The Fixed Income Digital Asset Revolution

The Fixed Income Digital Asset Revolution

December 6, 2021

It’s safe to say that digital assets are becoming more ubiquitous every day as the underlying technology is upgraded and applied to a rapidly increasing number of use cases, including tokenized securities, NFT-based art, and GameFi to name but a few. One of the use cases that could truly change the game is the development of sophisticated Fixed Income solutions.

The traditional equity market worldwide is valued at around $37.69 trillion USD, far behind Fixed Income valued at $119 trillion USD. Applying the same ratio to the digital assets investment landscape, it can be expected that Fixed Income covering digital assets could reach a total market value of $7.16 trillion USD, based on the current $2.27 trillion USD market capitalization for digital currencies.

It would grow the digital asset industry exponentially, making it an undeniable force in the global financial services industry.

Implementation of DeFi: Current Snapshot

Investors with a long-term investment approach have a natural tendency to seek returns on their assets, extracting value via appreciation or interests. With the breakthrough developments of Staking and Decentralized protocols in the DeFi industry offering yields similar to, and in some cases more than, traditional investment vehicles, investing in the digital assets industry has become much more approachable to retail investors.

However, many of the financial solutions currently available in DeFi lack accessibility when it comes to the financial institutions that are not digital natives. The technological barriers traditional institutions face when interacting with DeFi is still significant and it will take time before the right processes are implemented. Institutional-grade custody and infrastructure providers are at the forefront of this revolution, and the platforms under development by these digital custodians are moving towards becoming the set-ups currently in place within large established institutions like BNY Mellon or State Street.

Technological advancements are not the only key to the omnipresent implementation of DeFi. Servicing clients and providing them with value-enhancing solutions under a regulatory-friendly environment is also critical for the success of the DeFi industry. Having the right KYC, AML, and legal processes in place are of paramount importance, and contrary to belief, these will not threaten the decentralized nature of the digital currencies or the broader digital assets ecosystem.

Institutions like Hex Trust aim to help bridge the gap between the digital asset ecosystem and the traditional financial system. For instance, bank-grade custodial services are part of the foundational infrastructure underpinning Central Bank Digital Currencies (CBDCs) and as this type of digital asset is deployed there will be no choice for the traditional financial services industry but to embrace cryptocurrencies. Consequently, as the two worlds integrate further, Fixed Income Digital assets products are bound to develop and thrive, making DeFi a force to be reckoned with in the finance industry.

Increasing availability of structured solutions

The current products offered in the digital asset landscape are not limited by the structure of the blockchain, but by clients’ demand. Considering that staking yields an average of 7% for the most popular coins like ADA, SOL, and DOT along with the possibility of farming 10–20% yields from fairly vanilla products like Term Futures, there is no urge for investors to pursue longer tenor fixed income solutions to extract value via a term structure.

Likewise, in the traditional finance environment, yields in the digital assets space have come under pressure already for flagship coins like Ethereum and Bitcoin. At the moment, the yield offered via deposit in the most popular decentralized platforms like Compound and AAVE are already limited to 0.05–0.10% and 0.30–0.50% for Ethereum and wBTC respectively. As a consequence, it is fair to expect investors to start exploring longer-dated deposit-like or even structured solutions in combination with option features.

The NFT revolution cannot be overlooked during the development of a Fixed Income market for digital assets and currencies. For the simple reason that anything of value can be used as collateral, there is an incredible opportunity in offering NFT-backed borrowing within the ecosystem in combination with traditional financial instruments.

Just like it’s possible to use a valuable Picasso as collateral for financing in today’s world, in principle, there is nothing against the use of NFTs in the same fashion. The only limit to this at the moment is the liquidity inherent in the asset and its safekeeping. Once again, institutional digital asset custodians can resolve these issues as they are best positioned to offer the safekeeping and servicing of assets.

The integration of two worlds

There is no doubt that digital assets represent the future: the more the technical aspects will become accessible, the faster the revolution will happen. The speeds of new blockchains being created and developed do require operational flexibility and technological knowledge that only digital native institutions can achieve.

However, it will serve everyone well to see that the digital assets space is not a threat but rather complementary to the traditional industry. Eventually, there may be meaningful integration between the two worlds when the speculative nature of digital assets fades and a more structured wealth planning approach takes over.

Dario Capodici
Dario Capodici
Head of Financing
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