Technology has brought tremendous progress to the realm of finance. From trade and transactions to data and assets, everything is now digitised, including critical financial processes. This digital revolution has paved the way for groundbreaking advancements, notably the rise of digital assets.
Data and scanned documents were once viewed as digital assets. The advent of blockchain and cryptocurrency has redefined this notion. With fast-paced technological changes and the growing importance of digital assets in finance, finance teams must effectively understand and manage these resources.
To provide a better understanding of the subject, this guide will explore:
- What are digital assets?
- Types of digital assets
- The role of digital assets in finance
- Understanding digital asset management
- Risks associated with digital assets
- What are current regulations governing digital assets
- Prepare your finance team for digital success
What are digital assets?
In simple terms, a digital asset is a piece of property providing value that exists in digital format. However, not all digital content falls into this category. The key distinguishing factor lies in the inherent value or ownership rights associated with the resource. Ownership rights often grant the owner exclusive privileges over use and distribution, which can be protected by copyrights, patents, or licenses.
For example, an e-book can be considered a digital asset because the author holds the copyright when it's distributed digitally. In contrast, a simple routine email, such as a quick update or casual conversation, typically isn't considered a digital asset because it lacks valuable data or intellectual property. It's transient in nature and holds little to no value beyond immediate communication.
Unlike traditional physical assets, they are intangible and, in most cases, can be easily distributed or reproduced.
Types of digital assets
Today, a wide range of items can be classified as digital assets. From simple text documents to digital currencies, the scope is vast. Making proper distinctions can be difficult, and the line between two groups can often be blurry. However, for ease of understanding, we have grouped them into two categories; traditional digital assets (these mostly include digitally stored content files and data.) and new-age digital financial assets (includes digital forms of traditional financial instruments or entirely new types of assets with financial worth.)
Traditional digital assets
1. Intellectual Property (IP) assets
These assets include creative or informative works valued for their content or functionality, and are protected by copyrights, licenses, or patents, governing their distribution and use. Examples include copyrighted works such as literature, music, and art; patents granting exclusive rights to inventions and processes; and trademarks like symbols, names, and slogans identifying products or services.
2. Digital collectibles
These are virtual renditions of collectible items like sports cards, trading cards, or artwork. Just like physical collectibles, their worth is influenced by scarcity and the interest of collectors. They may or may not incorporate blockchain technology.
3. In-game assets
As the name suggests, these are virtual items or currencies used within online games. Their value is typically limited to the specific game's ecosystem and may or may not be transferable to the real world.
4. Data
Often referred to as the new currency, electronically stored information whether personal or commercial holds significant value for marketing, analytics, and other uses. Protecting ownership and privacy rights is crucial when treating data as an asset.
5. Domain names and website ownership
Domain names and websites are valuable digital assets one can own and even trade. Their worth, however, depends on various factors like website content, purpose, audience reach, and revenue potential.
Digital financial assets
1. Cryptocurrencies
Bitcoin and Ethereum are prominent examples of cryptocurrencies. They are a form of digital currency that do not have any physical presence or issuance and oversight by a central authority, like a government or financial body. Acquiring them can involve mining, purchasing through cryptocurrency exchanges, or earning rewards within the blockchain network.
Built on blockchain technology, they can transform finance operations and offer significant benefits to organisations. Many CFOs are considering cryptocurrencies due to the inherent safety of sophisticated blockchain technology, which records ownership on a public ledger, ensuring secure and transparent transactions.
2. Tokens
Tokens are digital units of value on a blockchain network. They represent assets and various financial instruments like securities, loyalty points, or access rights that have been tokenised on the blockchain of an existing cryptocurrency. This process essentially creates a digital token representing the ownership or rights associated with the underlying asset. Security tokens and utility tokens fall under this category. While tokens may seem similar to cryptocurrencies, they differ by extending the functionality of blockchain technology beyond simple currency use cases. Their value comes from the underlying asset or utility they represent, not just from their use as a medium of exchange.
3. Non-Fungible Tokens (NFTs)
NFTs are unique tokens on a blockchain that represent ownership of a variety of assets. These assets can be anything from digital art and collectibles to shares in a company. Each NFT is unique and cannot be duplicated; this scarcity increases their value.
Before blockchain and NFTs, artists struggled with verifying the authenticity and ownership of their digital works. NFTs revolutionised this through 'tokenisation,' which assigns a digital ownership certificate to art for trading. This mechanism links digital art to a specific token on the blockchain, providing proof of ownership and legitimacy, turning digital artwork into a certifiable asset.
4. Digital securities
Conventional securities are traditional financial instruments like stocks and bonds that represent ownership (equity) or debt obligation. The digital counterparts of these financial assets are digital securities. Unlike traditional securities, they are issued, traded, and settled online through blockchain technology. This digital approach offers greater efficiency, security, and the possibility of fractional ownership.
5. E-money
E-money, unlike cryptocurrencies, refers to digital currencies issued by financial authorities such as central banks. Central Bank Digital Currencies (CBDCs) are a prime example, authorised by central banks and pegged to the value of the issuing nation's official fiat currency. Stablecoins are another type of e-money, typically linked to the currency of a nation, an asset, or another financial commodity for stability. E-money is valued for its convenience and speed, offering low transaction costs and efficient modern-day transactions.
The role of digital assets in finance
Cryptocurrencies and other digital assets are revolutionising the landscape of finance and are becoming increasingly mainstream. Their growing popularity stems from clear advantages over traditional financial instruments. Cryptocurrencies, unlike traditional markets, can be traded 24/7, offering incredible flexibility. They operate on a global network, facilitating easier cross-border transactions compared to traditional currencies. This opens doors for international trade and allows diversification by providing access to a wider range of assets and markets, potentially increasing returns and spreading risk.
Another advantage of digital transactions is that they settle almost instantly, saving valuable time. Transaction fees can also be lower compared to banks and stock exchanges. Some digital assets even allow fractional ownership, making them more accessible to everyday investors. By embracing digital assets and these cutting-edge trends, finance teams can stay ahead of the curve.
Understanding digital asset management
What is digital asset management?
Digital asset management (DAM) is the process of efficiently managing an organisation’s digital assets, encompassing organisation, storage, preservation, retrieval, and rights and permissions management. Other key tasks involve access control, version management, distribution, and usage tracking. A DAM system creates a central repository (archive) and develops an infrastructure for effectively storing, identifying, locating, and retrieving these assets.
Why is managing digital assets important?
Digital assets, stored on digital devices or cloud-based servers, can be easily transferred or duplicated without loss of quality. However, this high accessibility poses challenges in terms of managing and protecting them. As an organisation grows, the amount of data and digital assets it owns increases too. In this case, having a DAM system is essential. It centralises the data, organises it, and tags it with metadata, making searching and accessing it more efficient. It eliminates the need to manually search through folders and drives, thus saving employees time and effort. Access to this information is crucial for several critical business functions.
Managing digital assets also includes handling usage rights, tracking licenses, and monitoring asset expiration dates. This is crucial for maintaining legal compliance and preventing copyright violations. DAM systems also play a role in mitigating risks associated with digital assets.
Risks associated with digital assets:
-
Lack of regulation
There is still lack of clear regulations and strict supervisory frameworks surrounding digital assets. This creates compliance challenges and legal risks for businesses. In addition, it makes them more vulnerable to fraudulent activities. They become highly exposed to theft, fraud, and unauthorised transactional activities.
-
Cybersecurity threats
Hosted on networks, digital assets are vulnerable to cyber threats like hacking, phishing, and various data breaches. Such risks can result in the theft of critical data and financial assets, potentially harming the organisation's reputation, viability, and security.
-
Technical risks
Reliant on technology, digital assets are at risk of tech failures, leading to data loss, corruption, and technical malfunctions such as hardware breakdowns, software errors, blockchain forks, and network vulnerabilities. Such issues could potentially cause operational disruptions and irreversible damage.
-
Market volatility
Cryptocurrencies are particularly vulnerable to price volatility, which brings a significant risk of loss. They can experience rapid fluctuations due to factors such as market demand and investor sentiment. Bitcoin, for example, has a fixed supply limit, making it rarer and driving up price as the limit is approached, especially when demand is high. Even large buy-or-sell orders can dramatically impact value. Regulatory changes, economic trends, and news can further influence market movements based on public perception.
The popularity of some digital assets like NFTs has diminished over time, with reports suggesting that 95% are now worthless. That said, some have maintained their value. With blockchain technology enduring, the future of digital assets remains uncertain.
-
Legal uncertainty
As a relatively new asset class, the legal frameworks around digital assets are in a state of flux, characterised by diverse regulations across regions. Breaching these regulations can incur significant penalties. Challenges may arise from their mishandling, storage, or transfer.
What are current regulations governing digital assets
The Financial Conduct Authority (FCA) is a notable body governing crypto assets in the UK. All crypto asset businesses, exchanges and custodians operating in the UK need to be registered with the FCA. They must comply with the Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs), aimed at preventing money laundering and terrorist financing activities.
The sale of crypto assets-backed Exchange Traded Notes (cETNs) and crypto derivatives to retail consumers is prohibited by FCA. However, professional investors, such as investment firms and credit institutions authorised or regulated to operate in financial markets, are allowed to deal in cETNs.
The FCA is continually collaborating with the government to regulate crypto assets. According to their Discussion Paper on Stablecoins, crypto firms must comply with new financial promotion rules, similar to those for high-risk investments, and follow Finalised Guidance (FG23/3) outlining expectations for the communication and approval of financial promotions for qualifying crypto assets.
Considering their growing significance, the Law Commission, an independent UK legal body, has proposed the creation of a personal property law reform to create a new category to include digital assets, providing a legal framework that can accommodate their unique nature. The regulatory landscape is still evolving and requires a watchful eye on developments.
Prepare your finance team for digital success
To successfully navigate the opportunities of digital assets, businesses must develop a future-ready finance function. CFOs and finance teams should keep up with the latest FinTech trends, welcome new technologies, and prioritise continuous learning. One step towards this is adopting scalable cloud-based financial management software that can easily adapt to changes.
A cloud-based solution, like Financials can significantly enhance the efficiency and effectiveness of managing resources (both digital and physical). It centralises all financial data, providing clear visibility of potential risks and value-creation opportunities. It offers real-time insights and accurate data, driving informed business decisions. The solution streamlines financial functions with various management modules while remaining agile and adaptable in an evolving landscape.