When we first talk to Fidelity International, it’s one of the coldest days of the year so far in Europe, with temperatures in some parts dropping as low as -10°C. It’s representative of the mood that has swept over the crypto industry in the past year, undergoing a winter of its own. In part that has been affected by unfavourable economic conditions, price volatility, and the collapse of crypto exchange FTX and crypto lender Genesis.
Retaining investor confidence in crypto, then, could be seen as an unenviable task. For Luc Froehlich, Global Head of Digital Asset Solutions at Fidelity International, it was a challenge he wanted to take on, being an early adopter of crypto. Froehlich, who talks to me from his office in Hong Kong, started investing in bitcoin back in 2015 – the early days, so to speak, for a sector that has moved with pace in such a short period of time.
Froehlich has a background as a credit analyst, trader and a fund manager, working for industry heavyweights like Credit Suisse and Manulife Asset Management. Cryptocurrencies were still an incredibly new frontier at that time. In 2016 and 2017, shortly after Froehlich took a step into crypto investing, a wave of initial coin offerings (ICO) started coming out. Froehlich says, over the next couple of years, he underwent an “educational journey” – and senior leaders at Fidelity, whom he joined in 2016, started becoming more vocal about the potential for cryptocurrency.
He believes that a lot has matured in the space since those halcyon days, sparked by the increasing mainstreaming of cryptocurrencies like bitcoin. In the beginning, crypto was the preserve of geeks and tech nerds – but in the last couple of years, it’s started to attract the attention of those in the traditional finance space.
“You have a space that is more professional, with quite a few people coming from a traditional finance background. There is definitely much more of a focus on real-world applications now – how can distributed ledger technology, in particular blockchain, be used to solve day-to-day problems? That makes it a slightly less exotic space but more interesting in the sense that it's an opportunity to showcase how blockchain is not just a buzzword or a fad.”
Fidelity’s strong culture of innovation
The part of Fidelity’s business headed up by Froehlich focuses on digital assets and only started at the beginning of 2022, but it was the culmination of a long journey into decentralised assets. Not only was Fidelity seeking to enter the digital assets space, it was striving to future-proof its business by preparing for tokenised securities and central bank digital currencies (CBDCs) too.
One way it did this was by examining the tokenisation of some of the fund share classes it offered, and identifying where there was demand in the market, Froehlich says: “If you think of digital-native investors, which are naturally more adept to digital assets, they are also looking at ways of integrating traditional assets into their portfolio or wallet. Tokenising this asset necessitates a change, an upgrade in our infrastructure, which is another area that I'm focusing on. So it's both this convergence from client demand and need for an upgraded infrastructure that led to the decision to dedicate resources to this topic.”
The fact that Fidelity’s customers were asking them to invest in this space was one of the primary motivating factors. Froehlich believes that it would not be possible to test out this emerging area without the backing of key stakeholders within Fidelity, as well as a desire to meet customer demand.
“I think we have a philosophy of pushing the boundaries and using new technologies,” he tells us. “There is a very entrepreneurial spirit that runs within Fidelity. Most employees have an opportunity to test certain assumptions and hypotheses, to potentially launch new solutions, new services or new lines of business.”
“It doesn't have to come from the top; there are a lot of people within the company that are given the flexibility of testing a new concept. That's also one of the reasons that we managed to launch a standalone business dedicated to digital assets.”
Fidelity’s first digital assets product launch was not just a case of a new asset class, it was a case of a new technology that clients had to become accustomed to. Questions around custody pervaded at that time, as they do today, and there was uncertainty about the regulatory wrapper that would surround a launch of this nature.
This was in spite of the loud noise that reverberated around the crypto space. These were crucial concerns, such was the breakneck acceleration of digital assets. “Because there was so much uncertainty about the technology and a few of the environmental impacts, as well as the valuation… the question was whether it was appropriate for us to launch a product like this for our clients,” Froehlich explains.
“We came to the conclusion that, because the client demand was there, our role was not necessarily to dictate what to do but to offer investors a convenient and secure way to access this asset class. So the way this product was positioned was as an access product. If you are interested and if you think that you are knowledgeable on the topic, we will provide you access. That also meant that the focus has been very much on institutional investors, and not on retail investors.”
Supporting Fidelity’s digital asset growth journey
As part of their digital asset growth, Fidelity International has been partnering with Keith Bear, Associate Partner at Elixirr and a member of the Bank of England Central Bank Digital Currency Technology Forum and ESMA’s Consultative Working Group for financial innovation.
“Within digital assets, whilst we may be in a ‘crypto winter’ at present, institutional interest in digital assets remains high, especially with recent gains in prices of bitcoin (up 20% in recent weeks) and Ether,” Bear says. “Failures of centralised entities like FTX have prompted a ‘flight to quality’, which has benefited firms like Fidelity International. The increased focus on crypto by regulators around the world is leading to greater confidence in the asset class by institutions, and the innovation and low costs seen in DeFi protocols is prompting a wave of innovative proofs of capacity (PoCs) and pilots by leading banks, regulators and central banks, such as Projects Guardian (MAS, JP Morgan, SBI), Mariana (BIS, SNB, MAS and Bank of France) and SocGen Forge’s recent US$7m loan from the Maker Dao DeFi protocol.”
Fidelity International and Elixirr recently collaborated in researching how many institutional clients are offering crypto and digital asset services to clients, how many have dedicated digital asset units in place, and what the perspectives are for growth of the digital assets industry.
“We are at the early stages of a transformation of financial markets,” states Bear. “Whilst the crypto market may be beginning to show green shoots in its recovery, the bigger opportunity is how the key technologies from crypto (blockchain, tokens, automated market making.) will transform traditional financial markets. Tokenisation can bring great investor access to illiquid markets like private equity and real estate, broader investor access through fractionalisation of assets like art and collectibles, and great efficiencies to post-trade through the instantaneous exchange of tokenised cash and securities through atomic settlement, reducing friction and costs. Some estimates see tokenised markets being a $16tn market (10% of global GDP) by 2030, and the early innovators such as Fidelity are well-positioned to ride this wave.”
Institutional investors adopting a long-sighted approach
The issue of knowledge and education continues to be one of crypto’s sorest points. On the retail side, research from Cardify suggests that a third of consumers who invest in crypto admit to having little or no understanding of the products they’re buying. Crypto has moved into the mainstream so quickly that some consumers haven’t done their research properly before parting with their money – and although the picture is different with institutional investors, it points to broader challenges within the digital asset space.
Extreme price volatility and the prevalence of crypto scams leave a lingering sense of unease among retail investors towards crypto – something that the past few months have only exacerbated.
“The level of understanding is still limited,” Froehlich says about retail investors. “Bitcoin was launched in 2009, so some passionate people have had time to explore the concept and make an opinion about that, but most consumers started looking at cryptocurrency around 2020 or 2021 when bitcoin was making all the headlines. In this sense, it has been a relatively short period for people to learn about digital assets. You also need to take a multi-disciplinary approach, from technology to economics, which is time-intensive and takes a while to digest.”
Like many trends within the industry, the COVID-19 pandemic has proved to be a catalyst; some people spent lockdown baking bread, while others got to grips with the mechanics behind cryptocurrencies and the blockchain. But, within the retail market as a whole, there is still progress to be made.
On the institutional side, investors who have already made that decision to include digital assets within their portfolios are generally unflinching – perhaps, as Froehlich alludes to, it is because their crypto holdings represent a fairly low proportion of their overall investments and because they appreciate that, whatever happens with cryptocurrencies, traditional finance and decentralised finance are converging thanks to the adoption of distributed ledger technology.
“In addition, through the process of experimenting with digital assets, those investors have been gaining an understanding and a comfort level with this asset class,” Froehlich continues “Interestingly, theses vary with some investors hypothesising that bitcoin could be, for instance, the future digital gold, or Ethereum could be the next platform on which the majority of financial services are going to be built.”
Barriers to traditional adoption still persist
Despite the robust confidence in digital assets that exists among institutional investors, there are still considerable barriers to adoption. That situation has not been helped by events involving FTX and Genesis.
Froehlich states: “Even before FTX and other collapses, one of the biggest hurdles was regulation. For an institutional investor, especially if you invest on behalf of clients, you need a high degree of certainty that you are operating within an acceptable regulatory framework. That regulatory framework is not clear in most jurisdictions. There's a lot of challenges in understanding the current statutes, and they are also continuously evolving. But this issue is normal for new technologies, and it is an opportunity for established houses like Fidelity to help share the future of this industry.”
There is also a challenge in getting institutional investors to consider what they could be doing with digital assets. That necessitates a different approach and a different way of thinking from Fidelity. He likens it to the iPhone; when that groundbreaking technology was launched over 15 years ago, people didn’t understand the full capabilities of what they could do with it, whereas now it seems second-nature to most consumers. Perhaps in 15 years’ time, the same will be said of digital assets.
“There is a bit of a change in the philosophy of how to approach investment solutions in digital assets,” Froehlich continues. “We need to be a little bit more experimental and push for innovation. This is not straightforward for traditional asset managers because it's a different process to traditional asset classes.”
In the next couple of years, we should expect to see a rebound in the crypto market after a difficult patch – but there will also be a flurry of new applications and use-cases for digital assets, from sustainability to carbon credits and food safety. It will take time for us to identify which trends are worth capitalising on but it will be worth it because there is room for significant improvement and new business models, Froehlich says.
There will also need to be a conversation about how distributed ledger technology is implemented – whether it’s a way to provide a more convenient and cheaper access to your fund, or whether it’s the start of integrating new types of assets through tokenisation.
“I think it's a golden era for institutional investors to move into the digital assets space because what this washout has done last year was not just to remove bad actors, but also to recognise that there were a lot of companies that just didn't know what they were doing or didn’t have the means to cope with hyper-growth. I see the opportunity for established, highly licenced operators like Fidelity to position themselves in this market and help shape it in a way that make it more suitable for institutional and retail investors.”