Yesterday the SWIFT Institute published an article on digital assets written by Professor Alistair Milne of Loughborough University School of Business. Professor Milne envisions the widespread adoption of digital assets, but predicts that decentralized finance (DeFi), where there is a direct exchange of crypto assets without intermediaries, will continue as a “fringe” activity. Instead, institutions will play a central role in digital assets.
The document was commissioned by SWIFT but is not reviewed by the organization nor does it represent its views.
Professor Milne’s observation may sound provocative, but most crypto transactions go through exchanges that may be more heavily regulated in the future.
He makes some useful observations about what makes digital assets distinctive. “To some extent, new digital assets are simply the presentation of ‘old wines in new bottles,'” he writes. But he thinks digital assets are new because they involve the owner directly holding the assets rather than through financial intermediaries.
Historically, assets have been held directly. Only in the last 150 or so years has there been this shift to indirect holding both for cash through banks and for investments through depositories.
As a result, there is “no need for settlement” with digital assets. Transactions involving conventional assets are generally divided into two parts, the trading side and the post-trade side, which involves the payment and transfer of the asset. With digital assets, trade, settlement and transfer are all part of an atomic transaction.
As a result, many of the business models of these intermediaries will be challenged by this shift to direct holdings. The costs of switching are very high, as are the potential regulatory changes required if one moves away from typical two-day settlement and clearing. Of course, there are also huge potential savings from efficiency gains that can be gleaned.
Regulation
The document divides digital assets into three compartments: cryptocurrencies and anything that runs on a ledger without permission; regulated digital currency; and authorized ledgers used for digital securities and capital market automation.
When it comes to DeFi and cryptocurrencies, “all regulation can do is control the regulatory perimeter, the boundary between decentralized finance and traditional finance.” However, Prof Milne notes that most crypto transactions are conducted through intermediaries, so crypto exchanges can expect to be regulated.
One area Professor Milne does not explore is that of certain moves in the DeFi world to have permissioned DeFi pools such as Aave Arc running on permissionless blockchains. And several players are working on a decentralized identity to make KYC possible for DeFi outside of centralized exchanges.
Another point is not said in the document. And this is where SWIFT fits into a future of digital assets when there is no need for a separate payment message from digital cash.
Therefore, last year SWIFT launched a series of experiments with Accenture to explore its potential roles. One area it is investigating is whether it can be a trusted third party to enable interoperability between central bank digital currencies (CBDCs) and non-CBDC payment networks as well as digital asset networks. It also plans to operate a DLT network on which the CBDCs are built.