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Three blockchain application scenarios for the financial services industry

By Dr Nils Bulling, Head of Digital Strategy and Innovation, Avaloq

Bitcoin and other cryptocurrencies such as Ethereum continue to make headlines. In addition, the rapid rise of non-fungible tokens, or NFTs, is also becoming mainstream news and, in the process, an exciting new asset class. But, in the debate about Bitcoin and other digital assets, the underlying use case for blockchain technology should not be overlooked.

Blockchain is one of the most compelling contemporary technological developments in the world, and this momentum will continue to accelerate. It has an increasing number of real-world applications in a range of industries, including the financial sector.

The global wealth management industry, in particular, is well placed to benefit from blockchain technology, with three application scenarios particularly promising right now: investing in cryptocurrencies and digital assets; tokenizing non-bankable assets (nBAs); and decentralized finance (DeFi).

  1. Investing in digital assets and cryptocurrencies

Challenge: It remains important for investors to have a diversified investment portfolio, and this will increasingly mean exposure to some form of digital assets. The digitalization of assets offers the public the chance to invest in and accumulate assets in new ways. Previously, such investments have been inaccessible to many investors, or at least very difficult to access. Today, there is a strong business case in making investors aware of the return opportunities – and the risks – of digital assets.

Solution: Technological solutions now exist that allow financial institutions to tap into the field of digital assets with surprisingly little effort. Banks and wealth managers can make all investment options available to clients from a single source or platform – from traditional cash investments and equities, to cryptocurrencies and other digital investments. Shares in unregulated funds can be issued in the form of digital assets and managed securely on these platforms, for instance.

Outlook: Digital assets allow financial institutions to offer their clients new investment opportunities. Different types of digital assets also offer financial institutions the chance to tap into new client segments. We believe that the financial services industry is entering a period of explosive growth in financial products based on digital assets. Banks and wealth managers will need to offer their clients the seamless integration of these assets.

  1. Tokenizing non-bankable assets

Challenge: Around a third of all global assets are currently illiquid assets, also referred to as non-bankable assets (nBAs). These include artworks, exclusive real estate, and classic car collections. Handling nBAs is often more challenging for banks than handling traditional, liquid assets, such as shares and bonds. This is partly due to the fact that alternative investments often entail high entry barriers for investors and partly because pricing, computing risks and forecasting returns are more complex for them.

Solution: Through blockchain technology, nBAs can be offered in the form of tokenized assets. This reduces entry barriers such as minimum investments, and liquid markets are emerging for these assets. The technology allows financial institutions to establish nBAs for a broader investor base.

Outlook: With tokenized assets, financial institutions can drive forward the democratization of assets and make alternative assets accessible to a broader investor base. Tokenization enables clients to trade fractions of a classic car collection, a luxury villa or a Picasso painting, for instance. This should push up demand for nBAs as well as for new advisory services. Experts anticipate a market volume of around USD 24 trillion by 2027. Long-term potential will certainly be significantly higher, if the total volume of all illiquid assets is taken into account.

  1. Decentralized finance (DeFi)

Challenge: Decentralized finance (DeFi) involves a decentralized model that runs counter to centrally organized financial services. The traditional centralized approach brings with it the existing advantages but also the disadvantages: a quasi-monopoly situation can make other parties dependent on certain entities and can expose them to red tape and inefficiencies.

Solution: Blockchain technology allows financial services to be decentralized, thanks to smart contracts, which store transaction data in the distributed ledger as well as rules for transactions. Investors interact with one another directly as the smart contract replaces the intermediary. Besides blockchain, other modern technologies, such as the internet of things (IoT), artificial intelligence and big data, also play a key role in the new DeFi concepts. Decentralized applications (Dapps) allow access to various DeFi services. These range from peer-to-peer payments to loans and decentralized exchanges. They can be accessed through the blockchain directly and without the usual need for a financial intermediary.

Outlook: DeFi opens up great opportunities for the world of business – especially as it can include people who previously had no access to banking services. Financial institutions can open up entirely new business models such as secure storage of private keys, innovative insurance solutions or automated verification of identities. The dollar value in DeFi applications has increased fifty-fold within a year; as such, it seems advisable to address the topic and identify business opportunities.

Conclusion: Blockchain is the future

We believe it is likely that blockchain technology and its applications will help to shape the future of banking. Also new stable coins – and perhaps even a digital euro – could end up driving this development forward. Digital assets and DeFi applications will significantly change the face of the financial services industry. At the same time, they will open up entirely new revenue opportunities for institutions.

Banks and wealth managers should examine the opportunities offered by cryptocurrencies and digital assets now so that they will be able to cater to growing demand as client interest increases. Any institution that is not prepared for this could easily suffer competitive disadvantages among new as well as existing clients.

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