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For Digital Assets, Private Markets Offer the Greatest Opportunities

Bain and Company | By Mike Kühnel, Thomas Olsen, John Fildes and Karl Gridl | Dec 16, 2020

digital asset private markets - For Digital Assets, Private Markets Offer the Greatest Opportunities

Despite decades of technological advances, global capital markets remain characterized by fragmented and siloed networks, with limited interoperability between them. Reconciliation between systems requires extra, sometimes manual, steps. Many processes across the financial ecosystem thus continue to be prone to error and high costs. This applies to public markets but even more acutely to private markets.

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As a consequence, a consensus across the global financial ecosystem has emerged: Digitized financial assets and distributed ledger technology (DLT) platforms will substantially improve transparency of information, automation, distribution and, ultimately, liquidity. Adoption of digital assets—assets and regulated financial securities that are represented digitally and administered on digital platforms—will expand beyond the first niche application of cryptocurrencies, with DLT removing many sources of inefficiency.

Exchanges, banks, technology companies and other financial market firms will need to make decisions soon about how to participate, as it takes time to build an economically attractive business model and the required capabilities and partnerships. Postponing this decision comes with the risk of losing strategic position as early movers gain share and replace or create new market infrastructure roles.

Despite uncertainty around the relevant legislation, dominant technologies and trustworthiness of some emerging firms in this space, we expect that digital assets will increasingly serve as substitutes for traditional financial products―not completely replacing them but rather operating side by side for many years. In the near term, DLT platforms can digitally represent traditional assets on a blockchain ledger to deliver more efficient administration, such as in managing collateral. But digital assets will also make inroads in issuance, trading, settlement, transfer and custody, because current systems for private assets involve expensive, manual tasks done by many intermediaries, resulting in cumbersome, duplicative and nontransparent processes.

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Private market opportunities

In principle, any type of asset can be tokenized, in the sense that related rights of ownership or entitlement to cash flows, along with obligations, can be captured and stored via DLT. We have already seen oddities, such as shares in a professional athlete’s contract or fractional ownership of a painting. Yet while DLT has earned broad attention and support, the biggest opportunities do not lie in public markets, whose current technologies are fairly efficient and would be expensive and complicated to replace in the near term.

To be clear, digital assets are not a miracle that will make very small companies easy (or more desirable) to invest in. Nor will they circumvent retail investor protections by, say, allowing anyone to trade any private asset directly on a mobile app.  Rather, the near-term breakthroughs consist of automating workflows and data ranging from capitalization tables to share transfers and dividend or interest payments. Digital asset platforms will bring benefits in efficiency and cost savings, accessibility and transparency. This, in turn, will enable new private capital market innovations to be more:

More Efficient:  Digital platforms will allow alternative asset managers to create new, more efficient investment products with portfolios of tokenized private assets. Transfer and trading of private company shares currently have high documentation requirements for new shareholders, creating an administrative burden. Digital assets minimize that burden through smart contracts, where the terms of an agreement are programmable and thereby automated. Instead of settlement processes that take up to two weeks, embedded holder rights and an immutable record will ease verification of ownership, accelerate post-trade processes and remove intermediaries. Digital assets can also unlock more efficient settlement using digital fiat currency tokens and central bank digital currencies, as they become available.

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More Accessibile:  Automating capitalization tables through DLT will make private assets such as private company equity, debt and real estate much more efficient to administer. Efficiency also allows for new types of private capital products that will be more readily available to a broader set of investors―for example, through 401(k) retirement savings plans.

More Transparent:  In the future, such platforms can be extended to help minimize costs and administrative tasks at the individual asset level. Transfer of equity tokens will also feature transparency of price and governance, including right of first refusal, proxy voting and divided payments. Automated administration would allow investors such as pension funds to more easily coinvest in specific parts or assets within a private equity fund portfolio.

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NCFA Jan 2018 resize - For Digital Assets, Private Markets Offer the Greatest Opportunities The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org

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