCs) and tokenised assets – are digital assets developed by regulated institutions who also support compliance processes, such as performing confirmations of identity as required by Know Your Customer regulations.
“Financial institutions today don’t typically engage with permissionless digital assets, because of their unregulated status and anonymity granted to network participants when trading these instruments,” says Thomas Zschach, Chief Innovation Officer at SWIFT.
“But many financial institutions, central banks, market infrastructures, and others including SWIFT are experimenting with digital assets – particularly CBDCs and tokenised assets. The aim is to uncover new opportunities to increase efficiency, reduce costs, encourage financial inclusion and continue to bring more value to our communities,” says Zschach.
New forms of value, new opportunities
There are many potential uses for digital assets. For one, CBDCs – digital versions of central bank cash – are being explored by governments to further accelerate digital transformation of their economies. Proponents also highlight that CBDCs could empower people still transacting predominantly in paper cash to safely hold and transfer digital fiat money.
Elsewhere, wholesale CBDCs could be used to support international payments. In addition to bolstering competition for payment services, wholesale CBDCs could usher in faster payments through their ability to achieve instant settlement – generating further synergies and liquidity benefits.
Similar to CBDCs, stablecoins – privately issued, permissionless cryptocurrencies – are backed by an underlying asset. This structure helps minimise price fluctuations and could have a role in encouraging greater financial inclusion as well. “The use of stablecoins could play a role in improving liquidity management, but they may run into the same constraints as other form of private money,” says Zschach. “Market participants could use stablecoins to provide additional liquidity or better liquidity timing, thereby making more efficient use of capital. However, their unregulated status today could make some of these benefits challenging to realise.”
Another digital asset, tokenised assets, offer retail investors greater access to a wider pool of assets and returns. Through fractionalisation – where assets are broken into smaller value digital tokens – more retail investors will be able to purchase high-value assets such as funds or equity securities, or even illiquid instruments (loans, real estate, commodities, etc.), as they can buy smaller denominational amounts in digital token form.
“Tokenisation, which enables fractional ownership, allows people who could not normally afford to buy conventional assets to start investing,” says Zschach. “This could also bring about greater liquidity across capital markets.”
Where the challenges lie
While digital assets are an exciting prospect, several barriers need to be overcome before they can be more widely adopted.
Digital assets will likely co-exist with traditional assets for the foreseeable future. As a result, having a variety of technologies, platforms and regulatory environments could create a thicket of connections for market participants to navigate. To avoid the fragmentation and inefficiencies that could result, there is a need for standardisation and interoperability across systems, asset types, and jurisdictions.
Compounding matters further, there is currently no legal definition as to what a digital asset actually is in many markets. This makes it difficult to develop a comprehensive regulatory or tax framework around it and could lead to the digital asset marketplace becoming disjointed.
One thing’s for certain though. Financial institutions should be looking closely at how digital assets could impact their business models and the opportunities they present within their ecosystems. “There are a lot of financial institutions that have not yet prioritised digital assets,” says Zschach. “And this could put them at a competitive disadvantage moving forward.”
Interoperability is key
To get the most value from digital assets, they need to be designed to integrate with other forms of value domestically. They also need to be able to interoperate with other solutions of different design and technology on an international level.
“It’s vital that new networks carrying digital assets and existing networks can interoperate with each other,” says Zschach. “As the global, neutral platform that enables institutions and ecosystems to interlink effectively and smoothly, SWIFT is poised to play a crucial role in enabling this.”
Given its scale and track record in facilitating standards initiatives, like ISO 20022 adoption for cross-border payment messaging, Zschach says SWIFT is well-placed to help the market develop common standards around digital assets too.
Test, learn, iterate, repeat
SWIFT is currently running a number of experiments to explore how digital assets could be used to solve real-world challenges and further transform financial services.
“One of the experiments aims to demonstrate how the SWIFT platform could enable linking between CBDC and real-time gross settlement (RTGS) networks, and seamlessly orchestrate CBDC cross-border transactions,” says Zschach.
“And on the securities side, we’re working with leading industry players to explore how SWIFT could act as an interconnector to link up multiple tokenisation platforms and various payment types throughout the transaction lifecycle of a tokenised asset.”
Which digital assets will gain the most traction and what role they’ll play in the future of finance is still to be seen. But through our collaborative experiments and promotion of dialogue around the topic, we’re committed to helping steer the industry’s understanding about digital assets and the opportunities they bring.
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