Digital assets are here to change the paradigm of how everyone will conduct their daily transactions.

In the wake of the digital era, originating in the 1970s, we find ourselves amidst a significant societal transformation, wherein every aspect of human endeavour experiences a profound enhancement marked by the pervasive presence of digital solutions. This transition has precipitated a fundamental shift in economies, cultures, and societal norms, heralding an era wherein virtually all facets of life have been redefined by the transformative impact of the internet. One such revolution has been in the retail banking sector, where the use of online banking and payments has replaced cheques and cash. Online retail companies, like Amazon, have benefited from individuals’ ability to pay seamlessly online.

Notably, within the financial domain, the rapid expansion of fintech has spurred a revolution, leading to the ascension of Digital Assets (“DA”) as a cornerstone of future financial landscapes. Despite the volatility inherent in cryptocurrencies, enterprises are discreetly establishing the frameworks potential global financial revolution with trailblazers forging a digital asset and decentralized finance ecosystem, primed to digitize and tokenise an array of assets. Innovations in blockchain technology are giving rise to novel DA and tokenized renditions of conventional assets, spanning realms from art to real estate and beyond. The single biggest barrier remains the implementation of a unified global regulatory framework by governments, with each adopting its regimes.

The importance of DA is highlighted by central banks looking to issue their own DA in the form of a Central Bank Digital Currency (“CDBC”). CBDCs represent a significant evolution in the realm of monetary policy and financial technology. CBDCs aim to combine the benefits of digital currency with the stability and regulatory oversight provided by traditional fiat currencies. The development of CBDCs has gained traction as central banks around the world explore the potential of issuing their own digital currencies in the first of our series exploring the world of DA, we start by discussing what they are and the challenges facing them, before exploring various aspects in detail.

What are Digital Assets?

A DA encompasses any item created and stored digitally, possessing identifiable and accessible attributes while imbued with inherent value. It relies on blockchain technology to prevent duplication, spanning a wide range from basic digital media like photos and documents to intricate entities like cryptocurrencies and tokenized assets. Unless explicitly stated otherwise in the relevant documentation, the associated distributed ledger, along with all stored data, operates independently of any singular entity's control, epitomizing decentralization. In our increasingly tech-driven landscape, the significance of DA holds promising value potential across personal and business domains.

The emergence of Bitcoin (and the blockchain) in 2009 following the Global Financial Crisis propelled blockchain technology into the spotlight, pushing DA beyond conventional boundaries. While virtually anything can be tokenized, the focus primarily revolves around cryptocurrencies (such as Bitcoin and stablecoins) and Non-Fungible Tokens (“NFTs”), with the US Securities and Exchange Commission (“SEC”) spearheading the regulatory discourse on whether DA are classified as securities, tokens, or currencies. Nevertheless, the underlying principle remains that for a digital asset to exist, it must demonstrate certain basic qualities, including value, transferability between wallets, utilization of smart contracts for creation and operation, and secure crypto encryption.

An illustrative example of a digital asset, led by the European Investment Bank, was the issuance of a EUR 100 million 2-year bond in 2021 on the Ethereum blockchain in collaboration with Goldman Sachs, Santander, and Société Générale. The entire financial securities sphere stands ripe for digitization, given that all transactions are conducted electronically. This digitization trend is poised to reduce intermediaries and fixed costs, enhance market transparency by revealing trading flows and asset owners' identities, and significantly accelerate settlement speeds.

The significance of DA is underscored by the pervasive impact of digitalization in contemporary society. As individuals increasingly rely on online platforms for rapid information access and opt to store personal data and vital documents digitally, the reliance on digital resources becomes irrefutable. We have already witnessed a transition from paper-based methods such as cheques and cash to electronic payments via bank accounts in everyday life. However, in the realm of DA, the necessity for traditional banking structures may become obsolete with the widespread adoption of digital wallets.

For instance, in emerging economies where a significant portion of the population lacks access to bank accounts but possesses mobile phones, digital currencies and wallets can facilitate transactions without the need for traditional banking services. The amalgamation of digital identity and payments holds the potential to empower individuals to take control of their personal finances, marking a paradigm shift in the financial landscape towards greater inclusivity and accessibility.

What is the Blockchain that is used by Digital Assets?

Blockchain technology began with the introduction of Bitcoin. It was conceptualised in 2008 when an individual or group using the pseudonym Satoshi Nakamoto published a whitepaper titled "Bitcoin: A Peer-to-Peer Electronic Cash System." The first implementation of this technology occurred on January 3, 2009, when Nakamoto mined the genesis block, also known as Block 0, of the Bitcoin blockchain.

At its core, blockchain is a decentralised, distributed ledger technology that records transactions across multiple computers, ensuring the security, transparency, and immutability of the data. Each block in the chain contains a list of transactions, a timestamp, and a cryptographic hash of the previous block, linking them together. This structure makes it extremely difficult for any single entity to alter the information without consensus from the network, thereby providing a secure and reliable method for recording and verifying transactions. Blockchain technology underpins cryptocurrencies like Bitcoin and has potential applications across various industries, including finance, supply chain, and healthcare.

In a later article, we will explain in more depth the concept of the blockchain.

DA: History and evolution.

The origin of DA can be traced back to 1998, when Nick Szabo conceptualized bit gold, envisioning a decentralized digital currency as an alternative to centralized financial systems. Despite its theoretical underpinnings, the concept remained resting until 2008, when Bitcoin emerged as a creative innovation. Introduced by the pseudonymous Satoshi Nakamoto via a whitepaper, Bitcoin revolutionized finance by leveraging blockchain technology, a decentralized ledger system that eliminates the need for intermediaries in peer-to-peer transactions. This innovation garnered widespread attention and adoption, heralding a new era in finance.

Bitcoin's rise paved the way for the proliferation of alternative cryptocurrencies, commonly referred to as altcoins. This trend began with Litecoin's introduction in 2011, as various projects sought to address perceived limitations in Bitcoin's design or introduce novel features, thereby diversifying the digital asset landscape. Concurrently, the introduction of stablecoins in 2014 marked a significant milestone in addressing concerns surrounding cryptocurrency volatility. These DA pegged to traditional fiat currencies or commodities, offer price stability while harnessing the transformative potential of blockchain technology. With features facilitating seamless peer-to-peer transfers, digital wallet integration, and cross-border transactions, stablecoins have emerged as a cornerstone of the evolving digital asset ecosystem.

Despite the promising trajectory, the DA market faced a significant challenge in 2018, commonly referred to as the crypto winter. During this period, leading cryptocurrencies such as Bitcoin and Ethereum experienced a notable downturn in prices. However, the market demonstrated resilience, with Bitcoin experiencing a remarkable resurgence by 2021 and then, end of 2021 until the beginning of 2023 bitcoin dropped. Now is at a record high again.

In the realm of NFTs, their ascent signifies a transformative shift in the digital economy, propelling blockchain technology to unprecedented levels of prominence in the Web3 era. The journey commenced in 2014 with the creation of the first-ever NFT, Quantum, by Kevin McCoy on the Namecoin platform (later migrated to Ethereum). Mainstream interest in NFTs gained momentum around 2017, coinciding with the emergence of Ethereum-based NFT collections enabled by smart contracts. However, the true explosion occurred in 2021, fuelled by two significant catalysts that accelerated NFT adoption and public interest. Firstly, the COVID-19 pandemic accelerated digital engagement, creating an environment conducive to the thriving of NFT communities on platforms such as Twitter, Reddit, and Clubhouse. Secondly, the creative sale of Beeple's Everydays — The First 5000 Days for $69 million at a Christie’s auction in March 2021 captured global attention, cementing the significance of NFTs in the art world. However, it's worth noting that the NFT market has seen fluctuations, with most of the pieces valued at nothing.

What is one of the most important characteristics of Digital Assets?

DA are categorized into non-fungibles and fungibles. NFTs represent assets tokenized on a blockchain, each possessing a unique identification code generated through metadata using encryption functions. NFTs are tradable and exchangeable for currency, cryptocurrencies, or other NFTs within the market. The first NFT, named Quantum, was created in 2014 by Kevin McCoy. Conversely, fungible assets are DA interchangeable with others of the same type, holding identical values. They are commonly built on blockchain platforms such as Cardano, Coinbase, Ethereum, or Solana. These tokens, often generated through smart contracts, serve various purposes, including virtual currencies or tradable assets on decentralized exchanges.

DA poses both benefits and risks.

In the digital era, businesses and governmental entities gather extensive data repositories, each with unique value depending on its utility and application. The advent of blockchain technology and cryptocurrencies in the 2010s revolutionized the concept of DA. Cryptocurrencies have evolved from their initial function to be recognized as valuable DA, reflecting a broader acknowledgement among investors, governments, and the public of the transformative potential inherent in blockchain technology and asset tokenization.

Decentralized assets (“DAs") offer several benefits. They allow asset owners to execute transactions directly without the need for centralized institutions or governments, providing users with a sense of authority and independence. Ownership records are meticulously maintained on a secure, decentralized ledger called the blockchain. While traditional systems may take several days to process transactions, DA transactions are comparatively faster. Additionally, anyone with an internet connection can trade these assets without restrictions based on background or financial status. DA transactions are secured by cryptography, making them a safe investment. Cryptography transforms plaintext into ciphertext using complex algorithms, making it highly difficult for unauthorized parties to manipulate the data. However, data security also depends on users taking appropriate precautions, like setting strong passwords and securely storing their assets. Another positive aspect is that DA offer semi-anonymous ownership, allowing users to protect their real-world identity while maintaining a certain degree of anonymity, although transactions are publicly visible.

However, alongside their benefits, DA present inherent risks. Cryptocurrencies exhibit heightened volatility compared to traditional asset classes, leading to significant price fluctuations. The decentralized nature of networks can facilitate cybercrime, with ransomware attacks often using cryptocurrencies like Bitcoin for ransom payments. The ability to trade and transfer DA without regulatory oversight has facilitated their use in money laundering. Nonetheless, authorities are improving their ability to track such transactions, aided by the transparency of blockchains. The energy-intensive nature of proof-of-work consensus algorithms, as seen in Bitcoin mining, poses environmental concerns due to substantial carbon emissions. However, newer consensus algorithms like proof of stake offer more energy-efficient alternatives. Trading platforms and systems for DA, along with their participants, could operate without regulation or under limited regulatory oversight, lacking the same protections as conventional financial markets. This includes safeguards against market manipulation and insider trading. Furthermore, DA are created, stored, and transferred on the blockchain’s distributed ledger. While blockchain technology provides several benefits, it does not allow transactions recorded on the blockchain to be deleted, altered, or revised. The lack of a mechanism to rectify such mistakes is a major drawback for DA.

As DA increasingly permeate various industries, they present both opportunities and significant risks. Given the rapid pace of technological advancement, understanding, and navigating the complexities of DA is imperative for making informed decisions in today's digital landscape.