The Ethereum blockchain, which is the most widely utilized blockchain technology for application development, has decoupled the application layer from the protocol layer of the blockchain itself. While the Bitcoin blockchain exists to facilitate the creation, transfer and storage of Bitcoins, Ethereum not only allows for the storage and transfer of Ether cryptocurrency, but also is used to develop smart contracts and Ethereum-based applications.
This has profound implications for financial services. One $3-$5 trillion example illustrates the point: Consider, if you will, that most non-listed private assets, such as hedge funds, private equity funds and real estate securities, do not settle through the Depository Trust Company or DTC, which handles clearing of most publicly traded U.S. stocks, ETFs and mutual funds. Instead, they settle through a manual, laborious and inefficient process consisting of paper contracts, faxes, checks and wires.
The Ethereum blockchain has the potential to revolutionize the way these non-listed assets are tracked and settled. Tokenization through smart contracts allows such assets to be securely recorded on the blockchain and transferred among professional intermediaries, such as broker-dealers and banks, or end investors. Last year, the emergence of ICOs (initial coin offerings) marked the first attempts to tokenize securities offerings. Ninety percent of all securities ICOs, now called Securities Token Offerings or STOs, have been done on the Ethereum blockchain.
One Year, Three Years
One of the unique aspects of blockchain technology is that network participants create or consume the digital (virtual) cryptocurrency that powers each decentralized blockchain. In this way, the network creates financial incentives for participants, and the market for the underlying cryptocurrency determines the spot value of the incentives. People in the business of investing find this attribute to be extremely interesting, and the market has assigned a significant market capitalization to cryptocurrencies—close to $350 billion as of March 22, 2018. It is possible today to invest in cryptocurrency directly and through private funds, but product sponsors are hard at work on the creation of registered funds that will bring crypto into the mainstream.
We are seeing private funds, ETFs, ETNs and managed account programs that are investing in crypto digital assets and companies focused on commercializing blockchain technology—and we will see a great deal more. In the near future there will be substantial exploration of all the ways the technology could benefit society, and investment opportunities will continue to evolve and improve.
Advisors will start to see blockchain technology being applied to solve specific problems they face. At North Capital, for example, we developed an accredited investor (AI) token, which is a smart contract developed on the Etherium blockchain. The AI token can be used by accredited investors and platforms to confirm an investor’s verified accredited status to invest in exempt offerings. We are also working on tokens for KYC (know your customer) and AML (anti-money-laundering), which will be available for use by advisors and securities issuers.
The exempt securities market is primed for disruption and innovation, and it has started with the emerging ICO market. We expect to see an increase in traditional investment managers launching exempt token offerings, because of the transparency value and scale-driven cost reductions.
What Should Advisors Be Thinking About?
These technologies are sufficiently new and speculative that clients may not yet be ready to invest. Many people see crypto assets as a curiosity or a fad. They read about the dark web, cybercrime and money laundering, and may be concerned about the security and longevity of cryptocurrencies.