Title LM07 Introduction to Digital Assets IFT Notes.pdf ✅

LM07 Introduction to Digital Assets 2025 Level I Notes © IFT. All rights reserved 1 LM07 Introduction to Digital Assets 1. Introduction ........................................................................................................................................................ 2 2. Distributed Ledger Technology .................................................................................................................. 2 3. Digital Asset Investment Features ............................................................................................................. 6 4. Digital Asset Investment Forms .................................................................................................................. 7 5. Digital Asset Investment Risk, Return, And Diversification ..........................................................10 Summary ................................................................................................................................................................12 Required disclaimer: IFT is a CFA Institute Prep Provider. Only CFA Institute Prep Providers are permitted to make use of CFA Institute copyrighted materials which are the building blocks of the exam. We are also required to create / use updated materials every year and this is validated by CFA Institute. Our products and services substantially cover the relevant curriculum and exam and this is validated by CFA Institute. In our advertising, any statement about the numbers of questions in our products and services relates to unique, original, proprietary questions. CFA Institute Prep Providers are forbidden from including CFA Institute official mock exam questions or any questions other than the end of reading questions within their products and services. CFA Institute does not endorse, promote, review or warrant the accuracy or quality of the product and services offered by IFT. CFA Institute®, CFA® and “Chartered Financial Analyst®” are trademarks owned by CFA Institute. © Copyright CFA Institute Version 1.0
LM07 Introduction to Digital Assets 2025 Level I Notes © IFT. All rights reserved 2 1. Introduction Digital assets are a relatively new investment class consisting of assets that can be created, stored, and transmitted electronically and have ownership or use rights associated with them. This learning module covers:  Distributed ledger technology  Investment features of digital assets  Investment forms and vehicles used in digital asset investments  Investment risk, return, and diversification benefits of digital asset investments 2. Distributed Ledger Technology A distributed ledger is a database which can be shared across computer entities (or nodes) in a network. This is illustrated in the following diagram. There can be a potentially infinite number of nodes in a network. Every node will have a copy of the distributed ledger. There is a consensus mechanism which ensures that all these ledgers are kept in sync. Through the consensus mechanism all nodes agree on a new transaction and update their ledgers. New records are considered immutable, which means once a record is created it cannot be changed. Distributed ledger technology (DLT) uses cryptography, which refers to encrypting and decrypting data. Through encryption, we ensure that the data remains secure. DLT also accommodates smart contracts. These are computer programs that self-execute on the basis of pre-specified terms and conditions. For example, contracts that automatically transfer collateral from the borrower to the lender in the event of default. DLT networks allow us to create, exchange, and track ownership of financial assets on a
LM07 Introduction to Digital Assets 2025 Level I Notes © IFT. All rights reserved 3 peer-to-peer basis. There is no central authority to validate the transactions. DLT benefits include:  Accuracy, transparency, and security in the record keeping process.  Faster transfer of ownership.  Peer-to-peer interactions. A drawback of DLT is that the computational processes underlying DLT require massive amounts of energy to verify transaction activity. Blockchain is a type of distributed ledger. Its characteristics are:  Information is recorded sequentially within blocks.  Blocks are chained and secured using cryptography.  Each block contains a grouping of transactions and a secure link to the previous block. The following steps outline the process of adding new transactions to the Blockchain network. 1. A transaction takes place between buyer and seller. 2. The transaction is broadcast to the network of computers (nodes). 3. The nodes validate the transaction details and parties to the transaction. 4. Once verified, the transaction is combined with other transactions to form a new block (of predetermined size) of data for the ledger. 5. This block of data is then added or linked (using a cryptographic process) to the previous block(s) containing data. 6. The transaction is considered complete and the ledger has been updated. Proof of Work vs. Proof of Stake A consensus protocol is a set of rules that govern how blocks in a blockchain network are cryptographically chained together for the verification of the complete and immutable history of transaction records. Consensus protocols are classified into two types: "proof of work" (PoW) and "proof of stake" (PoS). The Proof of Work Protocol The proof of work protocol uses a computationally expensive lottery to determine which specific block to add. To verify a transaction, the PoW consensus mechanism employs a cryptographic problem that must be solved by some computers on the network (known as miners) each time a transaction occurs. Miners use powerful computers and large amounts of energy to solve complex algorithm puzzles in order to validate and lock blocks of transactions into the blockchain and earn cryptocurrency in the process. The "proof of work" consensus process for updating the blockchain can require significant amounts of computing power, making it extremely
LM07 Introduction to Digital Assets 2025 Level I Notes © IFT. All rights reserved 4 difficult and expensive for a single third party to manipulate historical data. The Proof of Stake Protocol This protocol requires selected network participants, known as validators, to pledge capital in order to vouch for the validity of a block. This stake signals the network that a validator is available to verify the veracity of a transaction and propose a block. A majority of the other validators who have staked a digital asset in the network must then attest to the proposed block's validity. Validators benefit from both proposing and attesting to the validity of blocks proposed by other participants. The security standards of the PoS protocol are based on a group of stakeholders (and their pledged stake) controlling the network's computational power and protecting access from malicious parties gaining a majority. Permissioned and Permissionless Networks DLT can take the form of permissionless or permissioned networks. Permissionless networks are open to any user who wishes to make a transaction. Once a transaction is added, it cannot be changed. All users can see all transactions on the block chain. These networks do not depend on a central authority. Bitcoin is a popular example of an open permissionless network. In permissioned networks, network members may be restricted from participating in certain network activities. Controls or permissions might be used. Different users may have different levels of access to the ledger. For example, participants may be allowed to enter transactions while regulators may be allowed to view the transaction history. Exhibit 3 from the curriculum compares the features of permissioned and permissionless blockchains. Types of Digital Assets Digital assets are assets that exist only as an electronic record with the right to use, buy, or