Why should the buy-side care about blockchain sidechains?

Rage Review : A large number of sell-side financial institutions and back-end teams are studying blockchain protocols, while most of R3's blockchain alliance members are sell-side banks, lacking buyer participation. Buyer companies include pensions, mutual funds, hedge funds, private equity and other fund management companies. Buyers can reduce regulatory costs by using blockchain technology, because blockchain can encode systems into the blockchain, generate smart contracts, and reduce the cost of human intervention and supervision. Now that two Bitcoin global exchange-traded funds (ETFs) are awaiting approval from the Securities and Exchange Commission (SEC), it seems that it is only a matter of time before ordinary investors can use Bitcoin and other digital assets for investment.

Translation: Nicole

In the financial field, blockchain has become a very eye-catching term, attracting a lot of attention. It is a very rare phenomenon that a new industry technology that has just emerged and is unknown has become the cutting-edge of technological innovation.

However, if you dig deeper into the source of this interest, you’ll find that a large number of sell-side financial institutions and back-office teams are investigating blockchain protocols. For example, most of the R3 blockchain consortium members are sell-side banks. Conspicuously missing is the buy-side, which consists of pension funds, mutual funds, hedge funds, private equity and other money management firms.

The buy side has different structures and mandates, but ultimately, investor risk-adjusted returns are the primary concern, and blockchain can address this well.

The reason why the backend is interested in blockchain is that it can simplify the settlement process and provide data verification services to all parties involved without clarifying the boundaries of data movement and verification of each organization. Therefore, it is not necessary to verify the data every time you enter or exit, because the consensus mechanism of blockchain allows participants to jointly verify.

But while the buy-side has been reticent about blockchain, it would be a mistake for companies to ignore the technology.

Reduce costs

The obvious benefit to the buy-side is the efficiency gains that can be achieved by using blockchain-based solutions for back-end custody and settlement.

Asset custody services charge users a small amount of asset base point fees, which can be quickly calculated. With improved efficiency, the total cost of servicing assets for the buyer company will also decrease.

Other long-term benefits include reduced regulatory costs.

Today’s buy-side firms spend a lot of money on compliance and adhering to regulatory systems. If the market accepts blockchain technology, these systems can be encoded into the blockchain to generate smart contracts, thereby reducing the cost of human intervention and supervision.

In the future market, the CFTC (U.S. Commodity Futures Trading Commission) is particularly interested in such efficiency improvements. Such measures can make the market safer and more suitable for investors to invest in, while providing better market transparency.

Entering different markets

It is well known that global diversification improves risk-adjusted returns.

However, many money managers and buy-side firms want to invest in globally diversified portfolios because of friction in the management process. Global exchange-traded funds (ETFs) can solve this problem to some extent, but managers who focus on specific securities have a difficult time investing globally.

If blockchain technology can be widely used around the world, the current global custody model and expensive custody fees will become a thing of the past. Small investors will be the biggest beneficiaries, but for all buy-side companies, this will make the cross-border investment process simpler.

In this process, little human intervention is required - for example, cooperative behavior will one day become automatic cooperation in smart contracts, thereby removing intermediary financial institutions.

‘Digital assets’

The most exciting trend in the blockchain space is the use of public chains, not as a settlement layer, but simply as an asset and settlement layer. Bitcoin was originally created as an electronic currency system, but it is also used as an asset.

Large market players like CME Group have already seen blockchain’s future in the market, and investment management firm Ark Invest and blockchain startup Coinbase have also argued the same in a recently released report.

Digital assets offer the buy-side an entirely new investment class with the potential to improve risk-adjusted returns on existing portfolios. Some firms are already taking the lead.

Hedgeable, a New York-based robo-advisory company that has been advising users to invest in Bitcoin, has seen average gains of more than 60% in Bitcoin over the past year, accounting for 0.96% of annual returns, even though Bitcoin only accounts for 2% of the company's assets.

Hedgeable co-founder Matthew Kane told CoinDesk that 30% of its users have opened a bitcoin wallet service through Coinbase, which allows them to invest in bitcoin.

The average Hedgeable investor owns 1 Bitcoin, and Kane further said his firm views Bitcoin as a long-term asset class that can enhance risk-adjusted returns.

Looking ahead, with two Bitcoin ETFs now awaiting approval from the Securities and Exchange Commission (SEC), it seems that it is only a matter of time before ordinary investors are able to invest using Bitcoin and other digital assets.