Sunday, May 26, 2024


One of the many ways blockchain will revolutionize financial services is in the ability to tokenize real-world assets investment. Today we will learn how blockchain technology builds, trades and tracks real-world investment products.

Already we are seeing big firms (BNY Mellon, JP Morgan and BlackRock) tout tokenization projects, recognizing the efficiencies they can bring from a payment and settlement perspective. Still, the more significant potential of tokenized investments is their ability to democratize finance and bring broader investment opportunities to the general population through “fractionalized” investments in global opportunities.

As more investment products become tokenized, how will advisors help their clients access these new asset models?

Kelly Ye, head of research at Decentral Park Capital, takes us through tokenization thinking and where it’s headed, providing perspective on the activity across the space. And it’s a fascinating discussion.

S.M.

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Tokenization – The New Market Infrastructure to Democratize Alternative Investing

You may not have heard of tokenization, but you have probably heard of exchange-traded funds, or ETFs. Since their inception in 1993, ETFs have surpassed traditional mutual funds as the preferred investment vehicle for many investors to access capital markets. The remarkable growth of the ETF lineup has democratized the investment business, providing access to investment strategies and entire asset classes that were historically only available to the largest and most sophisticated investors.

However, there is still a substantial portion of the investment universe that ETFs cannot reach. Alternative investments, such as private equity, private debt and real assets, are typically available only in the form of private funds with constraints on liquidity, investor qualification, and minimum investment thresholds. According to a 2022 Fidelity study, institutions on average allocate around 23% to alternatives, while advisors only allocate approximately 6%. In an environment where a traditional 60/40 portfolio provides limited growth and income opportunities, alternative investments serve as valuable building blocks to enhance an investor’s portfolio.

It would be beneficial to have an “ETF”-like structure that offers transparency, liquidity, and efficiency to access these alternative investments – this is where blockchain technology can play a significant role through a process called tokenization. Tokenization involves representing real-world assets, such as private equity, real estate, fine art, commodities, and more, as digital tokens on a blockchain. By doing so, these assets become easily tradable and divisible, opening up new possibilities for fractional ownership and liquidity. Advisors can now present clients with a broader array of investment options, encompassing both traditional and digital assets, catering to different risk appetites and financial goals.

Blockchain technology addresses three critical challenges for alternative investing:

  1. Transparency: Blockchain provides a tamper-resistant and immutable record of ownership and transactions on the tokenized asset. The assets and their ownership details are publicly visible on the ledger, enabling stakeholders to verify and track asset movements in real-time. This transparency can help reduce fraud and increase trust among market participants.
  2. Liquidity: Tokenization allows fractional ownership, enhancing liquidity by enabling investors to buy and sell smaller portions of assets, rather than requiring substantial capital to buy an entire asset. These tokenized assets can also be traded on secondary markets 24/7, potentially increasing their overall liquidity.
  3. Efficiency: Tokenization allows for the automation of various processes, including ownership verification, settlement, and compliance. Smart contracts, self-executing contracts on the blockchain, can facilitate the transfer of ownership and automate certain aspects of asset management. This automation can lead to increased efficiency and reduced operational costs.

Once brought on-chain, tokenized assets can participate in the ”DeFi Flywheel” and create more financialization opportunities. For example, tokenized assets can serve as collateral for borrowing, thus improving the capital efficiency of owning these assets.

Large institutions have started testing tokenization. For instance, KKR and Hamilton Lane both launched tokenized private funds in 2022 with Securitize, a fintech firm specialized in tokenization. Franklin Templeton has launched a tokenized money market fund in 2023, which gathered more than $270M as of April 2023. Citigroup has forecasted a $4-5 trillion tokenized digital securities market by 2030 in their March 2023 “Money, Tokens and Games” report.

Tokenization Total addressable market

Despite all the potential benefits of tokenization, we are still at an early stage of development. Current tokenized products are all issued and traded within a walled garden, i.e., on a specific tokenization platform, which hinders wider adoption. Regulatory clarity on the legal status and classification of these tokenized assets is crucial in determining where and how they can be issued and traded. Market infrastructure also needs to be developed to facilitate trading across different platforms. More importantly, investors’ asset allocation model needs to evolve to embrace the possibility of allocating to real world assets. But, just like how ETFs democratized investing, tokenization is both a technological and financial innovation that could democratize alternative investments and open up many more opportunities for end investors to optimize their portfolios.

Kelly Ye CFA, Head of Research at Decentral Park Capital, board member of CFA New York and committee chair for Women in ETFs.

Ask an Advisor

Q: A client asked about tokenized assets, after hearing Larry Fink and some banks mention them. Can my client use them to invest in assets like wine?

A:

Tokenization is likely to become more prevalent in the next decade. It is generally taking a private or public investment, like a private placement in ultra-premium wine, and using blockchain technology to track your ownership.

If your client is able to invest in those placements now, because he/she isn’t accredited, tokenization won’t make them more accessible. However, we will likely see more of these investments come available over the next few years, as tokenization will make the securities more efficient, liquid, and transparent.

Q: Are tokenized assets legal?

A:

Most tokenized assets are simply regulated securities offerings, but the issuer is using the blockchain technology to make the tracking of ownership more efficient. Rather than using spreadsheets and proprietary databases to determine investment and ownership, they are using public, decentralized databases we call blockchains.

They are not volatile crypto assets like bitcoin and Ether, but are digital representations of real assets.

Adam Blumberg CFP, co-founder of Interaxis

Keep Reading

Cloud giant Amazon delivers a security token platform for financial services companies to build on.

Securitize is able to issue and trade tokenized securities in Europe and US as part of new pilot program for digital assets.

Asia is embracing tokenization, are they leading the way?

McKinsey report, why the time may be now for tokenization.

Edited by Bradley Keoun.



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