Mike Kühnel, Partner, Frankfurt at Bain & Company, Thomas Olsen, Partner, New York at Bain & Company, John Fildes, Expert Partner, Sydney at Bain, and Karl Gridl, Senior Manager, Zurich at Bain, have all co-authored a brief, titled “For Digital Assets, Private Markets Offer the Greatest Opportunities.”
The authors have identified several emerging business models that “hold promise” by leveraging the potential benefits of blockchain or distributed ledger technology (DLT).
As mentioned in the brief, private capital markets, which currently “overshadow” public markets in terms of overall value and growth, are presently plagued by inefficient, “opaque” processes. But now they’re expected to “experience a step change” via tokenized digital assets and associated platforms running on DLT-powered systems.
The authors pointed out that the biggest or best opportunities may be found in private debt, equity and real estate, because of their “relative inefficiency” when compared with related public market infrastructure. The potential benefits of all-digital platforms may include “more efficient administration processes, embedded transparency and governance, and, eventually, an expanded set of product options and pools of investors,” the brief confirmed.
According to Kühnel, Olsen, Fildes, Gridl, there are a number of key business models that have emerged “as viable over the near term.” In order to succeed when using each of these models, industry participants need to adopt an “end-to-end perspective along the entire value chain, from issuance through trading and custody,” the authors recommended.
Even after many years of technological advances, the international financial markets remain “characterized by fragmented and siloed networks, with limited interoperability between them,” the brief’s authors claim. They pointed out that reconciliation between different systems still needs extra, sometimes manual, steps to be completed. Many of these processes across the capital markets ecosystem “continue to be prone to error and high costs,” the authors claim. They also mentioned that this “applies to public markets but even more acutely to private markets.”
They further noted that “as a consequence, a consensus across the global financial ecosystem has emerged: Digitized financial assets and DLT platforms will substantially improve transparency of information, automation, distribution and, ultimately, liquidity.”
According to the authors, the adoption of these digital assets (assets that are regulated financial securities representing digital value and administered on digital platforms) will be able to expand “beyond the first niche application of cryptocurrencies, with DLT removing many sources of inefficiency.”
They also mentioned:
“Exchanges, banks, technology companies and other financial market firms will need to make decisions soon about how to participate, as it takes time to build an economically attractive business model and the required capabilities and partnerships. Postponing this decision comes with the risk of losing strategic position as early movers gain share and replace or create new market infrastructure roles.”
Even though there might be a lot of uncertainty around related legislation, “dominant technologies and trustworthiness” of some new companies in this sector, could lead to digital assets “increasingly serving as substitutes for traditional financial products―not completely replacing them but rather operating side by side for many years.”
In the short-term, blockchain or DLT-based platforms will be able to “digitally represent” traditional financial assets on a distributed ledger to offer “more efficient administration, such as in managing collateral,” the authors noted. They also pointed out that digital assets could potentially “make inroads” in issuance, trading, settlement, transfer and custody. That’s because existing systems for managing private assets require costly, manual/laborious tasks that are performed by many different intermediaries (leading to “cumbersome, duplicative and nontransparent processes”).
According to the authors of the brief, almost any type of asset may be tokenized, “in the sense that related rights of ownership or entitlement to cash flows, along with obligations, can be captured and stored via DLT.”
“We have already seen oddities, such as shares in a professional athlete’s contract or fractional ownership of a painting. Yet while DLT has earned broad attention and support, the biggest opportunities do not lie in public markets, whose current technologies are fairly efficient and would be expensive and complicated to replace in the near term.”
“Instead, private markets, which lack such efficient infrastructure, offer the most significant commercial potential. The size of private markets across three major asset classes significantly exceeds public markets by a factor of 2.5 in the case of debt markets, 4.5 in equity markets and over 30 in real estate.”
Available data indicates the “magnitude of the opportunity”:
Equity. In the OECD member countries, “of roughly 98,000 firms with more than 250 employees, only 22,000 firms are listed publicly.” Digital assets will “allow for more efficient administration of assets among alternative asset managers and enable a secondary market.”
Debt. Global debt “amounts to $258 trillion, but only $106 trillion of that is traded as securities on the public capital markets.”
Real estate. Global real estate “amounts to $317 trillion, but only $10 trillion of that is managed in funds and available to a broader investor base through the public real estate market.”
During the last 2 decades, the compound annual growth rate (CAGR) of private assets has been around 4x that of publicly traded assets. The authors noted that they’re projecting growth to further accelerate if private markets “become more accessible to investors via digital assets.”
Digital assets, however, are not some miracle that will magically make smaller firms more profitable (or “more desirable”) to invest in. The authors also don’t think these assets will “circumvent retail investor protections by, say, allowing anyone to trade any private asset directly on a mobile app.”
Instead, the authors believe that “the near-term breakthroughs consist of automating workflows and data ranging from capitalization tables to share transfers and dividend or interest payments.” According to the brief’s authors, digital asset services providers will offer certain advantages or benefits in terms of overall efficiency and cost savings, “accessibility” and greater transparency. This should “enable new private capital market innovations.”
The brief concluded:
“With more start-ups emerging, incumbent companies gaining a foothold through partnerships and consortiums, and venture capital flowing to insurgent companies focused on digital assets, the time is ripe for interested market participants to make their play. Early movers that take a systematic end-to-end approach stand to land the best opportunities.”
(Note: you may read the full brief here.)