Mathematician Dr Ian Hunt believes he needs just one willing participant to radically simplify the funds industry. He tells Nick Fitzpatrick that smart tokens, representing native digital assets, are the key – and could even transform capital markets.
When a fund or security is bought or sold, the transaction is funnelled through a transfer agent (TA) whose job is to manage the transactions and update ledgers of who owns what. This part of the investment industry garners little attention but employs thousands of people in the historically heavily manual work of form-filling.
Despite predictions of massive digital disruption leading to its extinction, TA has so far managed to survive through greater levels of automation.
However, Dr Ian Hunt, a mathematician, believes his proposal for a single operating model to support transactions in ‘native digital assets’, including native digital funds, could do away with the need not only for TAs but much of the wider asset servicing industry too. This would leave the two primary market participants only: the asset owner (or investor) and the capital issuer (or borrower).
“From day one, Corda has been designed so that financial agreements can be recorded and managed on a secure, regulated, shared ledger, a natively digital vision in other words, or ‘smart’."
To implement this native-fund digital infrastructure, he needs a venue in just one jurisdiction, where native digital assets can be issued and transacted within the single ‘smart token operating model’. This venue could be built by a TA provider or by any other financial actor (fund administrator, custodian, asset manager, bank or stock exchange). Whoever the first mover is, they could become the fulcrum of a new market infrastructure, says Dr Hunt.
It might sound irrational to expect a TA to support this, but Dr Hunt says that smart tokens have such radical potential to create a single model for both issuance and distribution of financial assets – and to simplify regulation and lower its related costs – that one participant in the capital markets ecosystem is sure to bite.
Engineered assets
Two facts define the smart token model: that the tokens represent rights to ‘future flows of value’ (not to conventional assets), and that the tokens are ‘smart’, meaning they can make those flows happen. This differentiates the proposal from hundreds of other projects that tokenise conventional assets – projects that are worthy, says Dr Hunt, but that won’t ever be transformational.
Smart tokens are digital assets held on a blockchain register. They could be made to act like equities or bonds, both public and private. But unlike conventional ‘dumb’ tokens, which merely represent ownership of underlying assets that exist in the conventional world outside the ledger, smart tokens are entirely digitally native.
The flows of value would be embedded in the initial agreement between issuer and investor. In a wholly digital world, that transfer of value will always be represented by the movement of tokens on the ledger. The agreement can be anything – and one benefit of this arbitrary nature is to do away with the plethora of fund share classes.
What’s more, smart tokens could be engineered to self-execute – automatically paying out interest or dividends, implementing corporate actions, executing orders, making capital calls and updating ledgers all by themselves.
“We also need to ensure these new asset networks – whether fully smart or hybrid – can seamlessly interoperate with each other: the future is one of openly interoperable networks of networks, built on a trusted foundation, architected and designed to endure.”
In a white paper published in 2023, Dr Hunt says that the benefits of the smart token model are “profound” and eliminate the boundaries between asset classes. They allow the investment industry to build “whatever assets and transactions that we want, and that are useful to issuers and investors”.
Issuers of capital could create exactly the funding that they want, while asset owners could find precise matches to their investment requirements.
Many processes currently carried out by regulated entities – including order management, execution, corporate actions, income payments, securitisations, and collateral transfers – would be carried out automatically by the tokens themselves. Humans would define the agreements coded on the tokens, but the smart tokens themselves would transfer value without human intervention.
But is Dr Ian Hunt – who runs the website Digital Issuance - just the latest tech evangelist to tout a white paper proposing yet another digital asset? And would the asset servicing industry hope that – like the semi-mythical Satoshi Nakamoto who authored the Bitcoin white paper – he might one day just disappear?
And even if there is substance to his proposals, would the industry listen?
Disrupter from within
For a start, Dr Hunt is very much an industry insider. He has spent 40 years working for fund managers, asset owners and brokers, including M&G, Insight Investment, the BT Pension Scheme, BNP Paribas and Charterhouse Tilney. He managed the launch of Winterflood Securities and defined derivative fund structures for Hiscox Insurance. He has piloted his plane between offices in London, Edinburgh, Paris, Brussels and Amsterdam for meetings spanning risk management, order management, compliance, custody and more recently, digitisation. “The smart token model is the summation of what I have learnt in the industry,” he says.
For many years now, Dr Hunt has been a consultant, author and public speaker on digital transformation. He’s also acted as an investment expert in a series of trials related to Bernard Madoff. In fact, that villain features elsewhere in the story, back when Nasdaq disrupted the New York Stock Exchange (NYSE). Dr Hunt draws a parallel with that event and the evolution of digitally native funds.
Creating a single operating model for issuance and transaction that centres on native digital assets is “not about getting the mess we have now and turning it into something else”, Hunt tells Funds Europe. “It’s about setting up a facility that is far better than what we have, and letting it grow naturally. I think it would be much more like 40 years ago, when the NYSE was an ‘open outcry’ market, and run by conservative, blue-suited New Yorkers. There were some disrupters in the NYSE, including Bernie Madoff, who wanted the exchange to become electronic. NYSE didn’t get on board with the change, so they went off and created Nasdaq. It was cheaper to issue and trade on Nasdaq than on the NYSE, and also quicker and more transparent. When Nasdaq got to critical mass, NYSE had to sit up and take notice.”
NYSE was disrupted from within. A TA (or other provider of market infrastructure) could do the same for the asset and fund markets, says Hunt, who adds that he’s talking to “quite a lot” of buy-side and sell-side actors, and to asset management boards, to foster interest.
“Like Nasdaq, we would just create the venue.”
Smart tokens but not complex tokens
No one, he says, has argued with the integrity or practicality of the single operating model that could arise from smart tokens implemented on a blockchain infrastructure. But people do ask: ‘How on earth do we get there?’
Making tokens smart is not as complex as it may sound and shouldn’t be expensive, he says. In a wholly digital finance environment, the only thing happening is the movement of tokens between addresses on the ledger. So, the only thing that smart tokens can possibly do is to move other tokens (or themselves) around on the ledger. As a result, they are relatively simple entities and would not be expensive to create. Smart tokens just need to ‘know’ what tokens they have to move, when to do it and what constraints they are operating under. Then they need the power to do it.
“The prize is high. Because native digital assets allow us to define any flows – and therefore any asset type – that we want, and the smart-token model allows us to trade these through a single, simple operating model, then we only need to build one platform."
To achieve this in a simple build, the support of blockchain developers is needed, and this may be a hurdle, admits Hunt. “Building the technology should be simple if the underlying ledgers support the idea of smart tokens that can move other tokens – but at the moment they do not.” The task is to persuade the likes of R3 – the builder of Corda, a leading financial-markets distributed ledger technology (DLT), or blockchain, platform – to admit smart tokens alongside their existing tokens.
“Corda supports smart contracts, but they are wrapped up in apps that live at a static location, and push tokens around. This architecture is very like conventional business systems, which are static, live at the location of the business, and push dumb data and messages around. We need to work with the DLT developers to deliver platforms which fully support the smart token construct – we need smart tokens to be on their roadmaps,” Dr Hunt says.
Corda’s “shared vision”
Richard Gendal Brown, chief technology officer at R3, tells Funds Europe that Corda “fully supports” the native-digital vision.
He says: “From day one, Corda has been designed so that financial agreements can be recorded and managed on a secure, regulated, shared ledger, where the ledger records the full set of rights and obligations, and the lifecycle of the asset and associated cashflows are automated – a natively digital vision in other words, or ‘smart’.
“Not all current projects have fully adopted this model yet, of course. Full industry transformation takes time, and it is often optimal to proceed via steps where the new coexists with the old.”
He agrees smart tokens could be transformational but says they are “only part of the story”.
“We also need to ensure these new asset networks – whether fully smart or hybrid – can seamlessly interoperate with each other: the future is one of openly interoperable networks of networks, built on a trusted foundation, architected and designed to endure.”
“If it works for loans, it will work for bonds and for collateral. If it works for them, then it will work for swaps and for funds."
Dr Hunt agrees smart tokens are only part of the story. Cryptocurrency, central bank digital currencies and tokenised conventional assets, among other innovations, are also needed in the ecosystem. But smart tokens are the highest-value part of the story, he says.
“The prize is high. Because native digital assets allow us to define any flows – and therefore any asset type – that we want, and the smart-token model allows us to trade these through a single, simple operating model, then we only need to build one platform.
“If it works for loans, it will work for bonds and for collateral. If it works for them, then it will work for swaps and for funds. This makes change quick and cheap and allows us to represent underlying assets, funds, platforms and distribution within the same model. That has profound impacts on the funds industry.
“It's also radical for regulation: we don’t need more regulations for native digital assets. In the smart-token model, to state the blindingly obvious, there is much less to regulate, not more.”
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