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Tuesday, 11 February, 2020

Will 2020 be the year of tokenization?

It is customary in articles like this to trumpet that “2020 will be the year when digital assets explode”. We are all eager to see blockchain achieve wider adoption, but I believe we need to adopt a slightly longer time horizon. It will most likely take three to five years to fully establish the infrastructural bedrock of this industry. But bearing in mind that the conventional financial institutions we now take for granted took hundreds of years to evolve, a few years is not long to wait.

2019 was an intriguing year for the digital asset economy. While the headlines in the mainstream press focused on Libra and the Chinese Central Bank’s plans to float a digital currency (CBDC), some promising developments elsewhere received comparatively little attention. Throughout Europe and Asia, regulators began to classify the legal status of digital assets, providing some much-needed regulatory clarity to the nascent industry.

Switzerland has been at the forefront of these developments. Although few newspaper editors are likely to devote much space to a FINMA guidance document on how to apply AML rules to blockchain technology or a classification of stable coins, this is exactly the type of careful, detail-oriented groundwork that will create the foundations for a robust digital asset economy in the years to come.

As these foundations are dug, sometimes competitors will need to temporarily set their differences aside and work together. As in any industry, businesses will jostle to establish unique selling propositions in order to compete. However, I firmly believe that at this early stage in the development of the sector, the need to collaborate is just as vital as the need to compete. Strong industry collaboration and common standards will be essential in order to establish the trust and familiarity necessary to bring digital assets into the portfolios of mainstream investors.

That is why SEBA has come together with other market participants to form OpenVASP, an open data exchange protocol. The purpose of the project is to enable all players in the digital asset industry to use a shared system to comply with the Financial Action Task Force’s transparency rules for virtual assets. OpenVASP is the first of a number of industry-wide initiatives which will be announced over the course of 2020. In this regard, industry bodies like the Capital Markets and Technology Association (CMTA), the Swiss Blockchain Federation (SBF) and the Crypto Valley Association will play a key coordinating role.

It is time for the digital asset industry to professionalise. Since its inception a little over a decade ago, the sector has embarked on an unlikely journey, but the path has not always been smooth. Too often, blockchain has been a solution in search of a problem. One of the most common mistakes was to try to put everything on a blockchain ledger because the technology was in vogue, without stopping to question whether it genuinely made sense. Some of the most bizarre proposals included tokenizing parenting and the “uberisation” of ceremonial services. Many other failed projects were simply attempts to raise capital from retail investors under the guise of issuing a “utility token”. Aside from the need for sensible regulation, the lesson here is that hype alone is not enough. Digital assets must address real-world problems if they are to survive and gain value in the long term.

Over the past decade, a relatively small group of pioneers have demonstrated the viability of digital assets like Bitcoin, but this should be regarded simply as a proof of concept at this stage. As the sector develops, regulatory clarity and infrastructural support will be essential to bring a wider pool of players into the fold and take digital assets into the mainstream.

To be clear, we should not aim to simply rebuild the traditional world in the crypto sector. As with so many exciting new technologies, it is tempting to imagine that they will replace everything that came before. For instance, at the advent of the commercial aviation age in the 1950s, science fiction books and even some mainstream publications speculated that flying cars would become ubiquitous in cities, displacing all other land-based forms of transport.

Indeed, aviation did have a bright future, but we still don’t have flying cars. It turned out that it makes little sense to fly to the local shop to buy some eggs. Instead, we have a multi-modal transport system involving bikes, cars, trains, ships and planes, with each mode being used where it makes most sense. Similarly, I see the future of finance as being multi-modal, with both digital and traditional assets being deployed in the areas where they work best.

Traditional security markets tend to be easier to access and more stable than the crypto equivalent, whereas blockchain-based assets excel in terms of efficiency. In particular, blockchain technology prevents duplication of effort when validating information, potentially enabling many of the actions of corporate intermediaries to be automated through smart contracts. The aim should be to achieve the best of both worlds. If we can combine the advantages of both traditional and crypto finance, we can create a digital asset ecosystem that is both stable and accessible, while being more efficient, liquid and dynamic than before.

So, what is needed in order to make this frictionless, hybrid digital asset market a reality? Firstly, we will need more players in the secondary market providing the underlying infrastructure. In addition, we will need to collaborate to create and adopt common standards to ensure interoperability between blockchain systems and legacy networks. This will be particularly important in facilitating the settlement of trades. While trading between different digital assets of the same blockchain protocol is largely frictionless, converting it back to fiat currency has remained complex and fraught with regulatory issues until recently.

A collaborative ecosystem of regulated market players will help to bridge that gap, building the roads and opening the airspace of the hybrid asset economy of the future.

About the author: Patrick Salm is the head of SEBA’s token platform and an elected member of the regulatory committee of the Capital Markets and Technology Association (CMTA).

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