SIFMA Chief Operating Officer, Joe Seidel, recently sat down with Tom Jessop, President of Fidelity Digital Assets, for a one-on-one conversation on the relationship between institutions and digital assets. This is an excerpt from their conversation, one in a series of Executive Viewpoints at SIFMA’s 2021 Annual Meeting.

About Executive Viewpoints

Filmed for SIFMA’s 2021 Annual Meeting, Executive Viewpoints is a series of insightful conversations about trends and innovations shaping the future of our capital markets. The capital markets are in the midst of major transformation, arguably one of their most fundamental shifts yet. In this special series, SIFMA president and CEO Kenneth E. Bentsen, Jr. and chief operating officer Joseph Seidel interview a cross-section of experts to understand just some of the dynamics at play in the market’s next evolution.

To view more from the 2021 SIFMA Annual Meeting, please visit www.sifma.org/annual.

A Conversation with Tom Jessop

Joe Seidel: To kick us off, can you start by giving us a brief overview of how the digital asset industry developed and, in particular, how it’s grown in the past two years?

Tom Jessop: I think as most people watching this know, really, this whole concept of digital assets started in 2008 with a Satoshi Nakamoto white paper talking about this peer-to-peer digital currency called Bitcoin. The way to think about this is that blockchains are a form of technology. The Bitcoin blockchain is one instance of that type of technology. What we’ve seen in the ensuing years is literally dozens, if not hundreds, of other protocols that have developed—things like Ethereum, as an example.

What we’ve seen from that genesis of that is an explosion of protocols and new ways to think about moving value or conducting various types of transactions over these blockchains. The way that’s sort of represented itself in the market or in metrics that are understood by financial market professionals is in things like market cap.

Right now the total market cap of digital assets is probably touching or above $2 trillion. To put that in context: A couple of years after Bitcoin was developed—probably in, let’s say, 2012—the total market cap of Bitcoin was about $140 billion. So very small, if not smaller.

We’ve seen an explosion of innovation in this space. Commensurate with that, we’ve seen the development of exchanges, OTC liquidity providers, custodial solutions. All of these artifacts or things that we’re familiar with in traditional finance are now fully instantiated in the digital asset world.

Joe Seidel: Fidelity was one of the first traditional financial firms to ender this space. Can you talk a little bit about the history there and why the firm decided to invest in research and capabilities? What’s next for you?

Tom Jessop: I’m relatively new to Fidelity—I’ve been here about three and a half years—and what I was pleasantly surprised by was the commitment of the firm to basic technology research and development. We primarily do that through a group called the Fidelity Center for Applied Technology.

Just to put things in context: Right now they’re looking at quantum computing and understanding implications of that for things like portfolio construction and risk management. Back in 2015, one of those emerging technologies was actually blockchain.

Within the FCAT group, they did everything from mining Bitcoin to running nodes in various networks to conducting user-experience experiments in the company cafeteria to figure out if people would spend Bitcoin for things and how that would work from a user standpoint.

We started to develop this view that this is really a new operating system for financial services. It can make existing things more efficient in some cases, will and has given birth to an entirely new asset class around native digital assets.

As a big financial services firm, it was something that we deemed important to research. We took those learnings and, in roughly 2018-2019, we launched Fidelity Digital Assets, which is the commercial expression of a lot of that research.

Joe Seidel: Fidelity is often known for its input and its footprint in the retail market. Let’s talk separately, then, about the growth of the institutional market. Many institutional investors are still in the exploratory phase, wondering how and where to get started with digital assets. For those looking to get into that space, what would you recommend is a good place to start?

Tom Jessop: Let’s just talk about one aspect of crypto or digital assets which is interesting, which is: It really is one of the few inventions in finance which starts with retail. It was much more of a retail phenomenon before it became an institutional one.

I think institutions are very measured and thoughtful in their approach to any new asset class. We see call it a three-stage process, which really starts with: “What is it?” and “Why should I care? What is my thesis around the implications of this technology for the world or for my business?”

The second phase is a little bit of: “Okay. Now that I understand the technology and I can talk knowledgeably about it to my investment committee or my colleagues, what role do these assets have in my portfolio? Am I looking to amplify my returns in my alt sleeve? Am I buying these assets because they diversify my core portfolio? Or am I doing it for other reasons?”

And then once you have that investment thesis, the third step is: “Okay. Now that I’ve got that, how do I operationalize this? How do I source liquidity? How do I do a transaction-cost analysis? How do I ensure that the assets are safe with a custodian?”

We’re seeing an increasing number of investors move through that pipeline, and they’re at this stage of: “How do I pick a partner?” I think any financial services firm buying services from a third party or from another financial institution, involves diligence—fairly detailed diligence, not too dissimilar to what folks do in other asset classes. I think that that’s probably where most people who are kind of in the game are at right now or thinking about.

For those that haven’t actually gotten into even that first bucket—”What is it? How does it work?”—there’s a plethora of resources on our website, as well as the websites of many other service providers, that provide primers and other detail on: How does the technology work? Why should you be considering allocations to the asset class?

There’s an abundant set of resources now. Even the CFA Institute has published what I think is probably the best primer on blockchain technology and digital assets for a traditional financial services professional, and they did that back in January. If you were to go to the CFA Institute website, that’s probably a good start for people that are just getting their toes wet.

Joe Seidel: Fidelity Digital Assets recently released its annual Institutional Investor Digital Asset Study, which has helped the firm track attitudes and behaviors in the institutional space. From your perspective, what were some of the more interesting findings this year?

Tom Jessop: This is the third year we’ve done the survey. We have a nice time-series analysis of attitudes towards digital assets, and I think there are a couple of things worth highlighting.

Generally speaking, interest is moving up and to the right. Both the percentage of respondents who have a current allocation to digital assets as well as those who intend to start or increase their allocation in the future, year on year those numbers have increased.

What was interesting this year is that in certain client segments, like registered investment advisers, we saw double-digit percentage increases in clients or respondents that had exposure to digital assets. We’ve seen interest in a wider range of assets. A lot more interest this year in things like Ethereum and other assets, not just Bitcoin. Those are sort of the primary findings.

I think at the same time some of the concerns that investors have about this space, notably volatility, regulatory uncertainty, and a few other things, year on year those risks seem to have subsided as a primary concern. I think what we attribute that to is not that the regulatory environment has gotten any clearer. In fact, I think there’s been some progress, but it’s not like it’s been revolutionary progress.

I think people now realize that some of this uncertainty is just part of their risk equation when they think about making an allocation. Not too dissimilar to how investors perhaps thought about allocation to emerging or frontier markets back in the ’90s. A geopolitical risk or regulatory uncertainty was just a risk factor when weighing an allocation. In summary, we’re seeing a lot of positive development and interest that would suggest that this is becoming a more mainstream asset class.

Joe Seidel: Bitcoin investment products have been grabbing lots of daily headlines lately. Can you talk a little bit about the demand in the marketplace, how the U.S. compares with other regions in terms of product availability, and where you think things may be heading?

Tom Jessop: There’s tremendous demand for digital asset investment products. In fact, that was one key aspect of the survey that, year on year, we saw a great uptick in, which is demand for the product. I think that’s not only a recognition of the potential upside in this space but, also recognizing that having active managers who know the space and are crypto-native is probably a good way to think about allocating money than trying to understand this incredibly complex and diverse space yourself.

There’s definitely demand for investment products. With ETFs, there’s demand for an investment product that sits in a brokerage account. You can’t hold Bitcoin in a brokerage account, but there are vehicles that allow people to buy exposure to these assets in existing account structures. That’s a huge benefit for investors.

In terms of the global perspective, most overseas jurisdictions have a much more evolved or permissible approach to digital assets. For example, in Europe—and I don’t know the timeframe, but for several years they’ve had competing ETF products listed on multiple European exchanges.

There’s more an ability for investors to get exposure to some of the more exciting aspects of crypto right now, whether it’s DeFi or yield because the regulatory environment in many respects is clearer on how those assets are characterized. We see this space generally as being a source of growth for Fidelity and for the industry over the next couple of years.

Joe Seidel: Well, you can’t talk about digital assets with us without also talking about regulation. Give us your take on the regulatory environment and how it has evolved and what the most pressing needs are for the industry to continue to grow and innovate. It’s a challenging time right now.

Tom Jessop: It is. Maybe I am being a bit of an optimist, but I actually think a lot of the negative attention is a positive in one respect, which is it’s just drawing a lot of attention to the fact that there’s demand for the asset class. There are some interesting business models that are developing on top of these protocols that are important to the future economic success, potentially, of the U.S.

The bad attention in some respects is driving discussion, which is great. From our perspective, we just need to make sure that politicians and legislators understand the unique attributes of these assets and can incorporate them into — let’s call it a more traditional regulatory framework. There’s something that the industry is obviously very focused on.

I think around the edges we’ve responded to a number of [comment—] letters at the SEC and Treasury around transaction reporting, and we will continue to take some of our experience as a traditional financial services provider and an organization that’s now deeply involved in this space to try to act as a bridge between calling it the traditional and the new. We’re cautiously optimistic that we’ll make progress. I just hope it’s the right type of progress that, again, accounts for the uniqueness of this asset class.

Joe Seidel: In terms of the noise around this sector, help us break through some of that noise. You have price volatility, geopolitical developments, China, El Salvador, ESG. How do you approach these conversations with clients? How much of a barrier to adoption are some of these things?

Tom Jessop: It really depends on the client. Let’s just take the ESG question. Number one, not every blockchain-based technology uses electricity, or Proof of Work, to validate transactions. Something like Ethereum, as an example, is moving [in] something called Proof of Stake, which is much more energy-efficient. To say that the entire space is consuming a lot of energy on the surface is not accurate.

I think when you look at something like Bitcoin, which is Proof of Work . . . And quite frankly, the value of the Bitcoin network is a direct function of its electricity consumption because it is a trustless 24/7 ability to move value around the planet. I think, depending on where you sit, you have to ascribe some value to that. That value has a cost. The cost is electricity.

If you then unpack this a bit further, there is a very high percentage of power today coming from renewable sources driving validation on the Bitcoin blockchain. There’s a financial incentive for miners to find stranded intermittent power, whether it’s wind in West Texas or stranded natural gas—you know, flare gas—hydro in parts of the world that are very geographically far from commercial use to use the electricity. Over time the industry could demonstrate that that’s actually not as much of an issue as it might seem.

In terms of things like volatility, I think you can’t look at volatility in the absolute. No one is going to invest 100 percent of their portfolio in Bitcoin. It really is a function of looking at volatility through the lens of two things. One is a traditional portfolio construct, where you were adding assets to generate some incremental risk-adjusted return. that over longer periods of time with certain rebalancing criteria, Bitcoin actually can diversify. The volatility kind of helps you.

If you view this entire space as, effectively, a public venture market, where you get to invest in the new technologies and the protocols and business models that will drive future economic output, then you would kind of view it as an alternative investment where the volatility de facto is going to be much higher.

It really depends on your lens. If it’s an alternative investment, you understand the cost of that volatility. If you’re in a more traditional setting, it’s a function of, what does that asset do in your portfolio when commingled with other assets that have different risk/return profiles?

Joe Seidel: Fidelity’s business today is focused on Bitcoin, and that’s certainly the most significant digital asset by market cap. Can you help us unpack the broader opportunity for financial services [re:] digital assets, blockchain? If Bitcoin is the first inning, what do you think the next eight innings look like?

Tom Jessop: We have a fundamental view that we want to be asset-agnostic, which is to say you will have blockchain-based assets that serve multiple purposes, that look very different from one another. Our goal is to support all of them. To your point: Bitcoin is still the primary focus of interest for many clients, but they’re starting to look at Ethereum and other assets.

If I were to say—you know, maybe tying this back to more traditional finance—what are two of the areas that are interesting? One is certainly the concept of either a stable coin or CBDC in terms of making payments more efficient. Obviously now a lot of regulatory focus on stable coins and how they fit into a traditional framework. In most cases, with much broader acceptance for things like remittances, overseas commercial payments, et cetera. That’s an asset we would support, as we would a Central Bank Digital Currency.

There’s also a lot of interesting work happening in the tokenization space, people that are looking to issue private securities in token form as a way of making that process more efficient, tracking ownership, and potentially creating secondary market liquidity. So again, as that space develops, assets that we would like to support.

When you actually peel back the screen a little bit and you get beyond Bitcoin, there’s really quite a variety of use cases and business models that will all run on top of these blockchains with some native token that investors will want access to.

Watch the Full Conversation

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Tom Jessop is the President of Fidelity Digital Assets. In this role Tom is responsible for daily business operations while directing the company’s long-term vision to create a full-service institutional brokerage capability for native digital assets like Bitcoin and tokenized securities.

 

Joseph Seidel is Chief Operating Officer of SIFMA. He manages the day-to-day operations of the Association, including core legal, regulatory, business practices, public policy and communications activities.