The digital asset market is growing at a phenomenal rate and has now been afforded mainstream status by the world’s financial institutions. Some crypto natives already have bigger market capitalizations than venerable global financial services behemoths. Many governments around the world, including Switzerland, Portugal, Germany and Australia, have provided, or are in the process of considering, regulatory and tax clarity for digital assets.
Southeast Asia is an early adopter of digital assets. The region has seen strong grass roots adoption, with the runaway popularity of play-to-earn blockchain games (such as Axie Infinity in the Philippines), to central bank digital currencies like Cambodia’s Project Bakong. Now the digital asset universe is also being given serious consideration by institutional investors across the region. Similarly, for high-net-worth individuals (HNWIs), newly minted digital assets are proving to be an enticing new diversification play providing access to new investible assets, as we see the potential financialization of everything. Many HNWIs have already allocated, or are looking to allocate, a portion of their portfolios to digital assets either directly or via funds.
Not all jurisdictions are so crypto-friendly. Indonesia allows digital asset trading on its commodities exchange but, to date, financial institutions are not allowed to offer and facilitate digital asset sales. Whereas, Singapore has a flourishing digital asset ecosystem to support this accelerating trend. First and foremost, the garden city offers investors that all-important regulatory clarity. It’s also now home to well-established crypto exchanges, tokenization platforms, custodians, vendors, and digital asset auditors, lawyers and tax specialists.
All these ecosystem players are vital for the market to flourish. Digital assets have diverse terms and conditions that change their accounting treatment. Depending on their contracts, they may be accounted for as financial assets, derivatives or intangible assets. While there is some guidance on the tax treatment of income from digital assets, tax policy is likely to be reactive as the digital assets space and associated economics evolve at a rapid pace. As regulators adapt, so too will tax policy makers and in time, some may offer tax and non-tax incentives to digital asset players.
We explore three key areas that wealth and asset managers need to be able to answer for their clients.
1. Where and how will we play?
In this environment, many wealth and asset managers are starting to think about a digital assets strategy. They need to decide:
- Where will we play – origination, trading (direct, derivatives etc.), staking or yield enhancement?
- How will we custody and access assets?
- How can we onboard clients given anti-money laundering (AML) concerns?
- Do we develop in-house capabilities or collaborate with specialist providers?
- What sort of operating model will work best?
- How do we get comfortable around controls?
More and more of the wealth and asset managers we talk to are looking for speed to market. In many cases, that comes down to the right partnering or leveraging components from other service providers, such as technology firms.
Whichever path they take, institutions must, as a priority, build trust into their crypto and digital assets services.
According to data firm, Chainalysis, roughly $14 billion in fraudulent transactions occurred in the cryptocurrency world in 2021, up by 79% from a year earlier, thanks in part to the rise of DeFi.¹ Scams tied to cryptocurrencies and digital assets, including worthless NFTs, may well be the biggest threats facing individual investors in 2022.
A major issue is the "fine print" in the smart contracts that many cryptocurrencies are linked to. Investors who lack a knowledge of computer coding find it hard to understand what’s inside a smart contract. This allows hackers to launch scam currencies that either cannot be resold or, on resale, remit huge portions of the token’s value in fees back to its inventor.
No wonder the tech news site, Gizmodo, has started reporting on "crypto scams of the month", with the tagline "Be careful out there, folks".
2. How will we build trust?
Wealth and asset managers are under pressure to deliver secure digital asset offerings to a growing base of HNWIs, family offices, asset owners, and other investors.
Market leaders are putting their digital asset offerings through the same rigorous assurance as the rest of their business. EY clients, including traditional financial institutions, crypto exchanges and new funds investing in crypto, are increasingly asking for EY teams' help to validate controls, perform smart contract attestations, and assess governance and cybersecurity. They are even getting into areas such as SOC 1 and SOC 2 compliance – professional work requiring a deep knowledge of the idiosyncrasies of digital assets.
On the compliance side, digital assets also come with their own AML considerations. The global reach, and potential for anonymity and obscured transaction flows (crypto-to-crypto direct transfers) mean that AML needs even more work than normal. We see a number of firms only allowing fiat to crypto conversion for existing clients and they often won’t onboard digital assets directly. Wealth and asset managers will need to keep up with both new digital asset-based AML regulations and emerging trends in crypto-crime. Firms should also remember that sanctions apply to all assets.
3. How quickly can we move?
Engaging with partners with crypto experience will greatly accelerate speed to market and allow institutions to be a safe and trusted haven in the "Wild East" of digital asset investment.
