On January 7th, WisdomTree Investments Inc a provider of Exchange Traded Funds (ETF), Exchange Traded Products (ETP) and asset management services with over $63.9bn in Assets Under Management (AUM), globally, announced its strategic investment in blockchain based compliance and financial markets infrastructure startup Securrency Inc as part of the company’s $17.65 million Series A funding round.
WisdomTree CEO and President Jonathan Steinberg poses for photos after participating in opening bell ... [+]
Tapping A Large Market
It’s an important development for the financial services and blockchain sector insofar as it signals that a large traditional financial services institution on the “buy-side” is throwing their weight behind blockchain technology.
With such a major player in the space embracing blockchain, it is likely that they will pave the way for similar organizations to follow.
To understand why this development is notable, it is worth reflecting on how ETFs — WisdomTree’s core financial product — have come to dominate the way that money flows around financial services and how that financial product now faces challenges that a new disruptive technology such as blockchain may have a role in fixing.
First introduced in 1993 by State Street, ETFs provide a way for pension funds, large corporates and individuals, to achieve an exposure to multiple stocks or bonds in a way that is highly liquid with low transaction and administration costs.
ETFs have come a long way from their humble beginnings when the SPY ETF launched with $6.5m AUM, having grown nearly tenfold to $4.6trn of global AUM from $417bn in the last four years. This has been fueled by a trend towards passive investing products which track the market rather than active investing which involves investment managers proactively picking stocks, a practice that has underperformed the market in recent times.
Securrency's Logo
ETF adoption has rapidly eclipsed investments in their precursor mutual funds, owing to advantages such as lower administration costs, greater tax efficiency and being more easily traded.
However, the market has now become crowded and ETF providers are contending with eroding margins and profitability. With this in mind, organizations like WisdomTree are looking for the next wave of innovation that will have a similarly profound impact that ETFs have had on mutual funds.
The ETF industry has been experimenting with a range of new business models such as funds that incorporate cryptocurrency (something that WisdomTree has launched in Switzerland, but the U.S regulators have so far resisted), as well as embedding blockchain technology into their operations.
The industry is also experimenting with a product called non-transparent ETFs, although this is something WisdomTree has been wary of pursuing given its corporate values around transparency.
The Merging Of Buy-Side With Blockchain Platforms
Franklin Templeton Investments is another organization that has been innovating with blockchain in ... [+]
WisdomTree is by no means the first buy side institution to embrace blockchain; Franklin Templeton announced their intention to track funds of its shares using the blockchain in partnership with Stellar and wallet provider Curv; Vanguard is using Symbiont’s blockchain technology for index rebalancing and FX swaps; and USCF Investments LLC recently announced an intention to use blockchain technology earlier last year. Fund management giant Fidelity is also using blockchain, albeit for a rather different service - providing crypto-custody.
What differentiates WisdomTree from their peers is that they have been active investors in their technology partner, Securrency thereby economically cementing the two companies together in a far more tightly coupled way than other partnerships in the space have done to date.
Like others in the buy-side space, the WisdomTree and Securrency team both see a future where digital financial assets of all forms — not just ETFs — are traded across the world, both in exchanges as well as peer-to-peer, merging a fragmented global economy through blockchain technology.
Another unique aspect of Securrency and WisdomTree’s approach is that are placing an emphasis on how compliance will be integral to this emerging ecosystem.
Securrency describes itself as a powerful regtech and fintech infrastructure technology that delivers unmatched multi-jurisdictional identity and compliance portability across different networks. Put simply, Securrency doesn’t just turn the old world of financial instruments into blockchain based digital assets registries but also provides a mechanism to ensure that these assets are being offered and traded in compliance with regulations across the world.
Looking For A New Market To Tap
Last week, I interviewed Jonathan (he goes by Jono) Steinberg, founder and CEO of WisdomTree, William Peck, director of corporate strategy of WisdomTree and Dan Doney, CEO Securrency, to learn more.
Steinberg started with WisdomTree’s origin story, articulating how the company evolved from humble beginnings as a research and publications firm. In 1999 Steinberg wrote a research paper on the potential of an innovative financial product wrapper named the Exchange Traded Fund, which at the time was a nascent market only representing $40bn of assets, globally. But Steinberg saw the product’s revolutionary potential.
“ETFs are to the mutual fund, what the internet is to the newspapers”
In 2006, the company pivoted out of the research and publication business and launched its first ETF. Over the last 15 years, WisdomTree has grown its offerings and its investor base. Today it offers 92 ETFs and manages over $63.9bn in AUM. But as an innovator, Steinberg isn’t one to rest on his laurels, which is why the company started to look further afield for the next generation of financial products.
“About three years ago, I asked WisdomTree’s Head of Corporate Strategy to keep an eye out for a wrapper that can add functionality to investment products that is potentially better than today’s ETF wrapper. We came to the conclusion that there are certain characteristics that could be a better wrapper”
However, Steinberg points out, the company has needed to be cautious of innovations that may be at odds with WisdomTree’s compliance responsibilities. “We have seen some of the early work in the space today [that advances the thinking from ETF wrapper]. Some of the new exposures have been launched to-date, however, don’t meet WisdomTree standards as a highly regulated company. William [Peck] has been meeting different companies that we could partner with in the space to bring exposures to the market but with the regulators blessing.”
Its All About Compliance
Clearly, regulatory compliance is crucial for regulated financial institutions like WisdomTree. But that said, it’s rare for fund managers to get involved in the vetting and monitoring of individual investors as that tends to be the realm of the broker dealer middleman but that is what they appear to be intending to do given their partnership with Securrency. That raises some important questions; why would WisdomTree be seeking to get involved in investor compliance? Are they seeking to dis-intermediate the broker dealer?
According to Steinberg and Peck, the role of the broker dealer, isn’t going away, far from it. WisdomTree is seeking to use Securrency as a way of interconnecting what they refer to a “global mesh of broker dealers”, putting digital financial products – not just ETFs – into the hands of investors around the world.
To understand WisdomTree’s rationale, it’s worth considering just how fragmented the world of financial services is today; customers today are trapped within what Securrency’s CEO Dan Doney calls the “walled gardens” of banks and broker dealers, and information about customers isn’t shared outside of the confines of these establishments.
Anyone who has bank accounts or loans with multiple providers will be familiar with the challenge and the nuisance of filling out the same duplicative application information at each institution because banks don’t share personal information. That’s the walled garden problem.
Given banks and broker dealers rarely share personal information about their customers, it can be challenging for organizations like WisdomTree to sell financial products to potential customers. That’s a problem considering that there is a labyrinth of walled gardens in financial services today — for example, there are 3,600 broker dealers in the United States alone.
Whereas WisdomTree’s ETF product today is well known by broker dealers, and the rules around who can invest in them are simple, things become more complicated as the company starts offering a range of new digital asset based products. Ensuring that they get into the hands of suitable customers that are allowed to invest in them becomes challenging. The problem becomes compounded when factoring in that these new products may be offered globally and the regulations governing what products can be advertised and sold to a given customer vary radically from country to country.
To illustrate the point, Doney provides an example of the challenges that a domestic issuer has in reaching the Japanese market. Japan, like the United States, does place restrictions on the type of investors that can participate in certain offerings. However, there are material nuances between a U.S. accredited investor and it’s Japanese near-equivalent, the “professional investor”.
“A mid-western based broker dealer running a modest series B private equity issuance may want to reach Japanese investors, but cannot because he/she doesn’t understand the specifics of the regulations in that country”
With Securrency, WisdomTree hopes to tap into these walled “gardens” both domestically and abroad, allowing WisdomTree to offer financial products, in a range of countries, safe in the knowledge that the platform will perform the translation of what products are suitable for a given investor in a certain country.
And that’s something that Securrency excels in — adding identity to financial transactions, based on a philosophy that movement of value can only occur if all the parties are known and qualified. This means enforcing regulatory policy at the transaction level.
“If you have transactions with one user in the U.S. and another in Singapore, then that crosses regulatory boundaries and both laws have to be enforced”
Steinberg and the WisdomTree team were impressed by Securrency and their executive team from the start. “When we met Dan, we immediately saw the potential. Dan really has the best, earliest work in the industry around digital assets, he has a unique background, had some early observations, and he’s the partner that can help us come to market and gives us the chance to be first in this space”, said Steinberg.
Digital Asset Transactions Done Right
What is particularly interesting about the Japanese investment example cited by Doney is how the two organizations are thinking about the investment and exchange of financial instruments in a much broader sense than purely ETFs exchanged and settled on a domestic exchange. Instead are setting their sights higher – innovating ways to connect issuers (small to large sized companies, across stocks, bonds, property and so forth) with investors and to move money across the world enabled through blockchain enabled financial instruments.
In the case of international money-movement, Doney believes that many of the current blockchains are getting it wrong by turning a blind eye to compliance.
“We see some fundamentally incorrect assumptions in the blockchain offerings market concerning money movement. With stablecoins, you can move money internationally, but that doesn’t mean that you are free to ignore international money movement controls unless you are interacting with the regulated banking infrastructure, that’s where initiatives such as Libra are getting it wrong”.
Doney goes on to explain that if governments today are surveilling amounts as little as $10,000 that move through the international web of banks, then regulators are certainly going to be interested in money moving into or out of the country, even if it’s doing so only through via crypto-infrastructure.
This is an area where WisdomTree and Securrency believe they have an advantage in the market with their tie-up, blending the opportunity that blockchain provides to move money frictionlessly and instantaneously with the requirements that governments will have to ensure that those funds are not being put to a nefarious end.
Still A Lot To Do
WisdomTree and Securrency appears to be forging a path towards bringing digital assets to the global market. However, there remain a number of unanswered questions and certainties which will take the best minds of both companies to fully answer. For example, moving to a world where ETFs can be traded in digital asset form or where regulated securities of any form are traded on a peer-to-peer basis will require changes to regulations not just for the U.S. but potentially across all 195 countries in the world.
It will also require an evolution of an overall ecosystem that will enable these assets to flow seamlessly between banking institutions, through to exchanges and custodians. Switzerland, represents the gold standard for this ecosystem model, but even in this advanced country, it’s early days.
Certainly this is a space that is likely to offer up some interesting developments over the next few years.
