India’s finest minds are talking about transformation in securities markets through adoption of digital assets. In simple words, digital asset means assets in digital format. To decode the concept further: Ownership of any valuable asset which is tangible (such as stock, bond, cash, real estate property) or intangible (such as carbon credits) can be represented in computerized or digital format. This transformation is enabled through tokenization which deploys software codes to convert ownership rights into digital tokens. These records are stored and managed through blockchain technology or distributed ledger technology (DLT) where ownership records are securely maintained.
This same technology underpins the world of cryptocurrencies which has proven to be more cost-efficient in terms of infrastructure compared to traditional operating costs incurred by stock exchanges, clearing corporations and depositories. Let’s demystify how crypto markets use technology. First, transactions are decentralized, i.e. they rely on computer networks (referred to as nodes) to validate and record transactions. Second, smart contracts (i.e. self-executing coded contracts) automate various elements of trade cycle. Third, peer-to-peer transactions have the potential to reduce business-to-business transaction costs, improve transparency and reduce the lag or wait time between transactions. This also allows individual from other parts of the world to transact without barriers.
In short, DLT allows peer-to-peer transactions, eliminating requirement of traditional intermediaries such as banks, clearing corporations, etc.. The goal here is not necessarily to eliminate these intermediaries but to improve transaction efficiency and cost-effectiveness by embracing digital assets and technology. DLTs can streamline processes, make faster and accessible transactions, and increase transparency and security aspects in financial transactions. DLT could complement and enhance the role of intermediaries enabling them to adapt to digital landscape and benefit from reduced costs and create innovative solutions. Another benefit of recording assets on DLT is that it allows real-time tracking of ownership.
However, the demerit of such system is that it would eliminate netting from the system, i.e. each transaction by a client would be required to be fully funded and settled. Also, it is important to acknowledge here that fraud and disputes are potential threats inherent in this system so we need to adapt and innovate wisely to mitigate these risks. Further, the decentralised market infrastructures might not provide the same degree of accountability as current clearing corporations.
The market infrastructure institutions of the US, Hong Kong and Singapore have already recognized the merits in adopting these technologies. Project Guardian, initiated by Monetary Authority of Singapore (MAS) in collaboration with traditional financial institutions and fintech companies is a pilot project aimed at testing the feasibility of digitizing financial assets, tokenization and policy developments. Various financial institutions are exploring creation of different financial assets (fixed income products like bonds, forex and wealth management) and their subsequent listing on stock exchanges as well as clearing and settlement through digital asset networks. The Financial Services Agency (FSA) of Japan has also joined this project. Moreover on 6 September, the Monetary Authority of Singapore granted a license to Asia Next–the digital asset exchange. On 19 October the US DTCC (Depositories Trust and Clearing Corporation) signed an agreement to acquire Securrency Inc—blockchain-based fintech firm—to drive development of the post-trade infrastructure for the global financial markets. These are some of the path-breaking approaches taken by the regulators to encourage adoption of digital assets.
A four-pronged approach to facilitate establishment of a digital asset regime includes DLT, tokenization, central bank digital currency (for payment aspect of security settlement on DLT-based trading venues) and potential players. India already possesses the necessary technology, what is needed is its effective utilisation. The progression of digital currency initiative is already underway, making this transition viable and a multitude of fintech players are available to help realize this potential. Addressing regulatory amendments is another essential area of focus to pave the way for digital assets to become a reality in India.
Rasmeet Kohli is with the National Institute of Securities Markets. The views expressed in this column are personal.
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Updated: 31 Oct 2023, 09:26 PM IST