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In February 2021, Tesla announced that it had purchased $1.5 billion worth of Bitcoin. This decision was part of a broader strategy to diversify its cash holdings and ensure more flexibility. More recently, major corporations like MicroStrategy have been making headlines by investing parts of their financial reserves in cryptocurrencies.

This move highlights a growing acceptance of the value that Web3 technologies bring to the table. 

However, reports from Crunchbase paint a slightly different picture reporting an 82% drop in Web3 investments during the latter half of 2023. 

Despite conflicting information, what’s more interesting is how Capital Markets are gradually embracing Web3, laying the ground for what could be a slow but significant transformation.

In this blog, we explore emerging use cases of Web3 technologies in the US Capital Markets.

Tokenization of Assets

One of the most promising applications of Web3 in capital markets is the tokenization of assets. Tokenization refers to the process of converting physical and digital assets into blockchain-based tokens.  This can transform the way securities are issued and traded, by converting stocks, bonds, and other financial instruments into blockchain-based tokens, the process of issuing, trading, and managing securities becomes more efficient. This can lead to improved liquidity, reduced costs, and greater accessibility for investors.

This technology also allows for fractional ownership, making it easier for investors to buy and sell shares of high-value assets such as real estate, art, and even shares of privately held companies. By enabling fractional ownership, tokenization can democratize access to investments, making it possible for a broader range of investors to participate in markets that were previously inaccessible. The World Economic Forum estimates that 10% of global GDP will be stored on blockchain by 2027, highlighting the potential scale of this transformation.

DeFi 

Decentralized Finance, or DeFi, is another significant innovation driven by Web3 technologies.  While DeFi is broader in scope, its principles can be applied to capital markets. For example, decentralized exchanges (DEXs) allow for the trading of tokenized securities without intermediaries, potentially lowering transaction costs and increasing market efficiency. Additionally, DeFi lending protocols can provide alternative financing options for companies looking to raise capital.

DeFi platforms leverage blockchain technology to offer financial services such as lending, borrowing, and trading without the need for traditional intermediaries like banks. These platforms operate on smart contracts, which are self-executing contracts with the terms directly written into code. The use of smart contracts ensures transparency and reduces the risk of fraud, making DeFi an attractive alternative to traditional financial systems.

In recent years the entire ecosystem around decentralized applications has made significant development. For instance, as of 2023, there are over 4,000 dApps in operation across various blockchain platforms, compared to just a few hundred a couple of years ago. The DeFi space alone saw its total value locked (TVL) in smart contracts skyrocket from around $1 billion in early 2020 to over $80 billion by mid-2023.

Platforms like Aave and Compound have billions of dollars locked in smart contracts. These platforms allow users to lend their crypto assets and earn interest, or borrow assets by collateralizing their existing holdings. By offering these services directly to users, DeFi platforms can provide more competitive interest rates compared to traditional banks.

As DeFi continues to evolve, it won’t replace current financial systems, but it will have a a deeper integration with traditional financial systems, leading to a hybrid model where DeFi protocols complement and enhance existing financial infrastructure. Regulatory clarity will play a pivotal role in this integration, as clear guidelines will encourage more institutional participation. The future holds the promise of a more democratized financial system, where access to capital and financial services is not limited by geography or traditional banking constraints. With ongoing innovation and collaboration between regulators and industry stakeholders, DeFi could significantly improve efficiency, transparency, and inclusivity in global capital markets.

Blockchain: Potential for Improved Post-Trade Processing

Blockchain technology is increasingly being explored by asset managers, investment banks, brokers and other capital markets organizations globally with the objective to increase transparency and modernize market infrastructure. 

One of the most promising applications of blockchain in capital markets is in post-trade processing. Traditionally, the settlement of trades involves multiple intermediaries, which can lead to delays and increased costs. By providing a decentralized, immutable ledger that ensures all parties have access to the same data in real-time, blockchain can significantly streamline operations and reduce the risk of errors and fraud. This transparency is particularly beneficial in post-trade processing, where traditional methods involve multiple intermediaries and can lead to delays and increased costs. 

Furthermore, blockchain’s ability to offer real-time data synchronization means that all stakeholders, from asset managers to brokers and regulators, have a single, unalterable version of the truth. This can enhance compliance and auditability, as all transactions are recorded in a transparent and tamper-proof manner.

Significant Signs of Web3 Adoption 

• Goldman Sachs launched the new tokenization platform GS DAP in November 2022. It facilitates the issuance, registration, settlement, and custody of digital assets, including digital bonds.

• In Feb 2022, London Stock Exchange Group announced acquisition of TORA, through its Caspian platform provides digital asset trading technology that cover the entire lifecycle of a crypto trade. It includes a fully developed trade order and execution management system, algos and reporting.

NFTs: Moving beyond Speculation

NFTs introduce a new dimension to investment portfolios by representing ownership of unique digital assets.  For example, NBA Top Shot, a platform for trading officially licensed NBA highlight clips as NFTs, has generated over $700 million in sales in 2023, showcasing the commercial potential of this technology. 

Beyond collectibles, NFTs have the potential to revolutionize capital markets by enabling the tokenization of real-world assets such as real estate, fine art, and even intellectual property.

In capital markets, NFTs can be used to represent ownership of unique financial instruments, facilitate the trading of fractionalized assets, and ensure the authenticity and traceability of securities. By leveraging blockchain technology, NFTs can offer an immutable record of ownership and transactions, reducing fraud and enhancing trust among investors.

What to Expect Next?

Web3 technologies are poised to revolutionize capital markets, bringing a wave of democratization and innovation. The integration of decentralized finance (DeFi), non-fungible tokens (NFTs), and blockchain technology has the potential to reshape the financial landscape by making it more inclusive, transparent, and efficient.

The blending of traditional financial systems with Web3 innovations will create a hybrid model that leverages the strengths of both. Decentralized exchanges and tokenized assets can lower transaction costs and broaden access to investment opportunities, while blockchain’s inherent transparency and security can enhance trust and reduce fraud.

However, this transition is not without its challenges. Navigating regulatory uncertainties, managing technological risks, and addressing industry-specific issues are critical steps toward achieving the full potential of Web3 in capital markets. It is essential for stakeholders to approach this evolution with a balanced perspective, combining innovation with caution.

As we move forward, the collaboration between regulators, industry players, and technology developers will be key. By working together, we can develop robust frameworks that support innovation while safeguarding the interests of all participants. In essence, the journey towards fully integrating Web3 into capital markets is just beginning, and its success will depend on our collective ability to navigate the complexities and harness the opportunities that lie ahead.