Preparing for the Digital Asset Era
BondCom’s history and products have always been closely tied to developments in securities custody infrastructure. In 1982, our founder, Robert Apfel, played an integral role in the invention and adoption of the book-entry system, which eliminated the need for bonds to be held with paper certificates, forever changing the way we think about what it means for an investor to ‘hold’ a security. However, even in 2024, securities custody remains an extraordinarily complex, multi-layered ecosystem. In fact, all of our services (and those of our sister company Acupay) are aimed at filling gaps and strengthening weaknesses in securities custody infrastructure – particularly by connecting the dots between beneficial owners and securities issuers, which may span an exhausting chain of clearing systems, central securities depositories, nominees, banks, and brokerages, to help issuers achieve their goals.
The Digital Asset Era
In September 2023, DTCC, Clearstream and Euroclear published a joint Industry Paper titled “Advancing the Digital Asset Era, Together” which seeks to answer questions such as:
What is the Digital Asset Era?
How will it affect the way we hold and service securities?
What opportunities for generating market value does the Digital Asset Era create?
How can we accelerate the transition to digital custody?
An evolution in securities has already begun, and we are not just discussing digital currencies like Bitcoin, Etherium, and Dogecoin. ETFs offering packaged digital currencies have recently been made available to the market. Tokenized assets, i.e., digital securities representing valuable real-world assets such as real estate and fine art, are being developed. Additionally, and most relevant to BondCom’s history, digital bonds issued on public and private blockchain networks are already active and being traded daily.
What is a “digital bond”, you might ask? It is a bond that exists on the ‘books’ of a blockchain network using Distributed Ledger Technology (DLT), as opposed to through the traditional custody chain that might involve a central securities depository and custodian banks.
Efficiency, Liquidity, and Instant Communication
Securities issued using DLT have some significant advantages over their traditional counterparts. The Industry Paper states that “in addition to the overall automation of the issuance process, DLT (and smart contracts) are eliminating days from bond issuance cycles...”. Tokenized assets have the potential to ‘unlock’ traditionally illiquid markets and allow new investors to enter. DLT-based securities also allow more transparency in collateral-based assets given that up-to-date information about the collateral can be ‘baked in’ to the security itself, giving investor all the necessary information about their investment to make informed decisions.
Most excitingly to BondCom, we see enormous potential in streamlining and simplifying the communication corporate action events to the holders of digital securities. For example, a tender offer could be executed in the form of a smart contract which is added to the digital bond (your digital bond being a computer program, essentially). As soon as the tender offer is launched, the smart contract would be ‘tacked on’ to your digital bond, and you would instantly have the entire offer at your fingertips. Responding to the offer would be as simple as clicking a button. Notice how this process did not involve the transmission of the corporate action event or the holder’s response through the back offices of clearing systems, banks, brokers. Equally important, none of those entities had the need to ‘translate’ or ‘communicate’ the offer. All parties would see the same ‘golden record’ of the corporate action event.
Security, Regulation, and Interoperability
Currently, experiments and pilot efforts in digital custody have taken different forms including securities and tokens issued on public and private chains, giving rise to questions like:
What is the most secure and regulatable form of digital custody?
If securities exist on multiple blockchains, how do we ensure that trades between chains are settled correctly and that information about the securities is communicated accurately?
We believe an ongoing industry-wide conversation and effort will be necessary to ensure this type of interoperability to maintain the liquidity and security of digital asset markets. In the Industry Paper, DTCC, Clearstream and Euroclear have committed to “being at the forefront of this discussion”.
Integration
The Digital Asset Era is quickly approaching, but currently we are in a period where traditional custody and digital custody exist simultaneously. Investors will want their portfolios to be integrated, so banks and brokers will need to develop products that allow investors to seamlessly manage their traditional assets alongside their digital assets.
On our end, BondCom and Acupay will strive to continue to improve the servicing of traditional assets, while we continue to plan for our support of the Digital Asset Era.