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Digital Asset Working Group Report June 2019 Contents

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Digital Asset Working Group Report June 2019 Contents Digital Asset Working Group Report June 2019 Contents Executive Summary ...................................................................... 1 Level-setting .................................................................................. 4 Market Context ......................................................................... 4 Survey Results ........................................................................... 5 First Survey - November 2018 .......................................... 5 Second Survey - February 2019 ...................................... 7 Drivers for adoption across the digital asset value chain .. 12 Token Definitions & Taxonomy ................................................. 14 Defining Tokens ....................................................................... 16 Token Data Structures ..................................................... 17 Specific implications for tokens in financial markets ........ 19 Key Regulatory Considerations for Tokenizing Assets in the EU and UK ......................................................... 19 Tokenomics & governance sub-group input .................. 22 One specific area this group is taking forward ................... 25 Projects going forward ......................................................... 25 Decentralised Finance .................................................... 25 Why is DeFi important for financial institutions to watch? ............................................... 25 How is DeFi different from what came before it? 25 What are some of the larger projects? ................26 Next Steps .....................................................................................26 About R3 ........................................................................................ 27 opportunities and hurdles for Taxonomy & Definitions,” “Legal Executive the market. Surveys showed the and Regulatory Considerations,” following: “Digital Asset Network summary Governance,” and “Go-Forward • Blockchain-enabled digital Projects.” The digital asset ecosystem assets are primarily a revenue is the most exciting area for opportunity, held back The DAWG put forward a blockchain technology, and it somewhat by regulatory taxonomy and definition of digital has massive implications for uncertainty. assets, to help participants use the way businesses interact and custody assets from both • The most significant in every industry. This is most a technical and business sense. impact will be in digital immediately relevant in capital This taxonomy is purposefully representations of real assets markets, where the ability to and digitally native securities. aligned to the many digital represent assets and transact asset taxonomies taking shape over digital rails with new models • Most organizations plan in the market, in which R3 and of trust is changing the way that to have products in the other DAWG participants are capital acquirers and allocators market in these areas in the actively involved. The purpose interact. next 1-5 years. The most of this effort was to go further powerful forces for market than a simple taxonomy and advancement are digital-first Innovation in digital assets provide a reference model exchanges and new models has always been oriented to for how digital assets can be for custody of digital assets, connecting issuers and investors which fits with a broader represented in code and how in more efficient and valuable market theme of an evolving they are recognized by existing ways. The financial crisis of and expanding role for both laws and regulations. The Legal 2008 provided a moment of exchanges and custodians in & Regulatory group shared opportunity, which bitcoin and the digital asset space. implications from an EU and UK blockchain technology seized legal perspectives, including in the following years. The • The distributed nature of MiFID and CSD-R applications. blockchain business networks Ethereum ecosystem presented a This assessment highlighted offers advantages (verifiable new world of digital assets, which the importance of regulated provenance) and challenges (if culminated in a bubble itself in one is using PoS). Security Settlement Systems 2017, when capital was allocated and the role of custodians in a to projects with weak business There is little doubt that the ability market where participants can cases. The market is moving to to create smart contracts and manage or delegate ownership take advantage of blockchain put more automation into digital of digital assets and private infrastructure, but is focusing assets directly adds significant keys. The Governance group on real enterprise use cases value through the capital examined considerations of and institutional scale. It was markets lifecycle and may make network governance, which in this environment that R3 - a middle and back office functions changes based on the consensus blockchain software technology more efficient. For all of this to be mechanism, the stakeholders company - brought together a possible, the market needs clear in the network, and the way the group of 50 organizations and standards on asset issuance, network participants execute 100 participants, all of whom are exchange, settlement, and changes to the network. active in the digital asset market. management. The primary product of the The working group was framed The DAWG produced multiple DAWG as a whole was the by two sets of surveys intended sub-working groups, which identification and assessment to establish market readiness addressed different aspects of the market drivers for digital and the outlook for digital assets, of the digital asset ecosystem. asset market adoption. Those as well as identify the major These included “Digital Asset drivers are framed within the © 2019 R3. All Rights Reserved 1 digital asset value chain, which transaction finality, flexible trend is producing interesting includes issuance, registration, custody models, and a solution projects and innovations in exchange, settlement, and to include verifiable identity. financial markets. management. The general Finally, this paper addresses a requirements for market scale few opportunities for projects The Digital Asset Working Group and institutional adoption of going forward. For example, the included participants from the digital assets are clear standards, Decentralized Finance (DeFi) following organizations: Allen & Overy CLS ING PIMCO Alliance Commerzbank Intel Capital R3 Bernstein ATB CU Ledger Itau SBI Deutsche Latham & B3 SocGen Bank Watkins Deutsche BAML Linklaters State Street Boerse Barclays DLA Piper LSEG Trowe Price Blackrock DTCC Mizuho UBS BNC Euroclear NatWest US Bank BNP Paribas Fidelity Nomura Westpac BNY Mellon Fintertech Northern Trust WSGR Cambridge Judge Goldman Sachs Numerate Business School Citi ICICI Perkins Coie © 2019 R3. All Rights Reserved 2 APAC READOUT HIGHLIGHTS DIGITAL ASSET 74% IMPACT of participants pointed to “tokenized assets” as having the most important On May 22nd 2019, over two hundred impact on their organization as and fifty participants joined R3 at Singapore Management University to opposed to “cryptocurrency” (19%) or hear takeaways from the Digital Asset “neither” (17%). Working Group (DAWG) and to discuss the findings in the context of the Asian market. Live surveys of the participants further validated initial DAWG responses. Network fees (specifically “gas” to use Ether) was a significant impediment for the use of the cryptocurrencies that underlie public blockchains. 1-5 Years Similar to DAWG findings, respondents said it would take their organizations one to five years to roll out products and services around digital assets. © 2019 R3. All Rights Reserved 3 As complexity increased, the additional costs incurred. Level-setting trusted custodians picked This is causing pain for financial up another critical market institutions and dissatisfaction Market context function: reconciliation of asset among the most important parts composition and ownership. of the value chain: issuers and investors of assets. Across use cases, issuers and investors have always existed 2008 as the two primary parties to a Bitcoin transaction. An issuer is a party The financial crisis had many who makes a promise to the proximate causes, but the With one whitepaper that built marketplace and an investor market’s structural weakness on decades of cryptographic buys that promise by spending was the origin. Financial markets research and development, money or deploying capital. That did not accurately value assets Satoshi Nakamoto proposed promise could be a commitment and their risk profiles. Further, a system for anonymous, to deliver a good, provide a asset holders did not understand independent parties to transact service, or build a business. The the relationships between with assurances against double- investor is buying that good, assets, which was largely due spends. Bitcoin began as an service, or share of profits. We to the complexity enabled by interesting solution to preventing can call that promise an asset. technology in capital markets. double-spends (fraud) and Complex securitization made it showed how distrusting parties As markets developed, banks difficult to assess and manage could reach consensus about the were employed as trusted safe- risk. When one segment of an state of a global ledger through keepers of assets. They evolved asset class - retail mortgages cryptographic proofs. It was most to provide access to markets. - underperformed, a potentially interesting to institutions
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