Deep Diving
Into Digital Assets.

A person, or a natural actor (n actor), may have to be verified by another actor for the purpose of deciding whether they can onboard them into doing potential transactions. Onboarding is a risk management process.

This RDDQ is in relation to a person being onboarded. This is a typical activity of administrators and exchanges. This RDDQ can be used for ongoing monitoring too.

A group of n actors working together as partnerships, consortiums, joint ventures, funds or other legal entities are non natural actors (nn actor).

This RDDQ is in relation to an actor nn being onboarded and maybe used for continual monitoring. Onboard and off boarding decisions are a risk management process.

CEX is usually a dealer broker with custodial services that takes fiat currency for swapping into non fiat currencies and smart contracts. It maybe regulated in the jurisdictions it operates and will follow best practices re KYC and AML.

One of the main risks of a CEX is conflict of interest. Unlike most TradFi exchanges, a CEX may participate on the buy and sell sides, as well as controlling the assets through its own wallets.

A DEX is usually a matching service or brokerage that functions mostly by code and has few, if any real actors. DEX's usually operate a matched bargain platform. Unlike a CEX, which can act as a broker / custodian, the DEX facilitates trading only. The digital pairs do not include fiat. Many operate on the Ethereum platform. They may also offer other services to improve liquidity such as lending.

The key risks are smart contract risks and governance risks. DEXs require more RDD than a CEX. DEX are growing rapidly because of their speed, anonymity and lower transaction costs. However this presents challenges when things do go wrong.

A Smart Contract is business type logic written as stand alone code designed to self run, operate and close without intervention. The contract is usually if-then-else loops triggered by certain events. It is more akin to a stored procedure than a legal agreement.

Tokens (often called by other names such as crypto) are smart contracts. There are a number of contract standards devised on the Ethereum blockchain such as ERC-20, ERC-721, ERC-1155 where ERC is 'Ethereum Request for Comment'. However there are many other active smart contracts running on other blockchains with different standards.

Wallets are usually blockchain viewers; private key generators; swapping operators; bridging connectors.

Currently most Wallets have been designed for retail use where the digital values held and small. This can be a challenge when the value is considerable and reliance must be placed on one browser and wallet on a smartphone. If the first instance these should be run behind a corporate firewall.

Ideally a wallet should be held on a stripped down desktop with few apps and interactions. It should be air gapped where possible, especially when not in use.

A blockchain usually has the attributes of being replicated and controlled by nodes. It resembles an immutable accounting ledger. It maybe behind firewalls or open to all. The blocks follow code logic.

A custodian looks after an actors private key. For institutions, self custody - that is self insuring against loss - may not be the best solution. Hence outsourcing to a custodian, who has the technical expertise and insurance, may be a better solution

As with any outsourcing the key risk is trust.

A staking provider allows actors to participate in proof of stake blockchain activities. Staking cryptocurrencies is a process that involves committing your crypto assets to support a blockchain network and confirm transactions.

NFTs prove ownership of an underlying asset which maybe itself. As at Dec 21, the most expensive NFT sold was for Pak’s ‘The Merge’ — $91.8m.

As with most digital assets, private key protection is important to avoid theft or loss.

Tokens on smart contracts that allow for voting. As corporate actions move towards the blockchain, governance tokens will become extremely important.

Generic term to describe the pooling of assets for the purposes of yield generation, lending and borrowing. These are an important part of the DEX operation and are akin to TradFi dark pools.

The use of market data for research, audit and trading is an integral part of any treasury function. The DeFi space has a lot of easily accessible data with associated completeness and accuracy risks.

Prime Brokers offer many services to institutions in the TradFi world. As yet these are a rare breed but will offer similar services and facilitate faster onboarding and mitigate against DIY risk.

Use of indices and benchmarks are often used to reference portfolio returns.

They are also useful for researching trends and correlations.

Lenders often provide promises and use the loaned assets to provide liquidity. Lending has a high risk of default due to rug pulls, flash loans and inside trading.

Fiat pegged tokens have proliferated due to the inefficiencies in the current TradFi sector.

Stable coins provide liquidity and allow for easy swapping in and out of fiat. Central Governments are looking at their own centralized stablecoins called CBDC. Although the regulators are concerned about the systemic risks stable coins can have on the overall economic markets, the value of the USD stablecoins (Oct 2021) is less than $150bn. The total USD in circulation is in excess of $2 trillion. There are stable coins in other fiat currencies such as the EUR and there are others pegged, or collateralized, to fiat and non-fiat baskets. The collateral can be held by a commercial entity, and organization or other actor nn group. The collateral can be loaned, the way central banks provide lending to commercial banks. Some are interest bearing and others have elastic supply. Newer types include algo SCs, fractional basket reserves and protocal controlled value SCs (PCVs).

Stable coins should be considered "derivatives" or "synthetix" and risk managed in the same way the TradFi equivalents are.

Third parties who act as consultants, advisers or certificators in the area of smart contract validation

Being able to trade across exchanges, protocols and pools requires a consolidated PMS.

Key risks include who has responsibility for digital asset custody, trading and position secrecy and governance.

Accounting for portfolios including tax reporting and other regulatory reporting. Some PMS systems may produce this information.

The key risks are privacy and governance.

R&A covers many activities including pre and post transaction analysis. It may be required for bad actor hunting, trading strategy or regulatory purposes. R&A may require the use of Market Data, RDDQs, Auditors and so on. R&A maybe conducted by third parties with the associated risks of outsourcing.

Cloud storage is outsourcing to a third party the storage and control of data files. Decentralized storage ensures data is owned by the actor. Some storage is fragmented to reduce single point of failure risk events.

Insurance solutions provide security layers or protocols that verify pre and post transactions for vulnerabilities. Transaction risk management systems may help monitor and control risk but this could come at the cost of transparency and a single point of failure akin to the SolarWinds breach in 2020. The term insurance does not imply payouts if breaches are undetected.

Associations are communities of actors seeking to influence behaviors. They may operate as not for profit. They are likely lobbyist entities. We are an association.