2018 was the highwater mark for initial coin offerings (ICOs), when 1,253 new coins raised $7.8 billion. In 2019, this “Wild West” market went from boom to bust. Dollars raised in ICOs plummeted 95% compared to 2018, and the Securities and Exchange Commission (SEC) continues to announce new actions against various ICO players for fraud and unregistered issuances. The sheriff has come to town.
Regulation, my old friend
It’s no consolation to investors who lost millions in ICO scams, but they were part of a natural market evolution. The laws governing traditional securities were also originally inspired by bad actors like “bucket shops” that emerged as another new technology, the telegraph, was changing financial markets. The SEC’s decision to crack down on digital assets and apply those same laws to blockchain securities is good news for market participants.
Blockchain securities have the potential to increase efficiency, lower costs, provide greater transparency and mitigate risk. However, the financial industry can’t fully realize the potential of blockchain securities without a public market and regulated ecosystem to support their full lifecycle. That means fully compliant issuing, investing, trading, settlement and custody.
Governments around the globe are working to establish the necessary frameworks in their own jurisdictions. This is lowering the risk of investing in blockchain securities by introducing investor protections associated with traditional markets. Although different jurisdictions have different requirements for regulated entities, investors, traders and users, there are four common areas being addressed:
- Distribution – how are security tokens created and why, and how are they delivered to their owners?
- Custody – where is the ultimate record of ownership kept and by whom?
- Reporting and Record Keeping – what additional regulatory requirements are placed on participants such as transfer agent services?
- Specific Processes – what additional processes are required, for example, in order to move security tokens between personal and master wallets?
The SEC and the Financial Industry Regulatory Authority (FINRA) have established guidance in all four areas through a series of communications including the report on The DAO and a joint statement on broker-dealer custody of digital assets. The necessary U.S. framework is finally in place to allow regulated, public trading of blockchain securities to blossom.
If the juice don’t look like this
In parallel with these regulatory developments, companies have rushed to create the necessary market infrastructure. Critical components are in place and more are coming this year. The question for those considering whether to participate: is the juice from this 2.0 version of digital assets worth the squeeze? The answer will be yes if the blockchain securities market looks like an upgrade of traditional markets, which would require that it offers two key benefits to investors and companies looking to raise money.
The first is efficiency. Blockchain securities need to eliminate the cumbersome data systems and manual paper-based processes of traditional securities trading. The potential is there but execution is everything as the saying goes. Implemented correctly, blockchain can efficiently support the entire lifecycle of digital assets from issuance and investing through trading, settlement and custody.
The second benefit is smart oversight. To be viable over the long term, the blockchain securities market needs to be fully compliant not only to satisfy regulators, but to create liquidity. It needs to supply investors with convenient access to transparency, account safeguards, and regulated trading. This will require integration with traditional brokerage accounts as well as intuitive user interfaces.
I’ve become so numb
I was hoping to get through this article without using “disruption” because I know we are all numb to the concept. Unfortunately, I keep hearing that blockchain securities will disrupt financial markets. I’ve said it myself! But the reality is that blockchain securities are an evolution not a revolution. The same year that ICOs peaked at $7.8 billion, the traditional US securities industry raised $2.4 trillion. For blockchain securities to become a mainstream asset class, they can’t remain on the island of personal wallets. They need to be bought, held and sold by retail investors, institutions, and advisors through traditional trading systems and brokerage accounts. That could happen as early as this year.
Evolving Trends in Token Powered Networks: Part 2
by Mara Schmiedt, Global Strategy and Business Development Lead, ConsenSys Codefi
This is a two part article. Part 1 can be found here.
- The emergence of delegate work entities present a critical development to drive broader end-user adoption and participation, simultaneously posing new challenges to decentralization and token distribution in the evolving chapter of on-chain governance
- Token distribution strategies, as a result of the above, have seen a proportional increase in use-focused distribution mechanisms including proof of use and interactive airdrops
Trend 3: The New Kids on the Block
THE EVOLVING ROLE OF VCS AND DELEGATE WORK ENTITIES
With the rise of Proof-of-Stake, on-chain governance and other protocol-native work functions, networks require active user groups that have both the expertise and/or technical resources required to provide network-specific services and infrastructure. At the same time, these productive crypto-assets present new value accrual opportunities for entities with crypto-native business models that play an active role in network participation and adoption.
On one hand, traditional venture models are increasingly evolving into crypto-native hybrids. Capital providers with long-term holding strategies such as Multicoin Capital and ConsenSys Labs recognize the opportunity to create additional alpha by supporting networks in their portfolio through the provision of infrastructure and performance of crypto-native operations. These entities are uniquely positioned to support teams that are building decentralized protocols to bootstrap and jumpstart network effects.
Well designed agreements and incentives can ensure that all token holders involved in early stage project funding in the protocol’s development lifecycle can be valuable supporters that earn rewards from their own and ongoing participation and contribution to the network.
On the other hand, there has been a proliferation of another stakeholder group – so called ‘delegate work entities’ (see article by Ben Sparango). Delegate work entities are network stakeholders elected by a token holder to perform network-native work functions, such as staking and voting, on their behalf.
The premise of earning rewards on productive crypto-assets in exchange for contributions to the network is an attractive one, yet not all token holders necessarily have the time, desire, or technical ability to perform the required tasks themselves. This is where delegate work entities come in. Today, delegate work entities including non-custodial (Staked, Stakefish) and custodial (e.g. Binance, Coinbase, Anchorage) providers are largely focused on providing staking services to both institutional and retail clients. I believe custodians, exchanges, funds and independent delegate work entities will play a critical role in driving broader institutional and retail adoption of productive crypto-assets.
Source: PoS Bakerz, 2020
Recent developments such as Katalyst, Kyber’s 2020 protocol upgrade, reveal the increasing relevance delegate work entities will play in the governance realm either as direct actors in the voting process or by offering proxy voting functions on a token holder’s behalf.
I expect to see further growth and diversification in delegate work entities and other service providers as the Proof-of-Stake landscape continues to expand and believe these entities will continue to play a critical role in driving broader adoption and maturation of the industry. A research study conducted by ConsenSys in March revealed that across almost 300 active token holders 41.4% would like to participate in on-chain governance directly while 28.2% would like to delegate their vote to a representative.
Source: ConsenSys Codefi
It is important to note, however, that delegate work entities, particularly custodians, exchanges and funds with large and accruing token allocations, could result in centralization risks particularly as Proof-of-Stake systems increasingly co-evolve into on-chain governance.
Trend 4: Evolving Token Distribution Strategies
THE FUTURE OF USE-FOCUSED TOKEN DISTRIBUTIONS
As network participation data indicates, having a broad distribution is not enough and it is critical that distribution aligns incentives amongst all network stakeholders. Healthy networks have a representative and actively engaged network of stakeholders.
How have the aforementioned trends manifested themselves as design considerations in more recent token distribution models?
There has been a proportional increase in public token distribution mechanisms focused on targeting actively contributing users.
Source: Smith & Crown, 2019
These have come in the form of both interactive airdrops, such as Livepeer or Edgeware, as well as different implementations of proof-of-use enabled token distributions such as NuCypher, Solana and SKALE that are focused on distributing tokens to actual users.
I believe that designing distribution models that factor in self-selected productive efforts beyond capital contributions in a sale or (pseudo)-random selection in a passive airdrop is essential to:
- Maximize regulatory compliance by ensuring that a token is being used for its intended purpose on the network, rather than a speculative holding.
- Filter for participants most likely to participate in the network to disincentive short-term speculation, price volatility and dumping.
- Effectively bootstrap the network at launch, whilst enabling early adopters to familiarize themselves with the network and earn token-based rewards for their efforts.
With the technical maturation of token-powered networks, particularly in the context of rising Proof-of-Stake adoption, the industry is leaving its adolescent, wild west years behind as it enters the chapter of ‘actual’ use and utility.
The chapter of use also creates a new window of opportunity for stakeholders with crypto-native business models, including VCs and delegate work entities, that play a critical role in the adoption and maturation of productive crypto-assets and the decentralized networks they are a part of.
While there is still a lack of formal regulatory guidance on the blueprint for compliant token launches, I believe the emerging discourse, setting of industry best-practices and increasing focus on use-focused token distributions are steps in the right direction.
Evolving Trends in Token Powered Networks: Part 1
by Mara Schmiedt, Global Strategy and Business Development Lead, ConsenSys Codefi
- Regulatory scrutiny has increased, which has resulted in initial token distributions taking place in private rounds of accredited investors. Proposals such as the Safe Harbor present a first step in the direction of formal regulatory guidance that bridges the gap between regulation and progressive decentralization
- Private infrastructure and capital providers are increasingly evolving into Web 3.0 native business models, uniquely positioned to support early stage bootstrapping and ongoing participation in decentralized networks
- The road to Proof of Stake is transitioning from its lengthy research phase and genesis implementation to growth
Since 2016, a range of different token and network launch models have been deployed in an attempt to increase network participation and grow their respective communities. To date there have been +4000 attempts, test runs, and failures to efficiently and fairly distribute tokens to users that strengthen participation in a decentralized network, while avoiding a security-impeding concentration of holdings.
Have these attempts led to a golden blueprint for the right way to launch a network? The truth is, there is no archetypal, one-model-fits-all model, but one thing is certain: as the industry matures, token launches will increasingly evolve and coincide with actual network launches. What could be more fruitful than utility tokens with actual utility?
What is the outlook today? Let’s take a look at ecosystem trends and how these have evolved over time in the light of recent regulatory, technical developments, and the emergence of new players on the token-powered playing field.
Trend 1: The Regulatory Landscape
WHO IS ALLOWED TO SELL WHAT, TO WHOM AND WHEN…
The once proliferating, open-to-all token sale landscape that attracted early users, speculators, innovators and scammers alike, is a thing of the past and has seen recent shifts as regulators catch up to innovation.
‘It is during the development phase that questions about the securities/non-securities line seem to be most difficult to resolve.’ – Hester Pierce, SEC Commissioner
Arguably, with a fully functional network there is less need for participation restricting and complex legal agreements when ambiguity can be mitigated by ensuring that tokens are actually used instead of simply bought. Yet this requires the availability of a fully-functional network.
In an attempt to address impending compliance concerns, initial token distributions are therefore increasingly taking place in private rounds of accredited investors. Some have pointed out that these recent developments undermine what open-source protocols set out to achieve in the first place: putting tokens in the hands of users whose incentives are aligned with utility maximization of the network, rather than profit maximizing investors and private companies.
Finding a viable, compliant, and distributed funding model to finance the development of a to-be decentralized network, while ensuring tokens end up in the hands of long-term participants presents an ongoing, two-fold challenge. Proposals like the Safe Harbor and the proactive setting of rigorous, industry-leading standards, present a first step in the direction of potentially bridging the gap between regulation and decentralization.
Trend 2: The Rise of Proof of Stake
…AND WHY 2020 IS A MONUMENTAL YEAR FOR THE FUTURE OF PROOF OF STAKE
As of September 16 2020, the cumulative market capitalization of stake-able crypto-assets is $35.7 billion, with over a half (~52%) of this value currently locked in staking.
Source: Stakingrewards.com, 2020
Proof-of-Stake (PoS) networks utilize staking rewards, which are minted by the protocol, as an incentive mechanism to ensure users participate honestly in validating on-chain activity.
Today, it’s all about Proof-of-Stake chains entering the market. With layer 1 blockchains such as Tezos and Cosmos, as well as layer 2 solutions such as Matic and Loom launched in 2019, the lengthy research phase on the road to PoS is finally transitioning from genesis implementation to growth. In 2020, the long-anticipated launch of eth2 and Ethereum-powered DPoS layer 2 solutions such as SKALE mark a pivotal moment for the future of Proof-of-Stake adoption.
Moreover, the recent developments in Proof-of-Stake systems reveal the importance of designing and optimizing the initial launch of the network to achieve desired participation rates and ensure long-term viability. Within this context it is critical that pure or delegated Proof-of-Stake protocols distribute tokens so that a sufficient number of different actors can stake tokens and run nodes to secure the network. Poor and disproportionate distribution across individual actors can impair the network’s security or influence the general perception of the legitimacy of the networks’ governance.
This is a two part article. Part 2 can be found here.
Reinventing Wealth Management: How Technology is Shaping The Way We Manage Investments
Traditionally, wealth management has been a human-based professional service that provides financial and investment advice to clients of high-net-worth and ultra-net-worth category. Since the wealth management industry is made lucrative due to its one set fee charged to clients; despite the implementation of innovative technology, investment advice is largely still available to the wealthy and closed off to others. However, assets available to the well-off are becoming more accessible to non-wealthy clients, too.
Wealth management meets technology
The entire financial services industry has been shaken by the technological revolution, which in turn, has shaped the world. Wealth management in 2020 is no exception to this trend. Fintech has reinvented the landscape of investment management by incorporating Big Data, Artificial Intelligence and machine learning to optimise portfolios, mitigate risks and evaluate investment opportunities.
Fintech companies have become adaptive and attentive to the needs of the new generation of investors. Millennials demand, on the whole, easy, precise and flexible access to information on all aspects of their lives. It’s been found that affluent millennials are becoming increasingly comfortable using technology to manage their money. Mobile apps, Robo-advisers and AI tools provide a greater degree of control than traditional financial management methods.
Technology in action: Managing investments with intelligence
The emergence of fintech has revolutionised, improved and automated the delivery of financial services. Global investments in financial technology businesses have surpassed $100 billion over the past decade.
The proliferation of artificial intelligence has transformed the way financial advisors interact with their clients. The industry has long since been anticipating the disruption of the financial advisor model. The 80s and 90s gave way to online trading and the 21st century brings us Robo-advisers – i.e. the computer-generated investment platform that provide augmented, algorithm-driven financial planning services with little human input. Global assets under management by Robo-investors as of 2020 were nearly $1.1 trillion – and are expected to grow at an annual rate of 25.6% (Statista).
Typically, a Robo-adviser collects financial data from individuals through some form of survey and uses the information to offer advice and automatically invest client assets. The best of these automated services offer easy account setups, goal planning, portfolio management, security features, and of course, low fees.
Wealth management apps
Mobile portfolio management apps can provide information and the necessary tools to manage your investments from workplace pensions to ISA’s and personal capital. Many apps can sync with your existing accounts – completely free.
ARQ, for example, uses AI to connect investments and generate data to provide users with actionable insights into how their portfolios are performing. They’re dedicated to transparency by providing scores on what’s actually considered to be a good annual performance and whether the fees their users are paying are too high. Unbiased analytics display a number of metrics to show the value of investments relative to others.
Wealthsimple, founded in 2017, offers an unambiguous three-tier investment strategy depending on a user’s ‘risk profile’- conservative, balanced or growth. The premise behind Wealthsimple is to invest your money across the entire stock market; as opposed to a sole company’s stock, to induce a long-term practical investment strategy.
Setting up your Wealthsimple account on the app is simple. Fill in the form, select your risk and add the amount you’d like to invest. The algorithm processes your data and you’ll be presented with a portfolio and personalised dashboard illustrating how stocks are performing in real-time.
For the more visual investor, Personal Capital is an app that lets you track your budget and investments by displaying graphs by asset class or investment account – making them easy to read, track and manage your portfolio. The interface is incredibly intuitive and the visuals reactive on laptop, tablet, desktop and mobile.
Whilst there is more to say about the budgeting functions of other apps, Personal Capital serves primarily as a financial aggregator – bringing together all of your accounts on a single platform. The tool starts by determining your risk tolerance, goals and timeframe and generates a portfolio by investing across multiple asset classes for diversification. It should be said that the high fees of 0.89% are offset by Personal Capitals close-to-human investment management service.
Wealth management firms embrace technology
The wealth management firms who actively embrace financial technology tools – whilst maintaining their human input in helping investors navigate the increasingly complex financial infrastructure – have been found to be more likely to grow.
45% of wealth managers said that financial information from technology and data analysis using AI help them refine the advice they give to clients (PwC). 36% agreed that their clients will be able to see their investments clearly with AI.
B2B platform Cred, embraces AI to change the way financial institutions acquire and engage clients in investment advisory. The Barclay-based company helps financial institutions increase conversion rates, engagement and Assets Under Management. Wealth management firms using Cred’s data platform helps them utilise their client data to build relationships and offer the right financial products at the right time – increasing efficiencies for the firm and individual clients.
AdviceRobo is a software developed to assist wealth managers by providing predictive risk services using AI to generate behavioural data.
They help financial institutions by providing psychographic credit scores measuring financial attitudes, motivations and behaviour of people through online interviews. Detailed reports give wealth managers deeper insight into their client’s financial health – allowing them to optimise their client’s portfolios.
The accumulation of Big Data means that the pool of client information available to wealth managers is constantly increasing – meaning there is always room for optimising advice.
Morgan Stanley Online allows client accounts to be accessed via CRM which can be seamlessly fed into multiple financial planning software – which can be viewed by advisors and clients alike.
Technology has warmly welcomed the evaluation of ‘what-if’ scenarios. High net worth individuals can easily use Morgan Stanley Online to see the direct impact of or feasibility of spending – without consultation. A user’s spending and investment decisions are connected to their advisor – who will be alerted when a client is making an inquiry.
8 out of 10 wealth management executives have regarded technology as a significant factor in gaining market share (Deloitte). The future of investment management is largely reliant on the development of technology. Innovations in fintech have freed advisors from mundane tasks so they can spend more time providing specific insights based on individual customers.
Technology clearly has a role to play in the communication processes between clients and advisers, the way investors manage and track their portfolios, as well as the way data, is both collected and used. All of which continues to shape the way we manage investments.