Investment firms face a rapidly shifting landscape where many traditional products, tools and approaches no longer seem as appropriate or effective as they once were.
Investing in advanced technologies is one of the ways to keep pace with or even lead the market. However, the industry is still in the early stages of technology uptake. At present, asset managers are still exploring and prototyping with advanced technologies such as Artificial Intelligence (AI) and Distributed Ledger Technology (DLT). Nevertheless, based on our survey, 95% of asset managers believe that technological capabilities will be a differentiator by 2025. The gap between this vision and reality is wide.
Investing in advanced technologies is one of the ways to keep pace with or even lead the market.
The impact of DLT on the financial services industry is expected to be huge. According to the World Economic Forum, the tokenization market size will attain $2.67 billion within just four years. While 79% of asset managers are starting to explore DLT-based financial products as part of their changing product suite, being a ‘fast follower’ is not likely to be a winning strategy. Firms need to jump into the ring and act now.
There are many different platforms available on the market on which a DLT solution could be built. All these solutions are decentralized networks based on blockchain technology utilizing smart contracts to implement certain use cases.
A blockchain is a distributed database where data, for example, several payments between accounts, is stored as blocks in chronological, immutable order. The decentralized network is built on a peer-to-peer network where clients are called nodes and data is broadcast by a node to other nodes. The nodes reach a consensus on the network’s current state by using a mechanism that requires at least 51% of the nodes on the network to agree on the next global state of the network.
To compromise consensus, an attacker must control 51% of the network. Therefore, consensus mechanisms have been designed to make this ‘51% attack’ unfeasible and they are engineered to secure the blockchain in different ways. Proof of Work is done by solving a mathematical task. An attacker would need 51% of the network’s computing power to defraud the chain. A Proof of Stake protocol ensures that 51% of the network’s assets are required to defraud the chain. Proof of Authority is a reputation-based mechanism that allows only approved nodes selected as trustworthy entities to validate transactions. To build use cases beyond payments, smart contracts are necessary. These are programs that are stored and executed on the blockchain protocol when certain conditions are met.
Early adopters of DLT have been busy launching products focused on streamlining and accelerating their processes. One leading WealthTech company, together with several Spanish financial institutions, has implemented a fund transfer solution for Spain’s investment fund industry. A Luxembourgish company has built a decentralized platform that makes investment fund distribution easier, cheaper, and more transparent. Meanwhile, a London-based global funds network has introduced a solution to digitalize fund distribution, administration, and issuance processes involving all fund ecosystem actors, and a French investment company has created a pan-European investment platform for UCI units.
Technology investments are important, but only in the right areas and using the right tools. Investment firms that want to win the race must carefully select their use cases and direct their energy to areas that will deliver the most value. DLT can be a very powerful tool for providing a safe, reliable and leverageable technological solution, but value will remain locked if not identified beforehand.
Technology investments are important, but only in the right areas and using the right tools.
One way to ensure the optimal use of the technology and maximize its value is conducting a thorough analysis to identify potential pain points. Such an analysis must include the entire ecosystem and take regulations, asset types, geography, and market participants into consideration. Pain points may be driven by internal factors (lack of efficiency, security risks, aging technology) or by expansion ambitions (answering new customer needs, increasing market reach). Once these pain points are identified, DLT can be a catalyst for innovation and bring concrete improvements. These include the creation of digital contracts, providing a spot-on solution to answer increasing security and transparency needs, and efficiency gains through streamlining and automating processes to free-up time for actors to focus on high value-adding tasks.
Faced with a pressing need to adapt to recent changes in customer needs and technological requirements, asset managers must adapt. DLT will be one of the pivotal technologies pulling innovative solutions forward thanks to a data ecosystem that provides greater safety and reliability.