As the digital assets market continues to mature, retail and varying sectors of institutional investors are seeking different opportunities within the space. The Fidelity Digital Assets® 2023 Institutional Investor Digital Assets Study revealed that 67% of institutional investors surveyed view digital assets as having a role in investment portfolios. Despite tumultuous events in the market, investors still feel that there is a high potential upside to investing in digital assets, while carefully monitoring the trust and quality with these emerging and evolving products. Also, with the recent SEC approvals that allowed fund groups to sponsor and launch bitcoin exchange-traded products (ETPs) and ethereum ETPs the future seems bright for opportunities to attract retail investors. Thus, the possibilities across the digital assets ecosystem continue to evolve in a positive manner. With this backdrop, Performance Magazine sat down with Mike O’ Reilly, Head of Fidelity Digital Assets, to discuss the digital assets market and ecosystem.
Evolution of digital assets
A conversation with Michael O’Reilly, Head of Fidelity Digital Assets®
Authors:
Michael O’Reilly: Head, Fidelity Digital Assets, Fidelity Investments ®
Paul Kraft: Partner, Audit & Assurance, Deloitte & Touche LLP
Tim Davis: Principal, Advisory, Deloitte & Touche LLP
Lauren Campson: Senior Manager, Audit & Assurance, Deloitte & Touche LLP
Performance Magazine Issue 45 - Article 6
To the point
The path to offering digital assets is not dissimilar from launching other products. Evaluating the risks, controls, regulatory environment and investor demand should remain at the forefront. |
In 2023, foreign investment surged in India, flowing in from a variety of jurisdictions. The year also saw a spate of regulatory developments that underscored India’s unwavering commitment to fostering economic growth, streamlining investment processes, enhancing transparency, and nurturing a favorable environment for foreign investors.
As the global economy continues to intertwine with India’s financial markets, it’s increasingly essential for foreign investors to understand the country’s regulatory framework and keep abreast of its changes.
This article summarizes the different routes available to foreign investors, taking a closer look at the regulations governing foreign portfolio investments (FPIs) and alternative investment funds (AIFs) in India. It also breaks down the Securities and Exchange Board of India’s (SEBI) rules and compliance requirements for these avenues.
Evolution of digital assets
Performance Magazine (PM): As the leader of Fidelity Digital Assets, tell us about the business growth and where you and other digital business participants are focusing?
Mike O’Reilly (MO): Fidelity Digital Assets focuses on crypto custody and execution services for institutional and retail clients. Fidelity Digital Assets is different from Fidelity Digital Asset Management, which, under SEC approval, has launched ethereum and bitcoin ETPs. Looking at the digital asset marketplace, there has been evolution with increased investment, understanding, and knowledge across the institutional space. Trust and the breadth of offerings continue to be important to be successful among digital asset investors.
PM: What is your view of the overall digital asset marketplace including where it started and its continued potential and opportunities?
MO: The digital asset ecosystem has evolved significantly over the past decade, transitioning from niche markets to mainstream financial instruments. Initially, digital assets like Bitcoin were primarily used for speculative trading and as an alternative to traditional currencies. As the market matured, a variety of digital assets emerged, including ethereum, which facilitates transactions on decentralized applications, and stablecoins, which are pegged to fiat currencies (currencies that are issued by a central bank and do not have intrinsic value or backing by physical commodities) to reduce volatility. The financial ecosystem has expanded to include retail and wholesale central bank digital currencies (CBDCs) to facilitate cross-border payments within financial systems. The tokenization of real-world assets is seen as the next evolutionary step, accompanied by growing regulatory scrutiny and the need for robust risk management frameworks to mitigate potential market dislocations.
In terms of where Fidelity started in this space, the Fidelity Center for Applied Technology (FCAT) started looking at blockchain technology and networks back in 2014. They focused on innovation in the marketplace and how their clients would interact with innovative products. One such marketplace opportunity was the custody business, and from that idea, Fidelity Digital Assets was launched in 2018.
The key is to continue to innovate with investors to meet their needs but always know that they are a traditional financial services player that needs to get comfortable with continued innovation. There has been a focus on understanding and knowledge in the institutional space, which is good for the industry and the asset class. According to the Fidelity Digital Assets 2023 Institutional Investor Digital Assets Study, 67% of investors plan to buy or invest in digital assets in the future. That is an important maturity measure.
PM: Are there key offerings that are commonly requested from your user base—retail or institutional?
MO: We really try to meet each customer where they are, as that builds trust. Clients want the same interaction that they would have with any other part of a financial services organization. In order to meet investor expectations, organizations must be able to address key questions such as “What is the breadth of the product offering?”, “How many coins are you offering?”, “What are the right assets to invest in?”, and “What is the quality of your execution services?”
There is currently a retail and institutional divide in the marketplace. Institutional is a big market. We assess what a hedge fund wants versus corporate versus endowment versus ETPs. Clients have different viewpoints around quality, custody, the ability to generate yield, and the ability to protect your balance sheet so you don’t have to deposit across too many firms. It is different depending on what sector of institutional marketplace you are servicing. For retail, the goal was to tailor to what Fidelity’s existing clients want. The reason we turned the retail platform on is because we received feedback that people (retail investors) were buying crypto in other places but would have preferred to do business with an organization they already have a relationship with and trust.
PM: In the digital assets ecosystem, what risks need to be managed to have a successful offering and/or platform?
MO: This is often top of mind for customers thinking about getting into digital assets. Educating clients is still a priority, and we continue to invest in helping organizations to understand the underlying assets, the potential risks, and why an investment could be right for them. We are still in early days. It takes time for any asset class to be normalized and understood. A more efficient marketplace will evolve more broadly over time.
From the perspective of the sponsor or service offeror, education internally is important. You should understand the control environment if you want to build a product offering that is institutional grade. Talk to boards, risk departments, compliance departments, legal departments within your organization. More mature organizations often have committees for new products that have a defined level of risk tolerance. It is important that these types of committees are comfortable with the risk associated with digital assets. Be clear and articulate with the appropriate business line. There is just heightened sensitivity around digital assets. Intentionally, firms have set up operational processes for digital assets to look a lot like what they do for non-digital products and services. This includes front-, middle‑, and back-office similarities, as well as client onboarding protocols and distribution channels. As a result, a lot of processes for digital assets align with other asset classes. For example, some organizations have a books-and-records platform that functions as a dual-entry accounting platform, and there are controls around certain levels of movements. This platform and set of controls can be used to account for digital assets, as well as for other asset classes. There are differences in the processing of digital assets, but there are a lot of things that can be the same too.
Investor perspectives and opportunities
PM: What are your thoughts around distribution/future investors—institutional, retail, endowments, etc.? Where do you believe the puck is going? Who might the current/future influencers be to the ecosystem?
MO: As mentioned, 67% of institutions said they will bring this investment type into their investment portfolio. The retail side has seen positive growth, and younger investors are noticing this growth, which could help drive the success in the space as well. Regardless of the strategy employed, a custodian is critical for those that lack the expertise or desire to make the significant investment in self-custody required by institutions.
PM: What is the future role of staking? What are the roadblocks?
MO: Staking is important to the overall ecosystem. It continues to be an integral part of the ecosystem. For roadblocks, it can depend on what you are talking about in the institutional marketplace. The risk appetite and the understanding of a firm can drive much of their decision making on staking. Large institutional players want to generate yield, so staking can be used as a mechanism for them.
What is staking?
Staking in the context of blockchain and cryptocurrency involves locking up a specific amount of digital assets to participate in the network’s consensus mechanism. Participants, known as validators, are selected to validate transactions and create new blocks based on the amount of cryptocurrency they have staked. In return, they earn staking rewards, which are often treated as taxable income when received. This process not only secures the network but also requires careful tax accounting to track the basis and recovery of the staked assets.
PM: Where do stablecoins fit into the digital asset ecosystem?
MO: The marketplace for stablecoins has seen impressive adoption, with the potential for individuals to participate in the yield generated by the underlying assets. The ability to have a 24/7 marketplace, leveraging the power of blockchain and instantaneous settlement—that can be key for the longevity.
For tokenized treasuries or money market offerings, there is a lot of interest across the industry. It is another way to collateralize treasuries where you are providing a return to the holder in a way stablecoin does not. It is too early to tell if these two models can coexist. The market will determine that.
What are stablecoins?
Stablecoins are a type of digital asset designed to minimize price volatility by being pegged to a stable asset, such as a fiat currency (e.g., USD) or a commodity (e.g., gold). They aim to combine the benefits of digital assets—such as transparency, security, and speed of transactions—with the stability of traditional financial assets. Stablecoins can be categorized into fiat-backed, commodity-backed, and algorithmic stablecoins, each with different mechanisms to maintain their peg. Stablecoins have become a crucial part of the digital asset ecosystem, with peak market capitalization of $181 billion in March 2022, and a total market capitalization of $138 billion as of January 2023. More recently, the market capitalization of non-algorithmic stablecoins hit a new all-time high of nearly $170 billion earlier this year.
PM: What are the most impactful use cases of tokenization that you see in financial services? What are the levers that would accelerate and decelerate tokenization adoption?
MO: There are different use cases. Settlement of transactions, 24/7 basis, instantaneous settlements should drive scale and efficiency. You should have enough scale and efficiency to drive adoption, and that can happen over time. Tokenization does have a place in the ecosystem. We have seen early entrants already, which is great. A lot of firms are thinking about tokenization, which should help accelerate it. If it looks and feels like traditional finance, it can help everyone to be more comfortable. Also, prominent brands standing behind digital assets can help. There are also some barriers to entry. To most effectively set up a custody business and do it in an institutional-grade way is not easy and not cheap.
PM: How would your response vary between US versus non-US opportunities? Is there a geography that is in the lead?
MO: Fidelity has a US entity and had a UK entity introduced in 2020. What we are seeing in Europe with Markets in Crypto-Assets (MiCA) and regulatory clarity is great since it helps firms navigate entry into the digital asset space. As we see MiCA applications become available from central banks, we should get even more clarity on how to understand the regulations. It is truly a global market, and we’re starting to see the world economy evolve and normalize to welcome digital assets. MiCA is still in the early stage, but clarity is starting to come out. When looking at the market, we ask ourselves: 1) Economically does it make sense to play in that market? What is the potential upside/risk for the firm? 2) Can we expand and continue to give the same level of quality and service to our clients in our existing business? 3) Can we deliver the same level of service in that market? Fidelity sees itself as a long-term player in the marketplace, and expansion is a part of that.
Regulation – Headwinds/tailwinds
PM: What do you think is needed to better position digital assets for success in this regulatory environment? What are key hurdles, or unlocks, that would be pivotal for industry adoption of digital assets?
MO: Regulatory clarity, maturity of the marketplace, broader adoption by retail and institutional, and education is important for every segment. They should work together. It can happen over time. There are a good amount of industry groups in the US and more being formed outside the US that have had a positive impact because they help the industry coalesce. They help drive education and also provide an avenue to help connect with the regulators.
PM: The SEC approved the launch of both bitcoin ETPs and ethereum ETPs. What is next, and how is demand?
MO: A few high-level observations on this recent SEC development: With any asset class there is a law of diminishing returns with how many products you have (the number in the marketplace). I think it is good for the industry that the ETPs have come out. It provides the opportunity to see the success of these offerings through the trading and custody platform (giving the opportunity for end-to-end servicing to the retail market). Regulators accepting these new products and providing some regulatory clarity has been good for expanding the investment management ecosystem. Investors can hold digital assets in custody in a way they are used to holding a more traditional asset (equity or fixed income security). It fits nicely into a lot of investment mechanisms at registered investment advisers and within large funds. A lot of the firms have investment committees and can understand what the ETPs are achieving, which is helping to drive the maturity of the marketplace. As the marketplace matures, one can envision individual coin ETPs competing with the future launch of basket of coins that are part of an ETP. As far as demand, there were huge upticks early on and the market entrant’s great traction, but it is unrealistic to think that this will be sustained.
Predictions and final thoughts
PM: Any concluding thoughts or predictions you wanted to leave us with?
MO: It depends on where a firm is on adoption and their understanding of the asset class. If you have been involved in digital assets for multiple years, you likely have a good education on how the marketplace works. If you are a firm just starting to think this through, you should take the time to get educated. Think about what may be different and the same as traditional financial services. Like any other asset class, sometimes it fits into a portfolio and sometimes it does not. That is not digital asset-specific or crypto-specific. It depends on what the portfolio is. It should start with a top-down tone that emphasizes the importance of understanding and educating—not only how do you educate your team but bring legal, risk, and compliance along in the journey. As firms think of risk tolerance, it can be helpful to bring these groups with you to help you make the most informed decision. The ability to do experimentation in a controlled environment can also be helpful. An innovation and education mindset can help you to learn more and can help an organization make the most informed decisions.
Conclusion
With over half of investors in the Fidelity Digital Assets 2023 Institutional Investor Digital Assets Study reporting that they already invest in digital assets, it is not surprising to see the market continue to mature, the regulatory environment providing more clarity and new offer products that are better tailored to investor needs. Predictions for the increased demand and offering of tokenization and stablecoins are slowly emerging. With global interest, evolving regulations, and new product lines, investors and organizations should navigate the complexities of the digital assets space in order to achieve the upside more effectively they are seeking.
Learn more about tokenization in financial services: Tokenization in Financial Services | Deloitte US
The executive’s participation in this article is solely for educational purposes based on their knowledge of the subject, and the views expressed by them are solely their own. This article should not be deemed or construed to be for the purpose of soliciting business for any of the companies mentioned, nor does Deloitte advocate or endorse the services or products provided by these companies.
Fidelity Digital Assets is a service mark of FMR LLC. © 2024 FMR LLC. All rights reserved.
This article contains general information only and Deloitte is not, by means of this article, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.
Deloitte shall not be responsible for any loss sustained by any person who relies on this article.
About Deloitte
Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the “Deloitte” name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Please see www.deloitte.com/about to learn more about our global network of member firms.
Copyright © 2024 Deloitte Development LLC. All rights reserved.
