INDUSTRY WATCH

DLT , DeFi and digital ( crypto ) assets have the potential to accelerate and reduce the cost of asset transactions . DLT essentially acts as a digital system for recording transactions . This means it offers ‘ immutable records ’ – unchangeable digital logs stored on a distributed ledger or Blockchain – and so every asset transaction or change in ownership is documented in a permanent , verifiable manner . This can ensure greater transparency and security , whilst simplifying due diligence and transaction costs .

By converting physical or illiquid assets into ‘ digital tokens ’ that represent ownership , DLT also enables currently illiquid assets to be traded on Blockchainbased platforms – opening up opportunities to establish entirely new asset classes . Illiquid assets could be traded in a similar way to high-frequency trading , with more dynamic , AI-enabled investing strategies . It also offers the possibility of fractional investment .

For example , gilts could be used to fund capital investments – such as UK critical national infrastructure – whereby previously illiquid large infrastructure projects are fractionalised using tokens and linked to a UK digital gilt . This would enable UK national infrastructure to be funded by a larger number of investors , including private equity and global retail investors . At the point of selling , the larger size of the capital pool and the liquidity available could support getting the target sale price of these assets , with a new range of DLT-backed instruments phasing the sale of assets and smoothing price volatility .

Risks remain

In short , DeFi could drive significant innovation and democratisation in the financial sector . Yet it ’ s important to be clear sighted about the operational , regulatory and technology risks . Having a digital gilt will require a wholesale digital pound – that is , a pound that is a cryptoasset and uses DLT platforms for its issuance and the control of money supply . This is because a digital pound could enhance the speed , efficiency and functionality of digital gilts , enabling frictionless transactions with orders-of-magnitude lower transaction costs when compared with TradFi and its much higher settlement times .

Transactions with the digital pound will be faster than those for a physical pound . Whilst the difference will only be fractions of a second , in foreign exchange trading , these small margins matter . If a digital pound is traded quicker , it opens the possibility of closing a trade , and then using the small-time difference to either hedge the trade using a physical pound or manipulate the market through liquidity constraints .

There is also the risk that a DLT-enabled digital pound could affect the value of money . The decentralised nature of DeFi means that no central authority controls a digital asset once it has been released . The owner of a digital asset could therefore opt to destroy it , deleting the data and digital representation of its physical counterpart , and a bad actor could try to influence the money supply by acquiring and destroying digital pounds in significant quantities . These potential unintended consequences will need to be thought through and addressed .

Role of data

While technological innovation creates risks , technology – in the form of data analytics – also provides a way to manage and mitigate those risks . At the heart of DeFi is transaction data . Creating a digital gilt – and a digital pound – requires new levels of data , with higher quality customer data views and cleaner data processing .

Christopher Hinitt , PA Consulting ’ s Digital Banking and Operations Lead

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