Digital securities: Game changer for the DeFi sector?

Digital securities could be the reason why many banks will start offering cryptocurrencies soon.

Digital securities could be the reason why many banks will start offering cryptocurrencies soon. Here are the reasons:

For many crypto enthusiasts, digital securities like security tokens or even crypto securities are likely too boring and brittle. Who would still be interested in a real estate bond or corporate financing bond that pays 5% interest per year? The digital embodiment of securities via tokens on a blockchain currently seems to appeal mainly to people who work in banking and finance themselves.

Risk-averse crypto investors have little interest. Buyers of crypto-based securities are usually investor groups that previously weren’t in the crypto sector. With this background, it’s important to clear up a few misconceptions.

The potential of digital securities

Everything is going digital, not just our money but also our investment products. Just as we’ll have the European Central Bank’s digital euro in a few years, every security - whether it’s a stock, bond, or fund - will be issued digitally in the future. While the crypto market has a market cap of only about $1 trillion, we’re talking about roughly $100 trillion in the equity sector alone. This is even excluding derivatives or bonds.

Besides the expected conversion of existing securities into coins, it’s mainly new issuances driving the change here. A recent study from the Boston Consulting Group predicts a market volume of coin-based securities of $16 trillion by 2030.

Is Ethereum suitable?

All those billions of euros, dollars, and the like will be issued on public blockchains like Ethereum, Polygon, or Stellar in the form of security tokens. Because of high transaction costs on the Ethereum network, cheaper alternatives like Polygon have come to the fore in recent months for security issuances.

Institutional adoption via securities

But more important than the flow of funds to Polygon and other cryptos is the push for banks, exchanges, and other financial service providers to rely on crypto infrastructures. A bank that once dismissed Bitcoin and other cryptocurrencies got over that ignorance. But no savings bank, cooperative bank, or commercial bank can ignore the securities sector in the long run. That’s why all banks are working on crypto custody solutions.

For example, the German Savings Bank and Giro Association said a few weeks ago that this was only for digital securities, not Bitcoin. But one could overstate this and say digital securities are nothing more than a first big step toward cryptocurrencies. If the token infrastructure is in place and service providers for their securities business are forced to hold cryptocurrencies in their wallets, it will only be a matter of time before the institution’s Bitcoin skeptics yield. Mass adoption of crypto in the traditional banking system will thus get a major boost with the introduction of digital securities and, ultimately, the digital euro.

But this is just the beginning. The real game changer and the complete fusion of the traditional securities world and the crypto sector will come to light somewhere else.

Real assets in a DeFi environment

Amid the current financial and economic crisis—which is now normal to call the macro backdrop—the DeFi sector has likewise collapsed. The lack of stability and certainty could now be addressed in the sector by so-called real-world assets or digital securities backed by things like gold.

Let’s take the example of a decentralized autonomous organization, or DAO, set up as an investment fund. This decentralized investment fund, where decisions aren’t made by a single fund manager but by the community, has so far only been able to invest in cryptocurrencies or NFTs.

Of course, this made such structures vulnerable to volatility. With professional wallet management, an institution can fall back on multiple asset classes to optimize risk. So if we see further issuance of digital securities, also regulated, it will become easier to back a DAO fund with real estate bonds.

This example shows we’re just at the very start of the merger between the crypto economy and the traditional financial world. Additionally, it can be noted that both worlds depend on each other to develop further.

Praise for regulatory efforts

Although politicians and regulators are often quite skeptical of cryptocurrencies, they are very open and positive about digital securities. Even a Bitcoin opponent like Olaf Scholz thinks digital securities are great. He actively promoted the Electronic Securities Act (eWpG), on which so-called crypto-securities are based, when he was finance minister in 2021.

Since the previous digital form of securities carried certain limitations, Germany developed the special form of crypto-securities under the eWpG. Next year the eWpG will be expanded to stocks as described in the recently published Future Financing Act. At the European level, there’s an effort to create a uniform legal framework for digital securities with the DLT pilot regime. This is especially important for trading on the secondary market. There are still no exchanges for digital securities