State Street Digital Capitalising on Financial Market Transformation

Why now?

State Street Digital was launched in 2021 in response to a strong growth in client demand, initially for crypto currency investments, but subsequently for institutional infrastructure to support a wide range of digital assets. Grown out of a long-standing interest in the potential for all kinds of emerging technologies to transform the institutional finance and investment landscape, we recognised the need for a dedicated team of subject matter experts to address the growing opportunities using digital assets and the technology underpinning it.

Among the major buy-side players, virtually all organisations are looking for institutional grade solutions for holding and trading digital assets as they see the benefits for clients and members, not necessarily limited to Bitcoin and popular cryptocurrencies but using instead using that underlying Blockchain and tokenisation technology to trade the assets in their existing portfolios.

Tokenisation of assets

Tokenising existing assets can confer all kinds of advantages on investors. Liquid assets like shares and bonds can be transferred and settled for buyers and sellers immediately (or ‘atomically’). Tokenising an investment allows for the creation of tokens which represent shares in physical assets or unlisted companies. These tokens can also be traded atomically and in smaller volumes, bringing a broader array of investors into these markets. Tokens representing shares or other assets can be traded separately from the underlying asset, with implications for new secondary markets and share lending or repo markets. Shares or units in funds can be tokenised, allowing investors to access buckets of investments, as they do currently through ETFs and mutual funds, but with the cost and efficiency bonuses outlined above.

There are significant implications for asset security from digital assets

From a KYC/AML perspective, these assets may enhance elements of transparency through traceability in their coding which could reduce their attractiveness to launderers. Existing mechanisms for holding or trading digital assets are not yet suitable for mainstream investment institutions holding large volumes of people’s savings and investments. These organisations are looking to established, trusted service providers to offer the same range of custody, fund administration and other asset services they currently have access to in the traditional finance world.

“This trust, from a service provider and consistent, effective regulation perspective, is essential to give pension funds and their asset managers the kind of confidence they would need to engage with these kinds of assets in a significant way, once the tokenisation technology is widely available to do so.”

Aiding digital finance to enter the mainstream

We see ourselves as an essential component of creating and operating institutional-grade digital financial market infrastructure (dFMI). We recognise that this is going to be integral at an industry level. Without consistent, as well as reliable, standards and interoperability, digital finance cannot enter the mainstream.

1. We will serve clients who hold digital assets in many of the same ways we currently do, primarily through custody, trading, fund administration and accountancy. There will still be a core asset servicing component to digital markets, although it will function very differently from the existing back and middle office environment.
2. We are putting a lot of effort and resources into the tokenisation of assets itself. One example of this is developing the smart contracts necessary for the issuance of new shares and other assets onto the various interlinked Blockchains and other distributed ledgers where these assets will be held and moved.
3. We have developed operating models that take into consideration the complexity arising from cryptocurrencies. For example, adjusting accounting platforms for the level of accuracy required to strike a NAV on assets which have a longer decimalization than conventional assets, as well as partnering with fintech players to obtain best in class digital asset reference data into our platforms.
4. We will bring an institutional digital custody platform to market. At its core, digital custody shares the same basic objective as traditional custody services: the safekeeping and recording of assets. However, due to differences in the underlying blockchain technology supporting digital assets, how we achieve this diverges significantly. Whereas traditional custodians record cash and securities held at various sub-custodians and central securities depositories, crypto custody safekeeps the private keys needed to access digital assets recorded on cryptocurrencies’ respective blockchains. Not your key, not your crypto.
   

This presents security benefits, but also generates new risks, particularly in asset segregation (as in the Celsius bankruptcy, where many client assets were found to be the custodian’s legal property), and cyber security procedures to protect clients’ and custodians’ unique asset ownership, or ‘wallet’ keys.

Collaboration is key to evolution

As with the evolution of any industry, often the path is forged by industry participants old and new working together. This is true and apparent in what we’ve seen in the space of digital assets. We participated in the second phase of the Pyctor consortium, which leveraged investment firms from across the buy and sell sides, to develop, what they refer to as an institutional-grade proof of concept for DLT-based, tokenised key management and asset safekeeping. We have launched an internal private blockchain network whilst we continue work on developing a digital custody offering.

We are a founding member of the on-chain payment network Fnality, developed to provide the cash leg of wholesale tokenized transactions. A little closer to home, in Asia Pacific we collaborated with a global asset manager and a Singapore based fintech firm, InvestaX, on a proof of concept for tokenised funds, and with Marketnode on Fundnode, a digital funds utility.

Despite all this positive momentum and activity, there is not going to be a sudden ‘handover’ from the world of traditional assets to a digital one. Even when digital assets and related infrastructure becomes a part of the institutional mainstream, it will remain just one part of it for some time.

“Both methods of storing and transferring assets are going to run in parallel for the foreseeable future – a 'double bubble’ if you will.”

This is why, for our clients to get a toehold on the digital side and grow this area of their portfolios, DeFi and TradFi interoperability is going to be an essential component of our, and the investment industry in general’s, focus.

It is also why so many of our achievements in this sphere are products of consortia and collaboration. As development continues, it will be important to see the enablement and ability for tokenised assets to move between different organisations’ private blockchains/distributed ledgers, as well as decentralised public versions of the same. Cross chain interoperability is going to a key next stage development in digital tokenisation’s ability to create a more inclusive and efficient financial infrastructure.

What matters most

Importantly, there needs to be an infrastructure in which assets can leave traditional custody accounts and enter digital custody accounts as tokens (and vice versa), or real and tokenised versions of the same assets will exist for clients with different trading and custody needs.

This will require collaboration across the industry to develop a holistic digital infrastructure in tandem with consistent regulatory and legislative standards. It will be a complex private and public sector effort across the globe that will require huge amounts of innovation and changes to existing ways of working. But the opportunities presented by this technology are too great to ignore.

This is a guest post written by Irfan Ahmad, Head of Commercialization, APAC & MENA at State Street Digital

Catch Irfan Ahmad on 30th August, 12PM at Fintech Connect Leaders Summit Asia 2023 on "Keynote: Tokenisation of traditional assets - How blockchain is transforming the way assets are bought, managed and sold and providing greater liquidity and access to a wider range of investors". Find out more here!