We believe that the transformative forces of digitalization and the indispensable need for efficient issuance and investment processes will ultimately turn the tide for digital securities. If you look back at the development of the capital markets, technological developments were always the key driver of massive transformation and growth and lead to all the investment vehicles running the financial system today. We dive into how this is also true for ETFs and why we believe this will be true for digital securities explosion for the alternatives including real estate and private equity.
Besides smartphones, social media, U.S. e-commerce retail sales, and industrial robots, ETFs (AUM) belong to the fastest-growing fields of technology. ETFs are a perfect example of how technology has shaped the capital markets over decades transforming what started out as a $11 million USD sector into a $5 Trillion USD sector today. We want to draw some parallels between the ETF story and the development of the digital securities space.
But let us start from the beginning to understand the nature of this evolutionary process. The first ETF was created in 1989 and from that first fund (which was viewed by many as a failure) we now have over 5,000 globally traded ETFs and global AUM grew from a few million USD to 5 Trillion USD (AUM).
The ETF market grew from one fund in 1993 to 102 funds by 2002. By the end of 2009 nearly 1,000 funds were already created. According to ETFGI, there are now 5,000 ETFs trading globally. As the graphic below shows 2470+ of them are based in the U.S adding up to a 4.04T USD ETF AUM.
The ETF success story and digital securities
So what was the reason for the massive growth of ETFs over the past three decades? The answer is clear: New technology allowed the creation of new investment products offering a wide range of benefits compared to their traditional counterparts. In contrast to costly, illiquid, and complicated mutual funds, ETFs offered new ways of passive investing. ETFs allowed tracking indexes by the use of computers. The graphic below captures some of the resulting benefits. As you might have noticed, this is, in essence, the digital securities story, but it took place 3 decades earlier with the technology of lower capabilities than available today.
The similarities in the benefits between ETFs and digital securities seem remarkable. In comparison to traditional funds, ETFs provided: liquidity, accessibility, lower costs, operational efficiencies, and transparency. These are the same value propositions offered by digital securities. The difference though is that digital securities provide next-generation technology in the form of blockchain and Distributed Ledger Technologies (DLT) which allows for an even better and more efficient issuance and investment process.
The continued growth of ETFs illustrates that the value propositions of ETFs have not really changed over the past 3 decades. A new technology-enabled format like digital securities which allows for a next-level version of the above benefits is, therefore, a strong contender to capture a large market share in the future.
2 Learnings from the ETF story
- One key takeaway from the ETF developments is that the first wave of companies operating in a new technology-driven sector of the financial industry has (at first) to deal with resistance, confusion and lack of understanding. ETFs took off slowly but grew nearly exponentially after 1993. This indicates that it takes time for existing market participants and regulators to fully understand, accept and ultimately implement new technology-driven applications. Moreover, the financial industry has by nature a conservative mindset that has a mostly negative perception of new, upcoming technologies. Especially in the current low-interest rates environment, systemic institutions like banks dealing with an erosion of their interest margin are highly doubtful about the introduction of new, innovative technologies as this might further threaten their core business operations.
- Secondly, the brave first adopters are the ones who will capture the largest market shares. The most prominent example of this is iShares which debuted its first international ETF in 1996. Today, iShares captures 1.56T USD of a 5.8T USD market and has a total of 357 ETFs being in 4 different asset classes including alternative assets, commodities, fixed income, and equity.
Digital securities – A bright future
We believe that the transformative forces of digitalization and the indispensable need for efficient issuance and investment processes will ultimately turn the tide for digital securities. The case of ETFs shows how technology can and has radically changed the financial sector. We think that the financial industry is currently at an inflection point. We experience strong and persistent growth in interest and deal flow. More and more traditional market participants see the value in issuing and investing digitally. This gives us further confidence in the pursuit of our vision of a future where all participants in private markets use efficient and cost-effective technology-based platforms to leverage the full return prospects of their assets.