Token economy is much more than cryptocurrencies

A touchscreen instead of a keyboard with a pen, intuitive usability, reliable and secure operating system – when Steve Jobs introduced the first iPhone in San Francisco at the beginning of 2007, it was tantamount to a revolution. The smartphone has long been a constant companion and control centre for most people in their day-to-day life. Blockchain technology could similarly change the world for good. “Blockchain and the token economy have immense potential for change and are likely to revolutionise the world, the financial industry and asset management, just as the iPhone did starting in 2007,” says Daniel Andemeskel, Head of Innovation Management at Universal Investment Group and CEO and Co-Founder of UI Enlyte.

With a few exceptions, alternative investments – private equity, private debt or infrastructure projects – are still reserved for institutional investors. In the future, tokenisation of investments will make alternatives accessible to everyone. Major changes are also imminent on the service side: here, the blockchain creates more efficiency, transparency and security.

The “crypto winter”: A healthy correction

According to a study by the Boston Consulting Group (BCG) published in September, the market for tokenised illiquid assets will grow to 16 trillion US dollars by 2033.1 “Blockchain-based tokenisation can reinvent how investors connect to investment opportunities,” explains BCG.

However, after an exceptional 2021, the current year has not been easy for the crypto industry. The cryptocurrencies collapsed massively. Bitcoin has lost over 70 percent in value since its all-time high in November 2021. The situation is similar for the other cryptocurrencies, the supposed stablecoin Terra even collapsed completely. China and Russia banned all crypto payments. In addition, there was a lot of bad news from companies in the industry, such as the bankruptcy of the crypto lending platform Celsius and the US Treasury Department’s ban on crypto mixer Tornado Cash over money laundering allegations. The term “crypto winter” went the rounds.

“Cryptocurrencies are not the only digital assets, the token economy is much larger,” emphasises Daniel Andemeskel. These included tokenised private market assets (PE/PD) and bonds, hybrid products such as tokenised convertible bonds, Non-Fungible Tokens (NFTs), digital central bank currencies and also tokenised fund shares. “We don’t necessarily see the ‘crypto winter’ as negative, it’s more of a market shake-up, the bad apples are being sorted out.” The market is thus attaining a higher degree of maturity, which in turn is contributing to the fact that more and more serious investors are showing interest in its possibilities. Further maturity should also include supervisory requirements, says Daniel Andemeskel: “Regulation plays an important role. The market needs to be regulated.”

Funds: Crypto-friendly signals from Berlin and Brussels

In terms of the regulation of digital funds, further progress was again made this year. Under the German regulation on Crypto Fund Shares (KryptoFAV), which has been in force since June 17, 2022, the obligation to securitise securities no longer applies, namely for UCITS and AIFs. Issuers are thus now allowed to register securities in decentralised, blockchain-based registers monitored by BaFin, so-called crypto securities registers – a real leap forward. The Fund Location Act (FoStoG) and the Act on the Introduction of Electronic Securities (eWpG) had already come into force in 2021. Since then, special funds have been allowed to invest up to 20 percent of their assets in crypto stocks.

• Electronic Securities Act (eWpG): Germany’s Electronic Securities Act of June 3, 2021 essentially provides the legal framework for electronic securities trading. Securities no longer need to be issued as physical certificates.
• The Fund Location Act (FoStoG): Under the law, which came into force on July 1, 2021, domestic special funds can build up to 20 percent crypto exposure.
• Regulation on Crypto Fund Shares (KryptoFAV): The ruling has been in force since June 18, 2022. German funds can now also issue their share certificates via the blockchain.
• Markets in Crypto-Assets (MiCA): Regulating any digital representation of value or rights at the EU level using distributed ledger technology (DLT). The European Council adopted the final version of the draft proposal on October 5, 2022. It is expected to be implemented by 2024.

“There is a kind of competition in Europe as far as the introduction of digital funds is concerned,” explains Daniel Andemeskel. “Germany is now leading the way,” he adds. “The new regulation confirms our prediction that tokenised fund shares and ultimately fully digital funds will be the future.” He believes it is possible that the first digital funds will be launched in Germany as early as 2023. In addition, Daniel Andemeskel believes that cryptocurrency investments could also be opened for UCITS. Progress is also being made at the EU level: with the introduction of MiCA (Markets in Crypto-Assets), Europe is the first continent to regulate cryptocurrencies, thereby creating legal certainty for cryptocurrencies, security tokens and stablecoins.

“Digital assets have now become a serious investment opportunity. We can see this in the ECB’s considerations on the digital euro,” says Michael Reinhard, chief executive officer of Universal Investment.

Institutional investors and asset managers as winners

The token economy holds many advantages for institutional investors and asset managers. New diversification opportunities are emerging via tokenised assets for institutional investors – by investing in assets that cannot currently be invested in. Private investors can use STOs (Security Token Offerings) to access assets that were previously reserved for institutional investors, for example private equity and private debt. Digital securities also help to lower the minimum investment amount and improve liquidity. Asset managers can tap into new customer groups with their digital products, crypto and neobank-savvy millennials, for example. And they can likewise invest for retail investors with their products in assets previously reserved for professionals.

On the service side, efficiency, speed and transparency are improving, including in the buying and selling of funds and in settlements. One example: a blockchain solution can significantly speed up the process for identifying and verifying new clients (KYC – Know Your Customer) and make it more secure at the same time. New distribution channels are also emerging. “The token economy brings more liquidity and more fungibility,” Daniel Andemeskel sums it up.

Concrete projects in progress

Despite the crypto winter, Universal Investment observes that interest remains high among institutional investors and among asset managers. “Our clients continue to be on the topic and ask us about it,” explains Dr. Sofia Harrschar, Head of Alternative Investments & Structuring at Universal Investment.

The company is one of the most important points of contact in Germany and Europe as it has been working on digital assets and the blockchain intensively since 2019. In December 2020, Universal Investment founded UI Enlyte, with the goal of guiding clients into the blockchain world and aligning the traditional world of regulated funds with the new world of digital assets. “We’ve done some pioneering work here,” notes Michael Reinhard. “Now we benefit from the fact that we dealt with all these topics early on and built up know-how and technical infrastructure through our subsidiary UI Enlyte.” Clients come from a wide range of sectors, including alternative investment managers, who benefit from the expertise we built up at an early stage. “The early engagement was hugely important, because if you don’t invest in the future, you risk being irrelevant.”

UI Enlyte offers a self-developed, modular investment platform based on blockchain technology. All phases of the investment process are thus mapped end-to-end and completely digitally on a single platform – from simple and secure onboarding to issuing, buying and selling of token-based structures and their administration to reporting. Clients receive a holistic white label solution and save themselves the enormous efforts of building up their own capacities.

An important focus in the development of the platform was compliance with regulatory requirements and the highest security standards. This year, for example, UI Enlyte was ISO 27001 certified for the second time in a row.

The award for Best Digital Asset Initiative with the Asset Servicing Times Industry Excellence Award 2022 underlines UI Enlyte’s comprehensive offering and unique positioning in the international market.

UI Enlyte does not stand alone but is integrated into an entire ecosystem of established and reliable partners: on the one hand, the entire Universal Investment Group with the areas of structuring, sales, marketing, etc., on the other hand, business partners, custodians, banks, market makers and other participants.

Currently on UI Enlyte’s agenda: crypto assets in funds according to § 284 KAGB, the tokenisation of fund units for UCITS and AIFs, STOs, a crypto custody solution (for direct holdings) and also the launch of completely digital funds. Specifically, this means, for example, that UI Enlyte offers a technical solution that allows regular special funds to invest up to 20 percent in crypto assets, in accordance with today’s regulatory standards.

The next goal is internationalisation. Universal Investment already has offices in Luxembourg and Ireland and it plans to expand its blockchain and token economy activities there. “The recent entry of the Canada Pension Plan Investment Board into Universal Investment opens up further international perspectives,” Michael Reinhard notes.

Alternatives in the future: ESG, blockchain and “private” for all investors

So, what will the world of alternative investments look like in ten or fifteen years? “We expect to see a triad of sustainable investing, blockchain-based tech infrastructure and easy access to private markets,” explains Daniel Andemeskel. Sustainable, ESG-compliant investing will then be much easier. In the future, investors could, for example, use the blockchain to invest directly in forests or in the ecological production of tea in India.

_{This article already appeared in BAI Newsletter.}