The Digital Asset Opportunity

Digital assets have carved out a niche that is both intriguing and transformative. Both cryptocurrencies and blockchain-based tokens present an attractive proposition in the ever-evolving landscape of investment management. 

Over the past decade, digital assets have emerged as a compelling component within the broader landscape of investment management. 

Although still relatively small in size, the rise of digital assets is not merely a trend but signifies a structural shift in how assets are created, traded, and held – and looks set to play an increasingly important role in the future of asset management.  

Digital assets, including cryptocurrencies and blockchain-based tokens, offer a range of attributes that make them particularly appealing for investment management.  

This appeal — spanning from diversification and efficiency to transparency and beyond — make them an intriguing addition to the investment management toolbox. As the infrastructure surrounding these assets continues to mature and regulatory frameworks evolve, their role within investment portfolios is likely to grow.  

Investment managers who understand and leverage the benefits of digital assets can potentially gain a competitive edge, offering innovative solutions that meet the changing needs of investors in the digital age.  

However, it's also crucial to navigate the associated risks and regulatory considerations carefully, ensuring that the embrace of digital assets aligns with a firm's investment philosophy and risk management framework. 

The allure of digital assets

From the perspective of institutional investors and capital markets, both cryptocurrencies and blockchain-based tokens have interesting characteristics:  

Some investors see cryptocurrencies as a diversifying element in a traditional portfolio, given their risk and return characteristics. Others also see the potential future value of the underlying technology and the cryptocurrencies built on it as the main thesis driving exposure to the asset class. 

On the other hand, tokenized assets have the potential to not only bring traditional assets onto a blockchain but also open up alternative asset classes, especially those that, today, are hard to access or transact in for many investors.  

Some see this as an opportunity to bring a wider range of assets to a wider range of investors, offering the chance to create bespoke and efficient portfolios or products. 

Besides the investment aspect, some view the value of tokenizing assets in the potential gains in efficiency, transparency, and usability. Holding and trading in tokenized assets on a blockchain may provide considerably more efficient settlement systems and processes, as well as more interconnected markets. 

Beyond a niche market

With a market capitalization of, at the time of writing, between $2tn and $2.5tn, digital assets are still a relatively small market compared to other asset classes. The recent approval of approx. 20 Spot Bitcoin ETFs and its roaring success – they have been the most successful ETF launches in history – illustrate how Crypto Assets are moving towards acceptance by the mainstream asset management community.  

In addition, tokenized assets are moving further into the spotlight and, according to estimates including by The Boston Consulting Group, are expected to grow to $15-20tn in assets by 2030. This is also a testament to the large strides that have been made in terms of institutional-grade infrastructure as well as legal and regulatory clarity.  

Although there is still work to do, the asset class is starting to become more and more accessible to institutional investors. Major traditional financial institutions now offer digital asset services and regulated exchanges as well as brokers provide execution capabilities supported by professional data and index providers.  

This makes it a good time to consider an organization’s approach to digital assets. Underpinned by SimCorp’s commitment to offering clients flexibility and optionality in their investment decisions, we are continuously building out our capabilities to provide clients with the ability to manage digital assets in their portfolios alongside traditional assets.

Understanding digital assets

At their core, digital assets are anything that exists in a digital format and possesses value. In our context, we focus on those digital assets that exist on a blockchain.  

There are multiple ways to categorize digital assets, but from an investment perspective, we can broadly distinguish between cryptocurrencies, like Bitcoin and Ethereum, and tokenized assets - i.e., digital representations of real-world assets (i.e., anything from tokenized stocks, bonds, real estate, or even art).  

While cryptocurrencies have their very own economics as well as risk and return characteristics, tokenized assets broadly share the risk and return characteristics of the traditional assets they represent.  

However, it should be noted that they are not completely independent of each other: Some of the largest blockchains today serve as the settlement layer for all kinds of transactions, including those involving tokenized assets.  

A key component of a blockchain is some form of cryptocurrency, which, amongst other uses, often serves as a form of payment for the use of the respective blockchain infrastructure. As such, an increase or decrease in the use of tokenized assets may impact the economic value of the cryptocurrency that serves as the means of payment for “blockspace” on which the tokenized assets are held and transacted.

Terminology and why it’s important

Digital assets have undeniably generated attention in the investment world over the past decade despite their relatively small size compared to other asset classes. However, it is still crucially important to lay a foundation to understand digital assets more broadly and in particular in the context of investment management. 

Terminology in an emerging technology and asset class, especially digital assets, is important for investors to understand. In order to ensure information and data are put in the right context and clearly understood, some key terms need to be clear upfront.  

While in traditional finance, the terminology has evolved and been somewhat standardized or commonly accepted over decades – digital assets terminology is still rather nascent, and new terms evolve as the underlying technology develops.  

Even seasoned participants in the spaces may define certain terms differently or use two terms interchangeably. For the purposes of our article series, we want to ensure that the following terms and concepts are understood as follows: 

Cryptocurrencies, tokens and “crypto” 

Cryptocurrencies and tokens are both digital assets on a blockchain, but they differ mainly in function and the platforms they operate on.  

Cryptocurrencies, like Bitcoin and Ether, are native to their blockchains and serve as digital money for transactions and investments.  

Tokens, created using smart contracts on existing blockchains, represent various assets or utilities within a specific ecosystem, such as voting rights or service access. Technically, all cryptocurrencies are tokens, but not all tokens function as traditional currencies, often having specific roles in their ecosystems.  

For our purposes, focusing on an investment perspective and – more specifically – from a risk-return profile, the term "cryptocurrencies" is broadly used to include all digital assets except tokenized assets, given that tokenized assets usually derive their risk-return profile from the underlying real-world asset they represent. 

Finally, “crypto” is a much more loosely defined term that may include anything that has to do with the world of digital assets. We will be more precise in segmenting different categories of digital assets.  

Blockchains, Protocols, Platforms and DApps 

From a technical perspective, a blockchain is a type of data structure, while a protocol is a set of rules governing how data is communicated.  

In the context of cryptocurrencies, blockchains serve as the infrastructure for storing transaction data, so-called “state”, while protocols define how these transactions are transmitted and recorded on the blockchain.  

Ethereum, for example, is a blockchain. On top of Ethereum, new services and products can be developed with so-called smart contracts. The resulting transactions then settle on the Ethereum Blockchain. The user-facing application or platform is then called a decentralized application (or DApp).  

This is why protocols, platforms, and DApps are sometimes used interchangeably. In our discussion, we refer to blockchains as the main infrastructure, such as Ethereum or Bitcoin, and protocols or applications, such as Uniswap or Lido, as platforms and products that are built on this infrastructure. 

DeFi vs. TradFi 

In the world of digital assets, TradFi and DeFi are terms usually used to distinguish between Traditional Finance (TradFi) and Decentralized Finance (DeFi).  

In this context, TradFi includes our current financial system and capital markets, while DeFi, more broadly speaking, includes the financial system and capital markets built on blockchains. It can, therefore, also be seen as a distinction between traditional assets and digital assets.  

DeFi, as we’ll elaborate further below (see sidebar), also needs further clarification when navigating the digital asset world. However, when used in the context of TradFi, it often refers to any financial infrastructure, service, or product that’s built using blockchain technology. 

Decentralized vs. Centralized 

Decentralization is a key concept in blockchain technology and, as such, central to the world of digital assets. However, what is considered decentral vs. central is not universally agreed upon.  

Generally, “decentralized” in the context of digital assets refers to the fact that the infrastructure is not run by a centralized entity but rather runs on decentralized soft- and hardware that cannot be controlled by a single entity.  

One way of determining decentralization is, therefore, by examining the distribution of participants who operate part of the infrastructure. However, some also look at whether a blockchain or protocol is publicly accessible by anyone (so-called “permissionless”) or whether it is restricted (i.e., “permissioned”) or even privately run. Some consider “true” decentralization as necessarily meaning permissionless, while others consider something decentralized based on how the infrastructure is spread.  

In our context, we refer to “decentralized” as anything that is not privately run (such as a blockchain run amongst a consortium of companies) but rather built on a public blockchain, irrespective of whether it is permissioned or permissionless.  

On-chain vs. off-chain 

The terms generally refer to whether a transaction is performed on a blockchain (“on-chain”) or not (“off-chain”). This distinction is primarily useful from an investment and infrastructural point of view. Increasingly, there are hybrid solutions where transactions are primarily conducted off-chain, but settlement happens on a blockchain.  

Tokenized assets and “Real-World” assets (RWA) 

One significant development within digital assets is the tokenization of existing assets, which are on-chain representations of assets in the real world (such as equities, debt instruments, real estate, or even art).  

Even though technically real-world assets (RWA) constitute the actual asset that is being tokenized when used in the context of digital assets, the term usually refers to the (already) tokenized version of the asset: “tokenized assets,” “tokenized RWA” and “RWA” are therefore often used interchangeably.

Conclusion

In the realm of investment management, digital assets have caught significant attention despite their smaller market size compared to other asset classes.  

Understanding the terminology is crucial, as it includes cryptocurrencies, tokens, and blockchain technology, each playing distinct roles. The distinction between traditional finance (TradFi) and decentralized finance (DeFi), along with the concept of decentralization in blockchain, is vital.  

Besides cryptocurrencies, tokenized real-world assets (RWA) represent a growing form of digital assets that may provide interesting new and improved ways of accessing and transacting in traditional asset classes. Investment technology solutions are a key piece in connecting institutional investors with the underlying digital asset infrastructure.