The industries ready for transformation are all of those where the service is bad, the price is high, and the margins are high. So, that definitely will be finance, that’s my own industry!

These are the words of Tim Draper, legendary Silicon Valley VC investor, who has invested US$10 billion in over 1000 companies so far. Another big name, Harvard Business School professor Clayton Christensen, when asked about disruption in financial services, replied:

Banks will ultimately be the cause of their own demise if they limit investment in disruption innovations, and focus only on freeing up capital through tightening their belts and automating processes!

Neither of them mentioned asset management specifically, yet you would probably agree that both statements are equally applicable. There are reasons for optimism though! The first very promising proofs of concept (PoCs) are being tested (e.g. Fundchain Smart TA,¹ BNP Paribas Fund Link,² Funds DLT³) and there are many trail-blazing start-ups entering the field (e.g. Melonport,⁴ Polychain Capital,⁵ Blockchain Capital⁶). This is exactly what the asset management industry needs now – fresh ideas and many more real use cases to swing over all stakeholders.

What’s even more encouraging is the fact that in April 2017 the UK’s financial services regulator, the FCA, launched a new phase of their Project Innovate with the aim of helping financial service firms tackle regulatory barriers to innovation, and develop new products and services. Furthermore, the FCA announced that it would work with other international regulators on approaches to innovation.

Challenges and Opportunities

The asset management challenges and opportunities are numerous:

• New technologies threatening to disrupt the existing business model – blockchain, big data and analytics, artificial intelligence (AI), cloud computing and mobile.
• FinTech start-ups leveraging these new technologies most effectively.
• Extremely complex structure of the asset management value chain with many intermediaries and operational processes resulting in high fees.
• Low beta returns due to sluggish economic growth in the developed world and slowing emerging-markets economies.
• Changing demographics across geographies and generations creating new classes of investors – millennials, women and the newly wealthy in emerging markets. Their behaviour, values and expectations are radically different. Millennials are, for instance, more risk-averse and socially conscious than previous generations. They expect to be served 24/7, on demand and via multiple channels and devices. Currently the largest segment of the labour force, they are also the largest investor group.

This chapter will concentrate on the impact of blockchain technology on innovation in asset management due to its potential to completely transform business models in asset management and drastically improve the service the industry offers to clients, along with lower prices.

Blockchain can substantially reduce the costs and increase the speed of any digital transaction or interaction in the fund value chain by enabling investors and issuers to communicate and transact directly, without any intermediaries. Moreover, since all the blockchain transactions are time-stamped, immutable, transparent and auditable, even compliance processes will be greatly simplified.

Taking into consideration that smart contracts are executed as programmed, the data is secured by cryptography and there is no single point of failure, blockchain is also deemed reliable. Hence, the number of errors will also be dramatically reduced!

New Business Model

Figure 1 shows what the prospective business model of fund subscription could look like on blockchain.

• The investor’s fund subscription request sent via an application triggers the smart contract.
• In the first step, the smart contract performs all the required checks and verifications, such as client onboarding, AML/KYC, etc.
• Then, once the smart contract receives the computed net asset value from the fund, it verifies that all conditions are met.
• Subsequently, the smart contract executes the transaction – a newly created digital fund share is exchanged for a specified amount of digital currency, and both wallets are updated.

This is a pretty simplified version of the business model, but it is a very good illustration of how blockchain can streamline the complex operational processes performed on a daily basis by numerous intermediaries in the value chain.

Since everything is managed by smart contracts, all the costs associated with fund and cash processing, AML/KYC and due diligence, errors and reconciliations have been eliminated. Moreover, compliance is automated, since enforced by the blockchain. And the exchange of fund shares for payment is instantaneous.

It is worth mentioning that both the investor and the fund need digital wallets to store currencies and digital assets. Some physical assets, such as diamonds and gold, are already available as tokens on different blockchains (check for instance Everledger⁷ and Digix Global⁸). No doubt many more real-world assets will, in the not so distant future, get tokenized. With that, their liquidity will also be greatly improved!

Other digital assets currently available are cryptocurrencies, digital coins and tokens granting holders access to a software or service. They are all becoming increasingly attractive to investors due to their remarkable growth over recent years. This year, investors will finally be able to gain exposure to an actively managed portfolio of blockchain-based assets – rather than just the major digital currencies – via Polychain Capital.⁹

Ecosystem of Blockchains

Once assets are digitized and transferred onto different blockchains, we will be able to start trading across multiple asset classes in this new ecosystem of blockchains that will come in many different flavours: some private, some public, consortium blockchains, zero-knowledge proof chains, superfast blockchains and so on. They will match different requirements: for instance, a high-frequency fund will require a superfast blockchain. Besides, they will store different types of data such as identities, agreements, property rights, etc.

There will also be different blockchain platforms or marketplaces: for example, BNP Paribas is building Fund Link, dubbed “the next-generation fund distribution platform”, with the aim of enhancing operational efficiency in the fund distribution by utilizing smart contracts and shared information. An excellent example is a speedy onboarding process for fund buyers – they will only have to upload their profile and investor onboarding documents once. This information will then be shared with the various management companies on the platform. BNP Paribas Fund Link will also help asset managers meet the demands of new regulations for higher levels of transparency, such as MiFID II. On top of that, the platform’s analytics tools will enable investors to compare and select funds, and fund managers to fine-tune their distribution. In other words, BNP Paribas Fund Link will enable asset managers to sell funds directly to investors. (Funds DLT is another blockchain-based digital fund distribution platform for asset managers utilizing the powerful D2C business model.)

Adoption Stage

What the future business models of fund subscription and distribution on blockchain will really look like in 10 years is impossible to predict accurately. Not all intermediaries will disappear. Some of them will change their roles, since the new technologies and business models will create different requirements that will need to be met, whereby new roles will be created – digital IDs will have to be created, stored and managed, as well as private keys; smart contracts will have to be built, issued and maintained; smart wallets will have to be managed and operated, etc.

We are still in the PoC stage of the development. The first results are pretty encouraging, although the transformation is going to last for years. Transitional models in this adoption stage will still need intermediaries, because many transactions will still be executed in FIAT currencies, digital wallets for currencies and assets are not yet prevalent, and the new blockchain processes will at first need solutions for integration with the existing infrastructure in asset management.

New Revenue Opportunities

So far we have discussed the huge cost savings and operational efficiencies blockchain will create. Let’s now turn our attention to the new revenue opportunities it might generate. Lower trading costs, better liquidity, greater transparency and improved customer experience are all expected to considerably increase market participation. In addition, blockchain will certainly enable new product structures (e.g. digitized fund units). Analytics and real-time reporting will enhance value-added client services. And more complex instruments, such as syndicated loans for instance, are likely to become more economic.

Potential Disruptor

The picture of the current state of innovation in asset management would not be complete without mentioning at least one potential disruptor. Melonport’s idea is to make it much cheaper and easier to manage assets, or set up a hedge fund or portfolio on blockchain. The start-up is building Melon¹⁰ – open source software for asset management. Since the software is being built on Ethereum, accounting and security will automatically be taken care of, as well as any fund embezzlement or manipulation by fund managers.

Within a year, Melon will provide the first live release of a user-friendly interface and core tools. The first version will solely support crypto managers by enabling them to trade all ERC20¹¹ tokens, since Melonport firmly believe that crypto is the next asset class! Nonetheless, Melonport expect that within five years pretty much all assets will be collateralized. By then, the start-up will be capable and ready to help users build a well-diversified portfolio with a wider range of assets than in any bank portfolio today. And pretty much anyone will be able to manage their own portfolio on blockchain, invest in other portfolios or have others invest in theirs.

Exciting Times Ahead

Although a new operating and regulatory framework for the industry has not been defined yet, this is the right time for the players in the asset management industry to evaluate strategic investments in their own blockchain capabilities to ensure that they are able to compete and grow in the future.