BLOCKCHAIN, Expert opinions, FINANCE

Digital financial assets as promising tool to attract investment

Digital financial assets (DFA) can become attractive financial instruments both in the investment and lending markets. The DFA market is only starting to form; however, according to SberCIB, it has a potential of reaching tens of billions of rubles within one year.

What are DFAs?

Using blockchain for financial transactions started with the popularity of cryptocurrencies. The technology quickly conquered the market as increasingly more people are using cryptocurrencies for investment and payments, with numerous cryptocurrency exchanges emerging. Digitizing material assets opened up opportunities to create a scope of digital rights, prompting the emergence of first DFA operators. This instrument based on blockchain and smart contracts almost immediately drew the attention of businesses thanks to its transparency and convenience.

Many companies today are testing DFAs in deals for a limited circle of investors. According to Cbonds, the DFA market in Russia was worth RUB 32 bln ($359 mln) in 2023. Right now, digital assets are a solution that continues to improve in terms of technology. As concerns the process of purchase, not every platform issuing DFAs has convenient onboarding, which prevents wider adoption of the instrument.

DFAs are digital rights to a specific asset such as metals, real estate or right of monetary claim. Their issuance and accounting are performed by entering records into a blockchain-powered database. The digital format of the deals makes it significantly simpler to attract capital and to reduce its cost. SberCIB experts believe that DFA issuance may cost 28 times less than the issuance of ordinary bonds. Another important advantage of using DFA is speed as placing such assets takes only one or two days.

The most common type of such assets on the market is a DFA for a monetary claim. Their issuance is linked to the value of underlying assets like gold, precious metals, and cryptocurrency rates. They entitle the holder to receive funds from the DFA issuer. Another type of DFA is related to issue-grade securities, allowing the holder to exercise rights associated with them. A prominent example is the issuance of DFAs for traditional bonds or shares. The final class of DFA, hybrid, combines the properties of an investment instrument with utility digital rights. These include rights to demand the transfer of goods, assets, or intellectual property, the performance of work, or the provision of services.

The DFA for monetary claims is already undergoing active market testing. For instance, Norilsk Nickel issued a digital document for its employees. Each employee can act as an investor by receiving a digital asset from their employer, called Minetoken. This token certifies the right to receive payments and is equivalent to the market value of one Norilsk Nickel share.

How can a company issue DFAs?

The Central Bank regulates the issuance and circulation of digital assets in Russian information systems, overseen by responsible operators. Currently, the Bank of Russia’s register includes 11 accredited information system operators (ISO) authorized to issue DFAs. The recording of DFA information in the ISO system is governed by Federal Law No. 259-FZ, dated July 31, 2021. DFAs are stored digitally as token records in the database of the issuing ISO. Blockchain technology ensures the security of this information by preventing alterations to records. However, the system restricts turnover (i.e., any transactions involving DFAs), so token records cannot be transferred to another ISO.

To issue DFAs, a company needs to engage with one of the information system operators, which are responsible for issuing digital financial assets on their platforms. The most well-known ISOs include Atomize, Lighthouse, A-Token, and Masterchain. The issuance process is straightforward: the company enters into an agreement with the chosen ISO, completes onboarding, registers in the platform’s personal account, submits an application for issuing DFAs, and prepares an issuance agreement. Following this, the stage of collecting purchase applications from investors begins. Only companies registered on the issuing ISO platform can be investors. Once all conditions are met during the application collection stage, the DFA is released. All processes – from issuance to sale – are managed by the ISO without other intermediaries, unlike traditional securities issuance.

DFAs for business

A DFA is primarily an investment tool but can also be utilized in the lending market. For investors, DFAs offer the opportunity to invest in highly profitable financial products. For large businesses, DFAs provide a means to finance their receivables. For credit institutions, DFAs serve as an additional tool for structuring transactions, with the potential to transfer these assets to the market or other institutions. While most transactions typical of the financial market are possible with DFAs, they are confined to the perimeter of the ISO on which they are issued.

The primary advantages of using DFAs are their high speed and low production costs. Issuance and placement of such an asset take only 1 to 2 days, enabling companies to significantly reduce the time needed to secure financing.

DFAs can be issued for plenty of various assets, such as corporate debt securities. According to Russia’s Federal State Statistics Service, the accounts receivable market size is valued at about RUB 54 tln – yet, the degree of its digitalization is very low, making it difficult for the government to track and verify such assets due to the lack of a single format. DFAs allow for converting these assets into digital form for a more convenient use.

DFAs open up new opportunities for business development and provide new investment tools for investors. Digital financial assets allow SMEs to enter a new liquidity market previously available solely to major players. Thus, small businesses now can attract finances from private investors through a lucid mechanism that does not require large expenses.

Unlike conventional financial tools, DFAs are available to a wider scope of issuers and investors. DFA issuance procedure is much faster and less expensive, which allows small businesses to list their assets on an exchange and find new sources of financing.

DFA advantages also include their transparency and safety as they are based on the blockchain technology, which provides for reliable data protection as well as avoiding changes to the transaction, thereby reducing fraud risks. Such transactions are safe due to the use of one’s own electronic digital key for signing a contract and its automatic execution under the program code.

The future of DFAs in Russia

Digitalization in banking has significantly contributed to the introduction of DFAs as well as the digital ruble. DFA advancement allows for attracting finances and borrowed capital in a faster in less expensive way. Previously, such tools were available solely to large businesses, while today small companies are already making active efforts to test the new technology. By 2024, the trading volume is expected to exceed RUB 500 bln, according to TeDo.

It should be noted that the DFA market development will largely depend on banks and platform operators’ willingness to transfer part of bank balances into DFAs. While perceived as positive, there are still major limitations to utilizing this tool.

A key factor that hinders the DFA advancement in Russia involves investors and issuers lacking confidence in this particular format. They are primarily seeking its effectiveness in terms of liquidity, which has yet to be developed. While DFA issuance is convenient and effective, further distribution of these assets is rather costly as they are mostly sold for a limited pool of beneficiaries through intermediaries such as bank recommendations or an exchange. So far, this market lacks an independent investment flow. For instance, a client can simply use the app to purchase shares in a convenient way, while implementing the DFA technology currently requires a manager to attract investors and provide assistance.

Another DFA pitfall involves requirements for a qualified investor. While DFAs are presented as an asset that even individuals can invest in, their purchase requires the status of an accredited investor, substantially limiting a pool of potential users. An equally significant restriction occurs due to a lack of an established secondary market to sell such assets.

And yet, despite certain restrictions, Russia’s DFA market continues to grow, becoming increasingly popular every year. Embracing digital assets allows for automation of the transaction process, making it more transparent and flexible. Soon, DFAs may grow into a convenient alternative to traditional financial tools.

By Viktor Vernov, Co-Founder, ROWI fintech platform

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