The brave, bold and tangled world of Web3, where the metaverse and NFTs are opening up new avenues of business and investment
- Banks and other financial institutions want a piece of the action in the new frontier, but issues like investor protection and security need to be addressed
- NFTs can open the door to creative business models, innovation and new opportunities for investment, although regulatory scrutiny is likely to be a hurdle in the future
In March 2022, HSBC became the first bank to enter The Sandbox, a digital world where users can buy land and build virtual experiences. The bank aims to engage and connect with sports, esports and gaming enthusiasts via the acquisition of its site in the metaverse, and while uncertainty remains as to how the platform will develop moving forward, the move is a sign of the financial industry’s growing interest in the Web3 universe.
“What is certain is that where there is an economy, there will be intermediaries providing services – and financial services are a necessity,” HSBC’s Securities Services Digital and Data (SSDD) team told South China Morning Post in an email. “There will be financial transactions, a universe that requires a registrar who can securely keep ownership records and preserve its integrity in an unbiased manner, a virtual land where financial institutions can sell financial products and provide advisory services virtually, and several other opportunities and roles for the financial services industry to tap into,” it added.
Just a few weeks after the acquisition, HSBC Global Private Banking launched a discretionary managed portfolio for metaverse opportunities catering to its private banking clients in Asia. It is open to professional investors in Hong Kong, while in Singapore it is available to accredited investors.
Managed by HSBC Asset Management, the Metaverse Discretionary Strategy is actively managed and focuses on investing in companies within the metaverse ecosystem. The portfolio has five key segments, which are infrastructure, computing, virtualisation, experience and discovery, and human interface.
However, concerns about intellectual property protection, application of accounting standards, tax treatment of gains, antitrust violations, anti-money-laundering and know-your-customer data privacy risks also remain, as they do in many other areas of the Web3 world.
“The legal status of smart contracts, NFTs (non-fungible tokens) and Decentralised Autonomous Organisations (DAOs) are still to be defined in most countries, raising enforceability and financial protection issues for investors,” HSBC said. With the Covid-19 pandemic speeding up digitalisation, it is possible to handle nearly all areas of personal banking and finance without ever visiting a bank. But Web3 – an umbrella term that includes cryptocurrencies, NTFs, blockchain technologies and the metaverse – comes with a growing list of concerns, including those around ownership and regulation.
Banks and other financial institutions are looking at different ways to tap into Web3 and its benefits. One way is through NFTs, which can open the door to creative business models, innovation and new opportunities for investment.
“We have been contacted by a few global private banks who are interested in our art NFTs,” said Levina Li, co-founder of Art-Partners and The MetaArt Club, a collection of 9,888 fine art NFTs that are hand curated by 35 international artists.
For now, the involvement of banks in NFTs appears to be limited to hosting talks on art NFTs, Web3 or cryptocurrencies, and maybe gifting art NFTs to their clients, but there is growing interest in the space.
“Private banks catch clients and cultivate relationships where there is interest, but they are not telling clients which cryptocurrencies to buy. Just entering Web3 is brave, particularly with all the regulatory hurdles,” she added.
Brad Maclean, chief operations and compliance officer at Merkle, a Hong Kong-based digital asset-focused private wealth provider, agrees that Web3 initiatives have been focused on collectibles, with a heavy focus on contemporary art.
“Still, we have also seen other projects link the real world with the virtual, [connecting] physical collectibles with NTFs, such as wine, whisky, and collectable cars. Ultimately not all NTFs are created equal, and we see emerging use cases beyond contemporary art and collectibles,” he said.
Other Web3 initiatives that are attracting interest include Metaverse land, NFT whitelist queuing and NFT collateralisation. Given their flexibility, interest in NFTs’ potential for expanding market challenges around carbon credits and offsets is also increasing.
“Moreover, given the risk capital requirements set by the Bank for International Settlements for banks to participate in crypto-related trading activities … we are seeing some banks looking to explore NFTs as a type of regulatory arbitrage,” Maclean said. “Private bankers are also increasingly expressing an interest in helping clients conduct due diligence on platforms, as their clients are increasingly demanding exposure to the quickly evolving asset class.
“The market has been flooded with a flurry of overly complex, virtual, and abstract projects, with most receiving a lukewarm reception. Success, for the most part, has been driven by the project’s ability to attract influencers to help market and drive community engagement,” he added.
Regulatory scrutiny is likely to be a common hurdle in the future.
“NFTs continue to evolve and become complex. Regulators are likely to refocus, as with cryptocurrencies, their attention in the near term on the potential for NFTs to be used for money laundering and terror financing by bad actors, as well as overall investor protection from fraud and market abuse,” Maclean said.
Cryptocurrencies are a more appealing area for banks, even though their financial prospects may be uncertain. “The technology that underpins them, smart contracts built within a distributed ledger, has the potential to disrupt finance and investment,” wrote César Pérez Ruiz, chief investment officer, Pictet Wealth Management, and Olivier Ginguené, chief investment officer multi-asset & quantitative investment, Pictet Asset Management, in a recent white paper. “Through smart contracts, blockchains can introduce a whole new spectrum of assets that can be easily traded, and whose ownership is established and protected.”
Pictet also predicts that via smart contracts, blockchain can help introduce a whole new spectrum of assets that can be easily traded, and whose ownership is established and protected. Web3 and the metaverse also create new self-contained, and potentially immersive, digital environments that enable blockchain tokens such as NTFs to be traded and exchanged.
“But there’s also the prospect of tokenising existing assets, be they liquid, like publicly listed equities and government bonds, or illiquid, like real estate, private assets and collectibles. Significantly, if these tokens are created and exchanged on public blockchains, they could consign to history whole swathes of financial intermediation, including brokers, central securities depositories, and clearing houses. It could make decentralised finance a reality,” according to the Pictet paper.
However, dispute resolution, investor protection and security are among the issues that still need to be addressed and, so far, “cryptocurrencies have not been sufficiently time tested to become a new investible asset class”.