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A Stable Future: The Evolution of Trade Finance as a Digital Asset

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By Christoph Gugelmann, CEO, Tradeteq.

The emergence of digital assets such as cryptocurrencies as a means of achieving investment returns is gathering pace amongst bank and non-bank trading institutions. For example, State Street launched a dedicated cryptocurrency division while Standard Chartered announced plans to launch a cryptocurrency trading platform. Meanwhile, a survey of 100 hedge fund CFOs signalled their intent to significantly increase their exposure to digital assets over the next five years.

This comes at a time when cryptocurrencies face a wave of regulatory scrutiny. Regulators and policymakers see them as fraught with high risks and suffering from staggering levels of volatility. Recently, the Basel Committee on Banking Supervision (BCBS) proposed tough capital requirements for banks that hold crypto assets due to financial stability concerns. China’s ban on all transactions of cryptocurrencies has since fuelled the uncertainty and speculation over their future.

All this hasn’t stopped highly regulated financial institutions assessing cryptocurrencies from an investment perspective – but why not? The answer is very simple: a hunt for yield.

Traditional safe havens leave investors starved of yield

Bonds – the traditional instrument of choice for investors seeking safe, stable and long-term returns – can no longer provide reasonable returns. FX and equities had a rollercoaster year and remain unpredictable; subject to sudden bouts of volatility followed by an extended deep slumber. Added to this, oil prices moved into negative territory for the first time in history last year – shaking the market to its core.

Starved of yield, the widespread interest in cryptocurrencies from institutional banks, brokers and their clients – from family offices to hedge funds – is indisputable. While comparing asset classes like-for-like is not always possible, cryptocurrencies’ continued traction is a clear indication of their mainstream appeal and potential longevity as part of the investment mix. However, recent announcements from international regulatory bodies and central banks such as the Bank of England suggest it won’t be plain sailing.

Trade finance – a safe but overlooked asset class?

As a result – and as investment strategies mature – digital asset buyers are wise to balance out their portfolios of speculative cryptocurrencies such as bitcoin, which are prone to higher levels of volatility, with more robust alternatives. Stable tokens have emerged as a valuable instrument to help achieve this, pegged to fiat currencies or other reserve assets to offer greater price stability.

One instrument that is proving an ideal reserve pool for stable tokens is trade finance – a safe but all too often overlooked asset class. Trade finance can be delivered in many forms; as a traditional asset, repackaged into notes, or as a digital asset.

Despite this, trade finance remains one of the largest financial markets yet to be tapped into by institutional investors. According to MarketWatch in 2021, the trade finance market is worth an estimated $7.6 trillion. However, only 5% to 6% thereof were distributed between banks and insurance carriers, while the percentage amount distributed to capital markets was almost negligible. This presents a multi-trillion-dollar opportunity.

On paper, trade finance has all the components that investors look for – and not just within the digital asset realm. It is based on the tangible flow of physical goods, making it less susceptible to financial market volatility. This means it potentially provides more stable returns – as well as a robust foundation for stable tokens. It is also a low-risk asset class; default rates for trade finance products are lower and the time needed to recover in case of default is much shorter than for other products and asset classes.

So why has it been overlooked for so long? In the past, there has been a key ingredient missing: an electronic trading infrastructure that is easy to connect to, along with standardised processes and definitions.

Looking beyond digital assets to traditional asset classes such as equities and FX, the products being transacted are largely standardised and highly liquid, and the settlement process is secure. Trading these products is relatively easy, safe and highly transparent. Achieving a similar level of simplicity in trade finance – an industry that is historically paper-based and reliant on manual processes – requires seamless automation between a diverse range of industry participants. This includes banks, non-bank investors, credit insurers, data providers and regulatory authorities – just to name a few – to make it an efficient proposition.

Fortunately, the technology now exists for banks to distribute trade finance assets in an automated manner. Assets can be bought and sold through private distribution networks and settled like common fixed income products, while end-to-end processing across the entire trade lifecycle reduces friction costs, increases transparency and boosts the available yield for institutional investors.

Overcoming regulatory hurdles through trade finance distribution

Trade finance distribution is more than just allowing banks and investors to transact assets. It is about establishing an asset class that has mass appeal and generates meaningful returns.

Many investors believe traditional asset classes offer limited investment opportunities and have been forced to look elsewhere in their search for yield – with cryptocurrencies and digital assets currently flavour of the month. However, in the process, investors need to adhere to the very fundamental aspects of trading that underpin any financial market – a safe, stable, robust and regulatory-compliant trading environment.

Digital assets and trade finance investment are not mutually exclusive – and what’s clear is that when trade finance is delivered as a digital asset, it becomes particularly powerful. Pegged to a stable token, it can provide investors with a secure complement to the more speculative cryptocurrencies and, ultimately, a stronger tool in the hunt for long-term yield.

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