Family Offices in the age of Digital Assets
Digital Assets can offer an exciting avenue for Family Offices looking to improve their efficiency and expand their offering. Here is why and how.
Although still a niche market, the rise of digital assets over the past decade has opened an entirely new field of investment opportunities yet to be fully understood and explored by many institutional players.
Family Offices play an essential role in today’s economy regarding large-scale capital deployment. Working with or on behalf of wealthy individuals, they often seek to invest in assets unavailable to the traditional investor. Regarding knowledge, Family Offices have a unique skill set in analyzing non-traditional asset classes such as private equity, debt, and venture capital. As a result, Family Offices are familiar with illiquid assets, highly volatile markets, and complex regulations.
This article explores what Digital Assets are, how Family Offices can seek exposure to this new asset class, and what hurdles they must overcome.
- Digital Assets present an exciting opportunity for diversification
- They go far beyond Crypto and NFT
- Access to Digital Assets comes in a multitude of forms
- Digital Assets can be used to gain a competitive advantage as well as investments
- Before investing in Digital Assets, invest in knowledge
What are Digital Assets?
When hearing Digital Assets, most people intuitively would think of cryptocurrencies. But this could not be further from the truth. So what are Digital Assets? Investopedia describes them as;
“…generally anything that is created and stored digitally, is identifiable and discoverable, and has or provides value.”
This description is about as broad as it gets, but it clearly shows that we are not only talking about cryptocurrencies and NFTs. Especially if we are looking at it from the angle of a professional investor, we have to get more specific. With the introduction of blockchain technology, the world of digital assets has taken on an entirely new dynamic. Some would say to the extent that Digital Assets have evolved into their own asset class.
If you are entirely new to Digital Assets, check out our “Blockchain Guide for Beginners”
Are Digital Assets really their own Asset Class?
Although there is no universal definition, an asset class is a set of investments with similar characteristics. The most narrow approach in traditional financial markets defines four distinct asset classes;
- Cash & Equivalents
- Alternative investments
While the first three are undisputedly their own class, the term “Alternative Investments” is a somewhat spongy definition. In today’s markets, there is an argument to be made that there are more than four classes; think of Real Estate and Commodities, for example.
So whether Digital Assets are really an asset class lies in the eye of the beholder. At least an argument could be made that since the invention of blockchain, most digital assets have very distinct features that distinguish them from the more traditional asset classes;
- Open Source
- 24/7 availability
- Instant transaction settlement
- Fully customizable
- Carrier of value
Further discussion of how digital assets should be classified exceeds this article’s scope and probably deserves its own. For this article, I will refer to Digital Assets as their own asset class.
Why Digital Assets?
Now that we have established what Digital Assets are (or not), let’s look at why they provide an exciting field for Family Offices.
Although Digital Assets are a relatively new concept, they have gathered substantial momentum over the past five years, primarily thanks to cryptocurrencies such as Bitcoin and Ethereum. Despite crypto and NFTs dominating headlines, much more is happening than meets the eye. Blockchain technology can potentially transform entire industries, similar to the internet in the early 2000s. This transformational process leads to opportunities on multiple fronts.
As a result, Family Offices can either incorporate Digital Assets into their business activities or look at it from an investor perspective for diversification.
Incorporating Digital Assets
Since the financial crisis in 2008, the financial sector has been undergoing a digital revolution. While large traditional institutions will find it difficult to adjust to the digital age due to their size and complexity, Family Offices are at the forefront of technological advancements to futureproof their businesses and gain a competitive advantage. Being able to incorporate new and advanced technology helps to reduce cost, increase efficiency and add transparency. Perfect for small to mid-sized businesses.
Digital Asset solutions for Family Offices range from customer data management, data sourcing, and reporting to complete custodial solutions and smart contracting. And as the technology develops, so does the offering.
While setting up a fully digitized Family Office might be a bit far-fetched, being familiar with this rapidly evolving field and having Digital Asset friendly IT solutions is undoubtedly an advantage.
External factors such as the generational transformation of wealth will require Family Offices to cater to the needs of a new generation of tech-savvy clients or risk losing business. Hence seeking to incorporate state-of-the-art technology into their business culture can serve as a marketing strategy and help with next-gen client retention.
Incorporating Digital Asset capabilities can also lay the groundwork for a better understanding of Digital Assets as portfolio investments. First-hand experience with the benefits and drawbacks of Digital Assets steepens the learning curve drastically and can lead to a competitive advantage.
Investing in Digital Assets
Managing assets and deploying capital is at the core of most Family Office activities. Many tend to look past the traditional asset classes and already have exposure to fast-paced, illiquid, volatile, and due diligence-heavy investments such as private equity and debt.
And while direct investing in cryptos and NFTs might be too exotic for more traditional institutions, they can always seek indirect exposure through investing in Digital Asset companies and enablers. Many of those are startups and in search of capital. Recently, some more prominent players in the Digital Asset space have even been listed on global exchanges, making them accessible through traditional stocks and bonds.
With the right research capabilities, the risks of such investments can be quantified and used to diversify portfolios.
Certain cryptocurrencies are accessible through traditional investment vehicles such as exchange traded funds (ETFs), providing yet another easy way to gain exposure while operating within traditional investment frameworks.
Various well-known asset managers offer exposure to digital assets through fund structures, removing the family office’s need for active investment management. In addition, many of these fund structures are set up under regulated frameworks facilitating reporting and legal issues.
For Family Offices that aim for a more activist role, the community-driven approach of many projects offers a degree of participation unique to this sector. Many Digital Asset projects offer direct involvement through token holdings and voting mechanisms.
However, seeking exposure to Digital Assets is not only limited to blockchain-related companies. Digital Assets are ultimately closely intertwined with other sectors. Examples here would be IT infrastructure, natural resources, energy providers, and traditional companies that seek an early adoption of Digital Assets to gain a competitive advantage.
Financial institutions experiment with digital assets and cryptocurrencies. Some industrial companies seek to improve efficiency through blockchain-powered supply chains, and hardware companies race to deliver ever more powerful computing solutions. So instead of picking the next Digital Asset unicorn, Family Offices can take a more passive approach and simply try to identify businesses and sectors that could benefit from this new technology.
Roadblocks and Opportunities
Despite the recent popularity of Digital Assets, they have yet to experience large-scale adoption. Mainly down to a few persisting roadblocks. Let’s discuss some of these hurdles and touch upon solutions.
Problem: Many aspects of Digital Assets remain largely unregulated, although this problem is increasingly tackled. Although multiple jurisdictions are working on regulatory and legal frameworks for Digital Assets and associated companies, we are still far from having widely adopted standards. Institutional investors often have investment constraints when it comes to unregulated assets. This leaves the playing field uneven and gives an asymmetrical advantage to specialized niche players willing to accept the associated risks of Digital Assets.
In addition, the decentralized aspect of many projects means they lack jurisdiction, which can be uncomforting in the case of a dispute.
Solution: Location, Location, Location. Certain locations such as Switzerland and Dubai have started introducing rules and regulations to protect investors and are setting legal frameworks to allow institutional investors to enter this new asset class. Choosing the right location facilitates entry and provides legal comfort to investors, governing authorities, and other market participants.
Many Digital Asset friendly jurisdictions have specialized service providers, such as law and consulting firms, that can help to navigate the regulatory minefield. Larger Family Offices could profit from hiring an in-house Digital Asset specialist that acts as a gatekeeper.
Problem: The Digital Asset space is highly fragmented. Blockchain technology is a relatively new invention, and its capabilities and complexities have yet to be fully understood. Similar to the internet in the early 2000s, we only see a hand full of practical, real-world applications. Many projects lack transparency or don’t solve any significant problems. The concept of smart contracts, DeFi, NFTs, and other blockchain solutions requires an understanding of technology, coding, and familiarity with abstract concepts such as Decentralized Autonomous Organizations (DAOs). And even if the Family Office understands the complexity of Digital Assets, it has the difficult task of educating its clients.
Solution: Education, Education, Education. Family Offices that seek exposure to Digital Assets are well advised to acquire as much knowledge as possible. This can be either through hiring or via external partners. The cost of this might seem high, but it should be seen as an investment into the future of the Family Office. And while it might not be necessary to hire a blockchain developer just to understand Digital Assets, having some expertise at hand will bring comfort and helps to stay atop the latest industry developments.
Many locations host regular summits and conferences that inform about the latest developments in the Digital Asset space. They provide an excellent platform to meet with industry specialists and identify trends.
Many crypto platforms such as Binance, Kraken, and Coinbase offer free education and webinars, which can be a good starting point for acquiring a basic understanding of the matter. The web-based nature of Digital Assets provides a lot of online content, readily available for everyone. However, this information has to be consumed with caution and critical common sense.
Track Record & Comparable Data
Problem: Digital Assets represent a relatively new industry, so many projects lack a track record and little comparative data. This is a significant roadblock for many institutional investors, often requiring large amounts of data for risk modeling and reporting. Many projects’ digital and decentralized nature also means that traditional analytical methods struggle.
Solution: Little can be done about a lacking track record of a project or a company. But for seasoned startup investors, this is not an unusual problem to encounter. Instead of the project itself, one has to focus on soft factors, such as the people involved, the company’s jurisdiction, the business plan, and other comparables. As time passes, track records will get longer, and comparison is getting easier. But like with every other new and emerging industry, early adoption and involvement can lead to competitive advantage and significant risk premiums. Again, working with industry experts is strongly advised.
Alternatively, Family Offices can take a more indirect exposure through traditional companies and sectors, which likely will be impacted by the Digital Asset transformation. This will allow them to operate in a more familiar environment while still having an angle on Digital Assets.
Lack of Expertise & Credibility
Problem: Although this topic is somewhat overarching with the previously discussed issues, it deserves its own mention. Finding the right experts can be a significant problem for many companies since they are either costly, lack credibility, or, worst case, both. The Digital Asset space is still in a gold rush, attracting many shady figures and self-proclaimed experts.
Solution: Investing the necessary time and resources to acquire the needed expertise is an investment well worth the cost. Family Offices can partner with specialized solution providers such as digital asset custodians, prime brokers, and regulated exchanges for Digital Assets. Specialized law and consulting firms offer education, project management, and case studies. Many digital asset-friendly jurisdictions are home to third-party IT solution providers, offering integrations and compatibility with existing legacy systems to ensure Family Offices can continue to operate and transition smoothly into the digital age.
As we can see, there are many ways a Family Office can gain exposure to Digital Assets. Once the perception of Digital Assets consisting only of cryptos and NFTs is abandoned, a whole array of opportunities comes to light.
While the associated risks of Digital Assets require careful consideration, there are great opportunities to explore. As with every asset class, knowledge and education are essential. Approaching the topic with healthy curiosity can help Family Offices to gain a competitive advantage by offering their clients cutting-edge solutions.
As legal frameworks are catching up, Digital Assets are on track to becoming what the internet is today. It took us almost two decades to understand the true power, the risks, and the benefits of the internet, artificial intelligence, and cloud computing. And in many cases, we are still learning. The internet has matured and is firmly embedded in our everyday lives, and there is a fair assumption that Digital Assets will have a similar journey.
Any Family Office seeking exposure to Digital Assets is strongly advised to invest time and resources in understanding the technology, the risks, and potential early on.
Using dedicated third-party providers and credible partners can facilitate this journey, help avoid expensive mistakes and ultimately enhance the offering of a Family Office.
Looking for a partner to get the journey started? Here at Inside The Block, we are committed to helping our clients find the right solutions for their needs. We act as independent consultants, free from bias and restrictions, tailoring our advice to your specific needs and problems.
If this article has raised your interest in Digital Assets and you want to know more, contact us. Let’s start this journey together today.
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Disclaimer: Any information in this article is based on my personal experience and has been written out of personal interest to my best knowledge and ability. This article has no promotional purpose, does not represent investment advice and any names, brands and tickers mentioned in this article are for illustrative purposes only. Use any of the associated links with care and at your own risk. Always do your own research.
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