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19/04/2019

Three years ago, SGSS published its first Blockchain magazine. This was a few months after a major report had been published on the changes that blockchain technology would bring to financial markets, reducing the need for reconciliations and bringing many billions of annual savings* to the financial industry.

At the time, SGSS’ conclusions were that the Distributed Ledger Technology introduced by the Bitcoin could be a fit for a public decentralised ungoverned currency and that it would require several evolutions to become fit for the financial markets. Firstly, the scalability issue to process the volume, secondly the confidentiality issue to keep transactions private, and thirdly the regulation and governance issue to offer the same level of protection as current markets.

SO MANY ICOS, SO LITTLE ECONOMIC IMPACT

The past three years have seen the launch of thousands of cryptocurrencies, often through an Initial Coin Offering (ICO) process.

Andy Warhol said: “in the future, everyone will be world-famous for fifteen minutes”2;

it is now possible to create a cryptocurrency in fifteen minutes and possibly become famous. However, cryptocurrency issues have generated little interest from regulators because of their relative small size compared to the global economy. The global value of cryptocurrencies is around one hundred billion euros3. Just taking the euro currency alone, its fiduciary4 value is ten times larger5 and the euro supply is about one hundred times larger, so cryptocurrencies do not currently represent a systemic risk.

FROM COIN TO TOKEN

Inceptors of cryptocurrencies have tried to improve the technology to overcome the three main issues just mentioned. Most initiatives in financial services have, in various ways, reduced their scope to private, permissioned and partially recentralised technology in order to progress in the digital representation of assets. Financial regulators are showing themselves to be pragmatic, authorising issues on a case-by-case basis or on a sandbox basis.

The interest has now shifted from coin to token. From an initially complex taxonomy of tokens, only three are kept in focus: currencies6, utilities7 and securities8. Focusing on securities, security tokens have a clear issuer, which is not the case for the Bitcoin. This is why regulators want these issuers to apply to tokens the existing regulations covering their underlying assets. In Europe, they are making a clear distinction between securities and financial instruments, because they are subject to different regulatory frameworks.

The buzzword is Security Token Offering (STO). There are solutions to issue and maintain a registry of holders for bonds, equities or funds. The next challenges will be the ability to manage corporate events and to organise efficient secondary markets.

INTO THE TOKEN WORLD

In the mind of operators, a digital representation of assets allows a better circulation of assets, what they call a greater velocity, the capacity to exchange assets almost immediately. Taking a real estate example, buying a property takes weeks. Buying tokens representing shares of a company holding a property would take only minutes. Furthermore, if the token is properly designed, it could take little time to bundle this property with another one or, on the contrary, to split it into parts, bare ownership and usufruct, or into fractions. In other words, securisation and stripping made easy.

In these transactions, the trading, the settlement and subsequently the safekeeping of the representation of the asset could be done at once. Such immediate processing would require the use of a standard unit of account linked to one of the main existing currencies, and this is the reason why there is such enthusiasm for stable coins9 and whether to use them in Exchanges or for Registries.

BACK TO THE REAL WORLD

Issuers and investors need to know and apply the requirements of all applicable laws, regulations and tax systems. This includes identifying counterparties (KYC), checking the origin of funds (AML), making declarations of threshold crossings, checking foreign ownership restriction, as well as reporting capital gains, or even withholding tax. This applies to security tokens too.

Considering the number of initiatives, these digital markets will stay fragmented for several years before a cross-chain of integration is built or before a leading platform emerges. In the meantime, it seems necessary to rely on trusted intermediaries to provide a single interface for all these chains, convert cash to and from these chains, to safeguard the keys to access them or even hold the tokens themselves.

Imagining this world of digitisation is quite easy. Guaranteeing the reality of the assets represented by the tokens, and possibly their condition, or understanding the rules or assessing the fairness of a joint ownership agreement, would be additional services required by counterparties.

ONE STEP AT A TIME

Just like Artificial Intelligence, Blockchain is having a clear impact on the Financial industry. Learn more about these changes and how they might impact the investment management world and how the regulators will accompany these new topics.

THEY ALWAYS SAY TIME CHANGES THINGS, BUT YOU
ACTUALLY HAVE TO CHANGE THEM YOURSELF - Andy Warhol

 

(*)  Profiles in Innovation Blockchain by Goldman Sachs in May 2016, p. 5.
(2)  ‘How to create your OWN cryptocurrency in 15 minutes’.
(3) 120 billion euro market capitalisation for all cryptocurrencies on 14 March 2019.
(4) In this context, fiduciary money means banknotes and coins.
(5) banknotes and coins represent €1,034 billion, and total euros in circulation account for €11,618 billion.
(6) A token that is as a store value and as a medium of exchange, not issued by a central Bank.
(7) A token linked to a network or to an issuer to fund a project and later gives right to goods or services.
(8) A token behaving like a security with holders regarded as owners.
(9) Please read the article: Stable coin; the next big thing.

Head of Strategic Marketing Societe Generale Securities Services
Laurent Viellard Head of Client Strategic Marketing SGSS