How digital assets are democratizing the world of investing.

Those in and outside the financial services industry are seeking to reconcile this emerging technology and its impact on the ecosystem of investing. While predicting what the future of digital assets will be remains the purview of others, we acknowledge and embrace the notion that digital assets are indeed having a material impact on the landscape of global investing.

For this Pulse on the Future blog post, I invited my colleagues, Justin Hayer and Chris Bell, to share their perspectives on how digital assets are democratizing the investment world. -- Russ Kliman

Digital assets and distributed ledger technology (DLT), such as blockchain are fostering paradigm shifts in the way we create, process, interact, and transfer value. The space is still relatively nascent, terminology is still enigmatic at times, and there remains a large degree of uncertainly and opaqueness with regulatory and tax compliance, which hinders broader institutional adoption. 

However, for the right use cases, the benefits of decentralization, trustless consensus, transparency and the automation of complex functions through code, can enable the financial services ecosystem to streamline outdated processes like payments, settlements, reconciliation and capital formation (to name a few). When evaluating the impact of investment opportunities, it’s hard to ignore the potential of what these technologies can do and their influence on existing investment themes, technically or fundamentally. It remains a speculative environment, but let’s dive into some key themes.

Accessibility and open finance

Digital assets and blockchain technology are removing many investment barriers to entry and bottlenecks in the traditional financial system. Consider that anyone with an internet connection or smartphone can invest in digital assets, regardless of their network, location, nationality, affiliation, or accreditation. While the assets themselves are borderless and natively handle fractionalization, they also provide new opportunities to the under-banked. Users in the digital asset ecosystem gain access to a wide range of new markets and financial products, most of which were previously accessible to only institutions, accredited investors, and the ultra-wealthy.  

For example, decentralized protocols such as Aave and Maker allow users to borrow against their digital asset collateral. Decentralized exchanges such as Uniswap allow users to trade tokens that may not be available in centralized local exchanges and open new investment opportunities. Liquidity pools and automated market maker (AMM) protocols allow users to deposit tokens to participate in the business of market making and earn fees (and experience the risk) for providing liquidity.

Digital assets are also providing new means in the raising of capital, and in a dramatically different fashion than traditional venture capital or angel investing. By issuing a token, a startup project can now tap into a larger pool of investors—beyond the traditional VC fund—including, for the first time, the retail investor. These early investors are afforded a degree of liquidity not found in traditional markets, as the token they receive can be traded almost immediately against other digital assets (typically via a decentralized finance protocol). In fact, the project’s token can actually have liquid markets, even before they launch their product. Raising capital via a digital asset issuance is an order of magnitude quicker than raising capital via traditional means, and that provides projects a quicker path to obtain the funding to build and launch. At the same time, the retail investor can access these investment opportunities, which while highly speculative, offer an opportunity for asymmetric returns that previously were inaccessible.

As always, there are trade-offs. Methods of issuance are under regulatory debate, new frontiers present new risks, and users of these tools will encounter a wide range of new challenges, such as wallet security, smart contract interaction, impermanent loss, and bridge hacks. 

Ownership and monetization

The creator economy, or Web 3.0, are terms thrown around when you mention digital assets or blockchain. Web 3.0 is built on the infrastructure of digital assets and blockchain protocols, which has allowed a shift in ownership and control of user data, their privacy, and creative content—away from centralized “Web 2.0” companies and back to the creators.

To explain this, it helps to step through the evolution: 

• Web 1.0—considered the “read” era or static web era started with the introduction of internet browsers and email. As the World Wide Web matured, pathways were setup for creators and companies to deploy their content on centralized servers, or distribute said content via e-mail. Users with an internet connection could “search” and “read’ the same content almost simultaneously and, in most cases, an email address and password was their login. 
• Web 2.0—as we entered the early 2000s, the “read/write” era of the internet begins largely with the IPOs of Google and Facebook but is sped up through the proliferation of smartphones globally. With smartphones came the platform and app renaissance that heavily permeates our professional (e.g., LinkedIn) and social (e.g., Instagram) lives.  These centralized platforms and apps have changed the way we connect and interact with each other and across platform (e.g., login with Google) with the caveat that our personal data, our privacy, and the monetization of the content we create is largely controlled by these platforms. 
• Web 3.0—the “read/write/own” era emerges, which beyond achieving a semantic web, aims to change the model of content creation and monetization by allowing creators to choose how they interact with, distribute, and monetize their data or work within a decentralized network and ecosystem. As an example, using smart contracts and Web 3.0 native applications, Non-Fungible Tokens (NFTs), artists can program royalties into their on-chain digital asset’s token sales, which will continue to pay the creator well beyond the first sale. This allows creators to benefit from secondary market transactions of their work, which is not a very common practice in the art world, outside of some niche auction houses or high-profile artists. 

We are currently in the midst of the Web 2.0 to Web 3.0 transition. One could argue there will always be a Web 2.5, where for those organizations and individuals that choose not to or cannot fully adopt the responsibility and risk of controlling their data or finances, there will continue to be centralized entities that provide pathways for you to interact with Web 3.0 ecosystems. A question we might ask ourselves is, who stands to win or lose if creators find more value in Web 3.0 platforms?

Financial upside and utility

You can buy a company’s stock and/or buy a company’s products, but typically an investor doesn’t get one by buying the other. For example, if you buy Netflix stock, you still need to pay for the Netflix subscription to stream content. Having a Netflix subscription doesn’t grant you any voting rights on how Netflix should strategically operate or change its content lineup.  

In digital assets and blockchain, we see these concepts converge in various ways. Not only can an investor benefit financially from owning a crypto token/NFT that constitutes ownership of the Web 3.0 entity or its applications, but they can also gain voting rights, special access, “ownership rights,” and perks to the entity’s platform, product, and ecosystem.  

As an example, Sushiswap, a popular Ethereum-based decentralized exchange (DEX), provides a governance token called SUSHI. The SUSHI token acts as a governance vote for changes to the protocol and structure of economics within those LP relationships, and it also represents the fee income allocation taken into account when transaction fees are collected from swap trades across the available crypto asset pairs, and paid out to token holders.

Direct participation 

Unlike traditional investing, where an investor receives proxy voting rights, blockchain and digital assets provide investors with the opportunity for direct participation in the day-to-day governance of network decisions, product strategy, and protocol roadmaps.  

Through decentralized autonomous organizations (DAOs), anyone within the ownership structure, referred to as token holders, can participate in governance, usually either by proposals and votes via their wallet app. While on public networks, such as Ethereum, individuals can own crypto assets and also directly participate in the success of the network by becoming a node operator, validator, miner, or liquidity provider by setting up a desktop or laptop machine that meets the minimum system requirements.

Recently, the Uniswap DAO passed a governance proposal where the protocol will test introducing a fee mechanism, similar to SUSHI, into some of the protocol’s liquidity pools, which many believe will strengthen the “tokenomics” (token-economics) of its utility token UNI through direct value accrual. Anyone holding the UNI token could have participated in the vote by simply connecting their crypto currency wallet app to the Uniswap app and navigating to the governance UI.

MakerDAO, the organization that oversees the Maker protocol, achieved a historic governance milestone when they voted yes to integrate Huntingdon Valley Bank into a pseudo-collateral lending facility, which is the first of its kind in decentralized finance. MKR token-holders were able to participate in the vote.

In summary

In addition to the four major themes above, there are additional themes shaping how digital assets are influencing the investment ecosystem, including:

• Tokenization—taking real world assets (RWAs) and representing them on the blockchain to reap the benefits of transparency, ease of reconciliation, and efficiency of ownership and value transfer.
• Risk management theory—there are so many types of crypto assets and many have transformative characteristics based on when and how you use them. Crypto assets can look and act like currencies, commodities, securities, and fixed income in different stages and, based on governance decisions, their behavior can change, making it difficult to classify or confidently chart an efficient frontier despite our human behavior to bucket things into categories. 
• Always on—digital assets don’t sleep. It’s a 24/7 operation without a consistent close of business, and this can have a dramatic impact on what existing applications need to do to support an “always on” model. Systems should continue to function long into the night and support teams need to be appropriately staffed globally, across time zones and dates. 

Here’s a closing nugget on wealth transfer. According to Cerulli Associates,¹ from now until 2045, upwards of $73 trillion is expected to pass down to heirs and beneficiary generations that happen to fall into the most crypto-friendly and tech-savvy. With that as a backdrop, it would not be a significant stretch to imagine that some of this wealth will transfer from traditional assets to digital investment vehicles. This sizable wealth transfer could be an opportunity or risk, depending on the reaction and strategy of incumbent financial service organizations. Those who provide the right access, tools, safety, and support for these changing paradigms stand to gain, while those hesitant of change may find themselves on the losing end of the future wealth transfer.