The fundamental role of financial market infrastructure (FMI) providers has remained unchanged over the years – to ensure financial stability through the mitigation of risk, to promote industry standards and to eliminate risk, liquidity, and market access silos. This role looks likely to remain unchanged as digital assets become more prominent in the financial services industry ecosystem. How best to support and service digital assets will be the topic of discussion on my Sibos panel, and I will be focusing on the optimal role for market infrastructures in this area.
To summarise, I see the role of FMIs as twofold when it comes to digital assets – delivering interoperability and breaking down silos.
First, FMIs can help to ensure interoperability between blockchain-based solutions. Digital assets offer a unique opportunity for new operational processes to be established and handled through automated technologies like blockchain. However, a key factor in realising this opportunity will be ensuring interoperable technology stacks and standards across the industry – and all counterparties must buy-in to this approach to achieve this vision. Financial market infrastructures are best placed to ensure interoperability in the digital asset ecosystem as they are neutral and heavily regulated, with some also being industry-owned.
At the same time, FMIs can help to bridge the gap and deliver interoperability between digital assets and traditional assets. Currently there is a lot of focus on new, digital assets that hold promise of a more efficient and distributed future, but we must not forget the $100 trillion of assets that are already outstanding in the US. How do those become digital? Do they even become digital? The point here is that the market can only move as fast as the slowest asset, and therefore to some extent there is a parallel world of traditional and digital assets which market infrastructures can converge by creating interoperability between asset types. This is of critical importance, as above all, whether investors are retail or wholesale, interacting with traditional and digital assets in a consistent manner is a preferred approach.
Second, the fear of digital asset silos developing independently from traditional assets is not unfounded. A similar scenario can be well illustrated by looking at the history of paper securities contracts. Until DTCC centralised the contracts in one vault and then eventually created a database, contracts were held in separate physical vaults which created risks and inefficiencies to the industry. In a similar vein, without a consistent approach to the processing of digital assets, silos will likely develop, and market participants could experience operational inefficiencies which create risk and cost – the things the industry sets out to minimise in the first place.
There is also an opportunity for market infrastructures to breakdown silos in the world of Defi. Currently, Defi on ramps /off ramps are being created through the tokenisation of assets, the creation of permissioned sub-layers and the adoption of protocols to interact with these assets. While these efforts appear to be supporting adoption in the near term, they could drive fragmentation in the longer term, as the digital assets ecosystem develops. In a world where financial institutions continue to have fiduciary responsibilities and regulatory oversight, market infrastructures can serve a key role in providing unified on/off ramps or, at the very least, connecting existing ramps through a series of standards and practices.
In a world of digital assets, just like in traditional assets, standards are good and preventing silos is important. Therefore, it is likely that market infrastructures will perform a neutral and critically essential role in the digital asset ecosystem that is not too dissimilar from the role they play today in traditional finance.