MTL

As digital services proliferate, we’re entering a new age of commercial opportunity: one where the digital world increasingly reflects changes similar to the physical world of the past 100 years. The efficiency gains between the two (an exponential decrease in the marginal cost of the offered product) is now taking hold in digital services as they become productized.

We are quickly shifting from a variable cost economy to a fixed cost production economy where such investment is prioritized, resulting in higher and more permanent returns to capital. This transformation has led to multiple new types of business models, ranging from SaaS to Knowledge-as-a-Service.

Here, we look at how services have become “productized” over time, and how the automation and productization of human knowledge is revolutionizing today’s economy.

Legacy Businesses: Services and Products

There are two types of legacy businesses: those that render services and those that sell specific products. Product companies evolved from service businesses as a result of mass production. Prior to the ability to scale production of a service, everything was unique, niche, and one-off. Product companies generally represent physical goods, though as we’ll see in a moment—this understanding is shifting today.

SaaS (Software-as-a-Service) — 1990s

SaaS, at its core, is a delivery vehicle: it is a container that holds some form of data, insights, or knowledge, often generated by the consumer. The popularity of SaaS businesses is due to its recurring billing model that extracts additional rents from consumers. SaaS is still limited: it is often a set of intelligently organized containers, intended to hold and distribute some set of data, produced by the customers, to the customers. At its core, SaaS is the productization of distribution: using the internet to repeatedly deliver a software “product” that was previously sold on shelves via a shrink-wrap license. Today, there is a growing emphasis on the quality of what SaaS companies can do (e.g., data, insights, or knowledge) to provide value to customers.

DaaS (Data-as-a-Service) — 2000s

As the SaaS market matured, customers began to seek opportunities. Enter data companies. Data-as-a-Service models may be sold via a containerized set of data (stand-alone), or input into a piece of software (often via API or direct embedding). The primary difference between a DaaS business and a SaaS business: in a SaaS business makes money from distributing that content, rather than generating content. Take for example Salesforce and ZoomInfo. Salesforce is the container that can be used to hold known industry contacts, while a DaaS vendor like ZoomInfo might be used to enrich that contact data with better address or phone details. DaaS’s value is in the data produced, not the container it sits in.

IntaaS (Insights-as-a-Service) — 2010s

Data can be sliced, diced, analyzed, and cut into many different views, revealing profound insights. These insights are now packaged and sold to consumers through the Insights-as-a-Service model. An example of businesses that productize data into insights include companies like Nielsen, who have built a business around a straightforward set of metrics. IntaaS firms attempt to provide customers with insights from proprietary sets of data, thus reinforcing their competitive moats. These businesses represent a step toward the productization of knowledge, and their ability to provide insights on proprietary data is the differentiated product.

KaaS (Knowledge-as-a-Service) — 2020s

Much like a factory in the early 1900s, KaaS relies on an assembly line of knowledge that has a set of repeatable steps to create knowledge as a product. AI will often be the tool of choice in these businesses; they are the machines in the digital factory. In these businesses, both distributing a product (SaaS), and building a product (KaaS) are one-time fixed costs. This means more up-front capital required, but higher-back end margins.

As an example, Stitchfix, a modern personal styling service, invested a fixed amount of capital into building algorithms that create knowledge about each user to target a better fit for consumers and reduce the volume of misfits and returns. Stitchfix has thus turned a variable cost (rate of return per customer) into an up-front fixed cost which builds knowledge about its customer, and thus massively reduces variable cost. The “knowledge” product that Stitchfix sells is “optimal fit.”

Ascent as a KaaS provider | Ascent is a KaaS company that creates regulatory knowledge to help financial firms manage their regulatory risk more effectively than traditional methods. Traditionally, firms have used a mix of in-house compliance staff and outsourced resources like consultants or lawyers to analyze this text and determine which regulatory obligations are actually applicable to the business. Ascent has created an assembly line of engineers, data scientists, and compliance officers to build, train, and optimize intelligent algorithms that identify a firm’s exact obligations at a fraction of the time and cost. Only about 35 percent of any body of regulatory text contains an actual obligation (the rest consists of definitions, clarifications, and other ancillary information) and an even smaller percentage of those obligations apply to any particular business. Our algorithms are trained to spot the difference, and immediately get to work parsing out the text into obligations and non-obligations. To learn more about the granular information produced by Ascent, contact us.

What This Means for The Economy

Society is just beginning the shift towards the KaaS business. Up-front investments that yield productive first-to-market traction will mean more long-term revenue. The stickiness of KaaS businesses should be far superior to SaaS businesses when fully integrated. As algorithms become smarter, knowledge will be easier to generate, and the price of knowledge and expertise will decrease. As a result:

1. Expertise will become ubiquitous. The unlocking of human capital will be astounding: people will be able to create, accelerate, and design, while machines will calculate, advise, and build. For the first time in history we will be able to give people all over the world access to knowledge for free.

2. The Expansion of Human Potential: These knowledge machines will enable us to dramatically expand our abilities in areas like medicine, law, finance, and other knowledge disciplines. As the cost of knowledge drives to zero, people will be able to freely consume it. This will result in enormous consumer surplus, and benefit to society.

3. Returns to Labor will Remain Under Pressure: Shifting from variable costs like human labor to fixed cost like technology (built via capital investment) will create challenges as the economy transitions. Job dislocations will occur, but will be temporary. Similar forms of automation happened to blue-collar manufacturing work in the 50s and 60s. It is likely we will see similar automation and disruption to knowledge work in the 2020s, and more prolifically in the 2030s.

This shift is already underway. As knowledge is commoditized via algorithms, these business models will continue to evolve in a way that creates benefits for consumers and businesses alike. While temporary disruption will occur, the ultimate promise of knowledge products will usher in an era of productivity and growth, the likes of which we see once in a generation.

About the Author | Brian Clark is the President and Founder of Ascent. He has a wide breadth of regulatory compliance experience including derivatives exchanges, market investigations, clearinghouse compliance, and registered brokerage businesses. He is a former Chief Compliance Officer and General Counsel, and is passionate about entrepreneurship and technology. Connect on LinkedIn.

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In Part 1 (DiFi or Die Trying: A Quick and Dirty Overview of Digital Finance), we discussed the digital financial ecosystem that grew from the ashes of the financial wildfire that spread across the world in 2008. 

Here in Part 2, we discuss how regulators are grappling with the task of keeping weeds out of the digital garden. Since their approaches and speed by which they tackle this task differ and are evolving, it is as important to stay focused on the regulators, as it is to stay focused on the innovators. Regulatory Knowledge Automation from Ascent can rapidly bring both into your clear line of sight. Keep reading for a better understanding of the regulatory landscape around DiFi.

INFOGRAPHIC: Regulatory Knowledge Automation, Explained

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Regulation in the United States

Although ‘digital assets’ is a broad term applied across economic sectors, this discussion focuses on the financial services sector and, within that sector, crypto assets. This is because crypto assets (and specifically cryptocurrencies) have been given the most attention by regulators to date. Here’s a rundown of major events in recent weeks:

» May 17th — The FDIC issued a Request for Information and Comment on Digital Assets to learn how depository institutions interact with the cryptocurrency sector, how they might interact with the sector in the future and what, if anything, the FDIC should be doing about it. Questions the FDIC posed included ones relating to digital asset custody, coin issuance, trading, settlement and payment and regulatory supervision of digital finance activities.

» May 19th — In testimony before the U.S. House Financial Services Committee, OCC Acting Comptroller of the Currency listed adapting to digitalization as the third of four challenges requiring the OCC’s immediate attention. She emphasized that disintermediation is occurring in bank payments processing by FinTechs and technology platforms utilizing application programming interfaces, machine learning and distributed ledgers. Proof positive is OCC approval of two national trust charters for crypto platforms (Protego and Anchorage) within the past six months, and applications pending for at least two more (BitPay and Paxos).

» May 20th — Federal Reserve Chair Jerome Powell discussed the Fed’s response to technological advances driving rapid change in the global worlds of payments, banking and finance (including allowing FinTechs access to the Fed’s payment system under proposed guidelines).

On the other side of the house of federal regulators in the United States, the chairs have been rearranged, but who has jurisdiction over digital assets remains a persistent question. Breakdancer (pause while you check out the YouTube video)  and former CFTC Gary Gensler is now chairing the SEC, while Rostin Behnam is acting chair of the CFTC.  

While it is clear that the SEC regulates Initial Coin Offerings (ICOs), whether a digital asset in a specific use case should be treated as a security, a currency, a commodity or something else is more murky, despite recent SEC guidance on how to apply the long standing “Howey” test for defining a security.

Read More: Crypto Regulation and Changing of the SEC Guard

SIFMA’s May 20th reaction to SEC guidance on applying broker-dealer custody rules to digital assets addresses work in other critical areas of securities regulation that remains to be done i. Meanwhile, the CFTC launched its LabCFTC in 2017, both to encourage fintech innovation and inform CFTC thinking about its regulation. To date, LabCFTC has made the agency’s guidance more accessible, but it has been no substitute for consensus among regulators and a coordinated approach. 

Despite deliberate efforts by federal regulators to modify their rulesets for a digital world, important questions remain, including whether, how and who should regulate digital asset platforms, exchanges, traders, managers and advisers, asset repositories and transmitters, pooled products, derivatives and associated sales and marketing activities (especially those directed at retail consumers).

Further, at least some activities involving digital financial assets are regulated at the state level, where answers are distinct and could differ materially from answers at the federal level. As this March 2020 article explains, state money transmitter rules are an especially acute pain point for digital marketplace participants.

Read More: A Look at Money Transmission Laws + How To Know Your MTL Obligations

Regulation Outside of the United States

In 2014, the United States Law Library of Congress published a report on the regulation of cryptocurrency across forty countries and the European Union. In 2018, the report was expanded to cover 130 countries. The report seeks to determine how various countries are responding to the fast-growing cryptocurrency market, discern regulatory trends and organize data for region-specific comparisons. 

In 2019, a separate, more focused, report was published discussing regulatory approaches in the context of financial market and investor protection laws in 46 jurisdictions, as well as providing updated information on relevant tax and AML/CFT laws. These reports reveal a number of countries are applying existing rulesets to crypto assets, while at least a dozen countries have enacted new laws specifically governing crypto assets. 

In April 2020, China became the first major economy to pilot a central bank digital currency (CBDC) with the number of pilots in other countries surging to 19 as of May 2021. 

Stay ahead of the curve with Ascent

Meanwhile, the digital asset industry is not standing still while regulators work to catch up.  Instead, they are shifting from ‘pushing back’ to advocating for ‘smart’ regulation that can be operationalized cost-effectively and aligned with developing industry best practices and principles.  

Both innovation and regulation within the digital ecosystem are likely to occur at a rapid pace for the foreseeable future, making Ascent an essential tool for those seeking to discern and understand complex and challenging compliance obligations. 

Ascent’s AI-driven technology rapidly and accurately maps obligations to your specific business and automatically keeps them updated as rules change. By automating the tedious process of regulatory research, analysis, and change management, Ascent gets you 90% of the way there in knowing what you need to do in order to stay compliant. That means your team can focus on the most critical, most human, 10% — reviewing and interpreting the output and strategic decision-making.

Interested in learning how Ascent can help you eliminate risk with a single source of regulatory truth? Contact us for a custom demo.

About the Author | Jilaine Bauer is Senior Compliance Consultant at Ascent. Previously, Jilaine worked as a Compliance Officer responsible for regulatory change management at one of the world’s largest providers of financial market data and infrastructure, as an independent regulatory consultant within the financial services industry sector and as general counsel and compliance officer to multi-faceted financial services firms.  She holds a law degree from Loyola University (Chicago) and a degree in psychology from the University of Illinois Urbana-Champaign.  She also has corporate, advisory and nonprofit board experience. Connect on LinkedIn.

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Emerging from the ashes of the financial wildfire that spread across the world in 2008, the seeds of a new digital financial ecosystem germinated from an email sent by Satoshi Nakamoto to a group of techies that November:

“I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party. The paper is available at bitcoin.org/bitcoin.pdf.”

Two months later, Satoshi created 50 Bitcoins with the very first transaction on a blockchain on January 3, 2009. Today, there are some 4,000 cryptocurrencies in the digital ecosystem with a  total market cap reaching $2.2 trillion last month. As of June 2020, at least 45 central banks were reported to be researching payments technology and applications, known as Central Bank Digital Currencies (CBDC), and in October 2020 the Bank for International Settlements as well as seven central banks (including the Federal Reserve, the European Central Bank and the Bank of England) published a report laying out key requirements for CBDC

Fast following on the heels of cryptocurrency innovation, other forms of digital tokens were created, and the use of blockchain and “blockchain – like”  technology was expanded in the public and private domains. This facilitated the transfer of a broader range of units of value, digitized other types of tangible and intangible assets and enabled the satisfaction of counterparty obligations under smart contracts wholly unrelated to assets.  

In part one of our two-part series, we discuss what “digital assets” are, the blockchain infrastructure that supports them and the emerging products, applications, processes and organizations that use them,  known as digital finance (DiFi). 

PART TWO: A Digital ‘Token’ for Their Thoughts — Digital Finance from a Regulatory Perspective

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Digital Financial Assets

In the broadest sense, the term “digital asset” refers to anything that exists in a digital format, including photos, documents, audio, electronic records, websites, data related to individuals or accounts and cryptocurrencies. Physical assets can be converted to digital assets when they are scanned and uploaded to a computer. Digital assets are stored (carried) on digital appliances/storage devices that function like a filing cabinet (eg, computers, telecommunication devices and other modalities).

“Digital tokens” are financial digital assets that refer to a unit of value, which can be owned, assigned (traded) or redeemed later. Because tokens serve different purposes, they can be treated differently under the law and the law governing tokens and blockchains is not uniform across jurisdictions. For a more technical discussion, see this article published in Digital Asset Management (DAM) News.

Cryptocurrencies (digital coins) are the most common form of digital token and are used as a means of payment for goods or services and are “native” to a specific blockchain with a related name (e.g., Bitcoin/Bitcoin BC; Ether/Ethereum BC; NEO/NEO BC). Central Bank Digital Currency (CBDC) refers to a digital representation of fiat money issued by a Central Bank. Stablecoins are privately issued cryptocurrency with a mechanism to minimize price fluctuation to “stabilize” its value, such as linkage to a reserve of stable real assets such as currencies or commodities. For a discussion on CBDC and stablecoins, see this white paper published by law firm Clifford Chance.

They may be stored in “digital wallets” earning interest and may increase in value for later use.  Sometimes, they earn dividends (e.g., NEO pays dividends called “GAS”). In some cases digital coin owners also have a say in the design and function of the associated blockchain (e.g., DASH). Also, the sponsor of a blockchain platform (e.g., Ether and NE) may allow other tokens to be transferred on its platform subject to payment of a user fee. For a  “crypto” glossary and a list of cryptocurrencies, including their individual and aggregate market cap, see Coinmarketcap.com. 

Other tokens serve different purposes, but typically they all function as part of a platform that sits on top of an existing blockchain. The benefit to the token issuer is the savings in time and money required to launch and operate their own blockchain. Anyone can create a token paying the blockchain sponsor to create and validate (“mine”) transactions in his/her/their token.  Tokens may be created to activate features in another application (“utility” tokens) called a decentralized application (dApp) or may represent an underlying security (stock, bond, ETF) commodity, loan or other asset (“asset-backed” tokens). In 2020, the commercial real estate firm, Red Swan, partnered with the blockchain sponsor, Polymath, to tokenize real estate. There also are “hybrid” tokens. 

Non-fungible tokens (NFTs) represent ownership of something unique (identification code and metadata) for a particular user that can be bought and sold but, unlike cryptocurrency, they are non-interchangeable and do not have any inherent value. They can be used to represent people’s identities, property rights, and artwork. Many are built on the Etherium blockchain (e.g., cryptokitties).

WATCH NOW: [Compliance Over Coffee ft. Val Dahiya, Partner at Perkins Coie] Inside the Complicated World of Digital Assets

Smart Contracts are misnomers as they are neither “smart,” nor are they necessarily “contracts”! Rather, they are “business rules” translated into computer code (software algorithms) that “run the blockchain” (trigger actions) when predetermined conditions are met.  They serve as the basis for transference of a token, but they can also trigger actions that do not involve token transfers, including actions required under a legal contract. 

Distributed Ledger Technologies (DLT). A Distributed Ledger is a database that exists across a network of computers at multiple locations or among multiple participants eliminating the need for a central authority or intermediary to process, validate or authenticate transactions or other types of data exchanges. The design eliminates the “single source of failure” present with a centralized or intermediated system, and is quicker, more efficient and cost-effective. The DLT transaction only comes to rest on the ledger when consensus is reached  among the parties that it is real and valid. Transaction files are then timestamped and protected with a unique cryptographic signature providing a verifiable and auditable history. DLTs can be public or permissioned (invitation-only) and they can operate solely by smart contracts or governed by an entity.

Blockchains are a type of DLT distinguished by the fact that units of data are displayed in a sequence (blocks on a chain) with each unit dependent upon a logical relationship to all prior units. Public blockchains are used to process peer-to-peer (non-intermediated) anonymous transactions in digital assets (e.g., cryptocurrency) which, when verified, become immutable and cannot be changed.  Some blockchains, like Ethereum, will support token applications running on top of the blockchain, in addition to the cryptocurrency (payment token) that is embedded within it. 

Digital asset management systems (DAMs) incorporate software, hardware and services that together are designed to manage, store, ingest, organize and retrieve digital assets. 

READ MORE: A Quick Look at Money Transmission Laws (+ How to Know Your MTL Obligations)

Ascent is your partner in digitally transforming compliance

Wherever you are in your digital transformation journey today, the pace of that journey will accelerate in the months to come thanks to new possibilities enabled by rapid developments in technology, infrastructure and regulation. Using Ascent’s AI-driven technology to identify and evaluate the impact of existing and emerging regulations across jurisdictions and business activities, you can bring strategy into focus, improve business process velocity, and optimize your business.

Contact us for a custom demo to see how Ascent helps you comply with changing regulation more efficiently and accurately than ever before. 

About the Author | Jilaine Bauer is Senior Compliance Consultant at Ascent. Previously, Jilaine worked as a Compliance Officer responsible for regulatory change management at one of the world’s largest providers of financial market data and infrastructure, as an independent regulatory consultant within the financial services industry sector and as general counsel and compliance officer to multi-faceted financial services firms.  She holds a law degree from Loyola University (Chicago) and a degree in psychology from the University of Illinois Urbana-Champaign.  She also has corporate, advisory and nonprofit board experience. Connect on LinkedIn.