Written by Julie Bradini
Dec 21, 2023
In the dynamic landscape of financial markets, the transformative influence of digital assets and blockchain technology is challenging traditional norms. Despite the risks and volatility associated with cryptocurrencies, the potential for disrupting financial markets remains undeniable. The integration of cryptocurrencies has opened the opportunity for major developments in all kinds of investment products. Structured products, which were previously limited to traditional wealth management, have now found a new home in the decentralized financial space. To strategically position themselves for the future, issuers and distributors of structured products must actively build their expertise and infra- structure in the area of digital assets.
At the core of this financial revolution lies Distributed Ledger Technology (DLT) with its two most prominent applications: blockchain and cryptocurrencies. Blockchain technology, in particular, holds the promise of revolutionizing various financial functions by offering advantages such as enhanced transparency, seamless reconciliation, security, and operational efficiency. Processes like trade execution, monitoring, settlement, and clearing would benefit from implementing blockchain through the implementation of smart contracts. This not only accelerates transaction speed but also significantly reduced operational costs by decreasing the need for intermediaries. This evolution also democratizes access, inviting a more diverse range of participants into trading.
However, the technology is being developed and implemented at a very slow pace due to its significant challenges. These include regulatory uncertainties, vulnerabilities in smart contracts, cybersecurity threats, and a lack of standardized market practices. Given the increasing instances of hacking exploits, the instability of cryptocurrencies, an underdeveloped regulatory landscape, entrenched legacy systems in banks, and long maturing periods for certain financial products, there is a likelihood that Decentralized Finance (DeFi) will not disrupt but transition towards Traditional Finance (TradFi). This suggests a forthcoming coexistence of structured products issued in both traditional and blockchain formats.
Unlike traditional exchanges, Decentralized Finance (DeFi) operates without restrictions for retail users trading cryptocurrency futures. This creates a unique space for innovative investment strategies that were previously unavailable on centralized platforms. DeFi options (DOVs) represent the first steps into the world of cryp- to-structured products within DeFi.
One of the key differentiators of DeFi options is their operation without intermediaries. Traditional options trading often involves multiple intermediaries, such as brokers and clearing- houses. In contrast, DeFi options leverage smart contracts, cutting out the middlemen and allow- ing for direct peer-to-peer transactions. This not only streamlines the trading process but also enhances transparency by removing potential points of manipulation.
Additionally, DeFi options redefine the concept of market hours by operating 24/7. Unlike traditional markets that follow specific time zones and trading hours, DeFi options leverage algorithmically updated prices, ensuring continuous trading opportunities. Moreover, the decentralized nature of these options often eliminates the need for a Know Your Customer (KYC) process, making them accessible globally to anyone with a crypto wallet. This democratization of access opens the world of options trading to a broader and more diverse range of participants. Another feature of DeFi options is their resemblance to American options in traditional finance. These options are exercisable at any time during their lifespan, providing traders with increased flexibility. This contrasts with European options, which can only be exercised at expiration. The ability to exercise options at any point adds an extra layer of strategic decision-making for traders in the DeFi space.
The advent of DeFi options marks a significant step towards a more transparent, accessible, and flexible financial ecosystem. Operating without intermediaries, available around the clock, and with a unique exercisability feature, these options offer a paradigm shift in the world of trading. As the DeFi space continues to evolve, the allure of decentralized options trading is likely to grow, attracting both seasoned and novice traders looking for a more inclusive and innovative way to engage with financial markets.
While some banks have begun introducing blockchain technology in structured products, this initiative is still in its nascent stages. For instance, tokenized structured products have emerged as a transformative force, reshaping investment management. Notable instances include the first issuances of structured products by banks in Asia with the support of global institutions such as UBS. In Europe, traditional banks like SG and digital platforms like Taurus actively develop their infrastructure to facilitate the issuance of tokenized financial instruments in the upcoming future.
For investors seeking exposure to crypto through structured products, several ways already exist. These include crypto structured products linked to cryptocurrencies or crypto indices, as well as actively managed certificates. While the majority of available crypto structured products are leverage products, the market is witnessing an increase in the number of issued yield enhancement and capital protection products. As the DeFi space continues to mature, navigating the world of crypto structured products requires a balance between embracing innovation and recognizing the responsibility associated with the absence of traditional safety nets. Compliance becomes a primary concern as regulatory frameworks are evolving at a slightly slower pace than technologies, creating a challenging environment for those interested into connecting structured products to crypto and blockchain.
European Union has been developing the regulatory landscape for a new tokenised economy already for some time now. In 2024 a new Markets in Crypto-Assets Regulation (MiCAR) will come into force to regulate crypto assets. From March 2023 the DLT Pilot Regime, a regulatory sandbox, is on. Within DLT PR market participants can test DLT-based trading facilities and settlement for issuing, trading, and settling shares, bonds and funds. Currently MiFID II covers structured products linked to cryptocurrencies, but in the future it also should be applied to tokenized structured products. At LPA, we have consistently been at the fore- front of assisting financial institutions in adapt- ing to the ever-changing regulatory landscape. For companies issuing structured products linked to crypto, we play a crucial role in producing the necessary regulatory documents. As the regulation updates comes into effect, we are committed to being pioneers in navigating financial institutions through the evolving regulatory landscape. LPA’s commitment to automating regulatory compliance for banks ensures that we not only meet current needs but also anticipate and address the regulatory demands of the future.
This report explores the world of structured products, discussing their future in the era of automation and disruptive technologies. It gathers insights from the forefront of RegTech implementation and analyses distinctions between structured products markets in Europe and Asia.
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