TOKENIZATION PART 1: ASSET ALCHEMY
Making Illiquid Assets Investable; Democratizing Investing Through Fractional Ownership
As Fintech bankers, we engage with smart entrepreneurs and venture capitalists, peering into the future of finance. One area we are watching closely and seeing investments and deals happening in, is asset tokenization, a process of issuing a blockchain-based token that digitally represents a tradable asset. These assets could be common securities, real assets like Gold or real estate, intangible assets like IP and trademarks, and in the long-term, even consumer data and health records. This could result in an alternate method of raising capital (or funding assets) and provide much broader access to a wider range of investors. Over the long term, this could transform illiquid or lumpy assets (real estate, collectible art, IP) by expanding access to a broad range of retail and institutional investors. We believe this could transform finance: revolutionizing funding and investing, upending current business models, creating new opportunities, disrupting entrenched incumbents, and renewing opportunities for FinTechs. Best of all, it could be the elusive use case for Blockchain/DLT.
Power of Tokenizing Assets: Finally, The Elusive Use Case For Blockchain
Tokenizing an asset means creating a digital structure that provides evidence of ownership and allows investors to receive returns from the asset (e.g. rental yield from tokenized commercial real estate). Once tokenized, the asset can be funded or invested in more easily, and this fractional ownership by a wide class of investors makes it more liquid and investable. The form that tokenization takes may change over time: in 2017 it was ICOs, in 2019 it is STOs, but the essential concept remains the same. Other benefits are that asset owners get to fund the purchase of the asset more cost effectively and conveniently, while owners get to monetize or ‘cash out’ of all or a part of their asset, which they currently can’t do, because of structural or regulatory inhibitors.
Take residential homes, where platforms like Home Tap, Point Digital or Unison Home Properties enable home owners to cash out or sell their home equity to investors. That’s a significant improvement over a HELOC, which is essentially a time-bound loan, and keeps the homeowner exposed to a decline in home prices and a depletion of their home equity. Think of how important this would be during real estate downturns like 1992 or 2008. Tokenizing commercial real estate allows a broad range of investors to buy a small piece of the asset, instead of only large institutional investors being able to afford the high upfront costs or the lumpy nature of such investment.
Blockchain Makes Tokenization Economically Viable
Without the Blockchain, fractional ownership of an asset may be technically possible, but too expensive and onerous. That’s why an enormous range of assets (e.g. real estate, art) remain illiquid, and open to investment by only a small set of accredited, well-heeled investors.
What makes Tokenization economically viable is the Blockchain/DLT technology.
What’s The Big Deal? Transforming Illiquid Assets, Enhancing Fund Raising, Democratizing Investing
Tokenizing assets and enabling their fractional ownership has profound implications:
• It transforms illiquid assets into more liquid securities. In doing so, cumbersome and lumpy asset classes like real estate get transformed into more liquid, investable assets whose markets are more stable, deeper, with tighter spreads and lower transaction costs
• It democratizes investment in these assets, giving millions of people the opportunity to participate in capital appreciation, or diversify their portfolios. As public markets worldwide have become more efficient and correlated, investors desperately need new sources of diversification
• Tokenization introduces an alternate, more efficient way to fund not just the purchase of assets, but entire companies, whether startups or established firms. While early attempts to tokenize using structures like ICOs were fraught with fraud, the move towards STOs and newer structures promises improved opportunities for funding
• Tokenizing new assets creates much needed growth opportunities for securities and investments firms to offer investment advice, asset allocation, execution, settlement and custody. With traditional assets like equities and fixed income, fully automated and commoditized, our industry desperately needs new sources of growth and opportunity.
Investing, Banking Opportunities
Tokenization and the creation of digital securities offers sizeable investing and banking opportunities, but with three challenges: getting the timing right is hard, sifting the right opportunity out of the noise and fraud is difficult, and expect a high fail rate. Having said that, we see investment/banking opportunities in these areas:
• Marketplaces or tokenization platforms for primary issuance and origination (e.g. Cadence, Harbor, Rally Road, Securitize, SliceRE)
• Secondary trading platforms (e.g. TZero, Sharepost, Bakkt, ErisX, Binance)
• Trade Data and Execution firms (e.g. TradeBlock, Nomics, Caspian), as well as Trading Venues (Bakkt, ErisX, Binance)
• Custody and Trust infrastructure (e.g. PrimeTrust, SIX, Bankex, BitGo)
• Legal and Compliance solutions (e.g. Chainpoint, Coinfirm, Onfido, Vertalo)
• Games and Collectibles (e.g. B2Expand, ConsenSys, Enjin, Ubisoft, Ultra)
Like all emerging spaces, investing in this area is not for the faint hearted. It requires patience, vision and a stomach for loss. There is considerable risk that this pretty picture we have painted, may not materialize or may take 6-8 years, but the upside is too large to keep your oar out of the water.