Understanding Digital Asset-Backed Securities: Why is Blockchain Important?
In the second part of our interview with Florian Matthaeus Spiegl of FinFabrik, he explained how FinFabrik helps tackle challenges for many traditional financial services companies, and how the industry can work together to build more inclusive, accessible and efficient systems.
The digitization drive
Spiegl believes that Bitcoin and other cryptocurrencies are examples of a successful “Proof of Concept” for digital assets. FinFabrik looked at cryptocurrencies and said, “This is probably not the end of it. We will see assets that already exist in the traditional markets being digitized using the same principles and technologies.”
FinFabrik is focused on asset management, as innovation in capital markets systems has not been very strong. FinFabrik followed its market hypotheses and decided to go “all in” on digital assets.
“Blockchain is not the right technology to solve every problem out there, but for some things, it certainly is. In the private market asset management space, blockchain is a great solution helping to make processes more efficient and to improve access and liquidity while maintaining legal enforceability; for that, it is the right technology,” explained Spiegl.
FinFabrik chooses permissioned blockchains
To understand business enterprise blockchain adoption, we first need to differentiate between public blockchain (permissionless) and private (permissioned) blockchain. With FinFabrik’s target group set on institutions in the capital markets, Spiegl explained that many institutions want to be in control and deal with known and trusted counterparties while still achieving a reduction in middlemen and process complexity. At the moment, permissioned setups best fulfill these requirements. In the longer run, permissioned and permissionless setups will co-exist and interact with each other, depending on the specific use case. While looking at both approaches, FinFabrik eventually decided on permissioned protocol types, and they explained to Blockchain.News that their infrastructure integrates R3 Corda and Hyperledger Indy.
Understanding digital asset-backed securities: Nothing but a bundle of rights
Blockchain is used to dematerialize and digitize processes and workflows, starting with digitizing the asset. “Why is blockchain important? If you look at an asset, it’s nothing but a bundle of rights that counterparties agree to. The way we communicate and record these rights today is in a material way, typically on paper,” explained Spiegl.
“Token” is used as a technical term as the main process is digitization, and tokenization is a technical way of doing it. “A significant and important step is still to structure the instrument correctly, to make it hold up in a court of law so that the digital way of representing it is just as enforceable as the material way,” said Spiegl.
Spiegl further explains the importance of blockchain, “we believe it is best suited to keep a time-stamped series of immutable records, an efficient way to normalize and share information and creating an audit trail of the truth of historical events.”
By digitizing an asset and the respective workflows of managing it, overall costs are lowered, and the ownership of the asset could be broken down into smaller fractional parts.
Centralized vs. decentralized: The power is in collaboration
The decentralized finance (DeFi) approach aims to create a permissionless, public, and transparent infrastructure and to cut out the middlemen. For example, remittance costs are high for consumers because of the involvement of many middlemen who provide services along the value chain. Reducing these costs by connecting users more directly is one goal.
Spiegl believes that powerful change could be the outcome of DeFi but does not see value in putting centralized against decentralized infrastructure approaches, as he believes that they can coexist and “reinforce each other.” He added, “for institutions, this is an interesting development to pay attention to, although it will not solve everything or replace everything we have. There are complementary elements between the approaches.”
“We can work together to make financial markets better, to make them more inclusive, bring down costs, and allow much broader access. It really starts with the centralized and big institutions collaborating with players who have a more decentralized perspective. The power is in collaboration, I don’t think it’s trying to replace all of the status quo,” stated Spiegl.
The real challenge for institutions in digitization
Spiegl emphasized getting the foundation right, making sure digitization of assets and processes are adequately done; development and delivery of technology are then more effective.
“We are focused on enabling institutions and the more traditional types of assets on digitizing asset classes that are significant enough to have a positive impact on the industry and on our business model. For example, the private credit space, direct lending between institutions - there is a lot to gain by digitization using blockchain. First, the efficiency of digital workflows but also broader deal discovery and access and finally increased liquidity in secondary markets. Institutions in private markets will be able to lower complexity, develop new revenue sources, reach more clients directly, and manage their risk exposure more actively.”
Spiegl concluded, “We are well aware that, while everyone sees that digitization in private markets is inevitable, these are still early days and adoption will take time. I don’t think regulation is a significant hurdle. The real challenge for institutions is the need for cultural change, to take more risks and small steps of innovation, do pilots with companies like us to learn in this new field. The power is in collaboration.”