New global research by London-based Nickel Digital Asset Management, a digital assets hedge fund manager, has shown that institutional investors and wealth managers are increasingly focusing on the opportunities from tokenisation and decentralised finance solutions (DeFI).
Around three-quarters (75%) are predicting that tokenisation of investment funds and asset classes will increasingly be adopted by fund managers over the next five years with 14% forecasting dramatic growth in its adoption over the period.
The study with institutional investors and wealth managers in the US, UK, Germany, Switzerland, Singapore, Brazil and the United Arab Emirates who collectively manage around $816 billion in assets shows similar strong predictions about the impact of DeFi on traditional finance institutions.
More than four out of five (81%) expect DeFi to have an impact on the way traditional finance firms do business with 15% expecting a significant impact.
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However, the study found some wariness about the adoption of DeFi by institutional investors and wealth managers themselves with 62% citing KYC and AML concerns as a major barrier to institutional engagement with DeFi. Nearly half (47%) point to technology risks, while 46% highlight tax concerns and 45% say insufficient liquidity in DeFi investments makes it difficult to have a material impact.
Around 36% say more regulatory clarity on DeFi is needed for institutional investors to engage, while 31% point to a lack of safe custody solutions, and one in five (18%) admit they do not have the specialised talent to enable them to engage.
“One of the most important considerations for the tokenisation of real-world assets is the degree to which token holders have the same legal recourse as creditors to those underlying real-world assets,” commented Manu Choudhary, co-founder of DeFinity Markets, a digital assets ECN. “Whilst recent legislation passed in Liechtenstein and Switzerland create clarity on this point, I believe that there is a precedent in the UK with the dematerialised securities regulation, which creates a digital twin of physical securities, which I believe is broad enough to encompass tokenised assets.”
Tokenisation of real-world assets is a transformative concept that has the potential to reshape traditional finance and investment landscapes. However, one of the central concerns in this process is ensuring that token holders are granted equitable legal rights, akin to those of creditors, with respect to the underlying real-world assets they represent.
Recent legislative developments in Liechtenstein and Switzerland have admirably addressed this issue, providing a clear legal framework. Nevertheless, the United Kingdom has an interesting precedent within its Dematerialised Securities Regulation, offering an innovative approach that could conceivably extend its reach to include tokenised assets.
“In the UK, the Uncertificated Securities Regulations 2001, also known as the Dematerialised Securities Regulations, are pivotal in this context,” said Choudhary at DeFinity Markets. “These regulations grant holders of electronic versions of securities equivalent rights to their paper-based counterparts, effectively creating a digital twin of physical securities. These regulations, initially designed for traditional securities, might be extended to encompass the emerging realm of tokenised assets.”
Anatoly Crachilov, CEO and Founding Partner at hedge fund Nickel Digital, said: “Tokenisation and DeFi investments are increasingly on the investors’ radars and the research shows that the interest is only likely to grow. Nervousness about fully engaging is understandable as the industry is still in its infancy, but this leaves huge benefits to institutions who are willing to be early adopters.”
The increasing penetration of blockchain technology within the international banking and payments sector could address many of these KYC concerns in the long run. Other hedge funds in the crypto space which The Armchair Trader has spoken to are optimistic that the technology will soon be on hard to make meeting such regulatory requirements easier.
New legal frameworks paving the way for tokenization
Liechtenstein has taken pioneering steps in this domain by enacting the Token and Trustworthy Technology Service Provider Act (TVTG) in 2019. This ground-breaking legislation introduces an entirely new legal entity, known as a “token service provider” (TSP). Simultaneously, it formally recognizes a novel asset category – “tokens,” which are defined as digital representations of value or rights that can be electronically transferred or stored.
“The TVTG empowers TSPs to create tokenised assets, which are tangible real-world assets transposed into digital form and represented by tokens,” said Choudhary at DeFinity Markets. “For instance, a TSP could tokenize a piece of real estate or private equity fund. A hallmark of the TVTG is that, in the event of a TSP’s insolvency after tokenizing a real-world asset, token holders are accorded the same legal rights to the underlying asset as any other creditor.”
Other fund management groups are also sounding bullish on the prospects of tokenization. Marita McGinley, head of digital assets strategy at fund manager Schroders, has previously said that tokenization could represent a paradigm shift for fund managers and their customers. Funds could be traded on-chain without the need for a centralised clearing system, for example.
Tokenization could also make private assets opportunities like real estate and private equity more accessible to smaller investors. Fractional markets could be created where tokens based on private assets could be traded more easily. A common chain, with shared and synchronised data, could reduce costs and improve transaction efficiencies.
The legislative strides made in Liechtenstein and Switzerland cited above set a precedent for the global recognition of the legal status and protection of tokenised assets. These initiatives not only offer legal clarity but also facilitate the integration of tokenised assets into the financial landscape, safeguarding the interests of token holders. As the world continues to explore and embrace tokenisation, these legal frameworks serve as inspiring models for other jurisdictions to follow.
