The DIY investment model

Tokenisation is opening up a whole new world of tradable assets along with revolutionising the way the market can trade traditional products.
By Jonathan Watkins

What if I told you the portfolio of the future could contain horses, artwork and Beyoncé tickets? If your first thought is ‘who is Beyoncé?’ then I suggest spending more time away from your desk. But if your response is ‘that sounds interesting, how could this possibly occur?’ then read on as we’re about to explore how tokenisation is set to open up a whole new world of trading non-bankable assets, along with adding efficiency to existing products.

Let’s say you wanted to invest in real-estate without fronting up a whopping six-figure sum; well tokenisation is a method that converts rights to an asset into a digital token. So theoretically a USD 500,000 apartment could be divided into 50,000 tokens, allowing for fractional ownership.

Underpinned by blockchain technology, which would ensure irrefutable records of ownership, these tokens would be issued on a platform supporting smart contracts allowing them to be traded.

This could work with anything from a Monet painting to fine wine where assets can be broken down into pieces – digitally of course, please don’t attempt to tear a Monet to pieces and claim Club@Sibos told you to do so.

“We’ve had all these different kinds of instruments that need to trade on their own specialised kinds of markets,” explains Joseph Lubin, chief executive of Consensys. “We are starting to realise all these instruments in essentially the same form whether it’s a cryptocurrency, a debt instrument, an equity, or a Beyoncé ticket, it’s all just one of these cryptographic tokens.”

This is uncharted territory for a financial industry where new products have been few and far between over the best part of a century. The emergence of exchange-traded funds and cryptocurrencies have been eye-openers, but exposure to movies, museums and diamonds will be something else entirely.

“Everything that was not in the reach of the financial industry now becomes something you can start looking at,” says Valerio Roncone, head, product management and development at SIX, which announced a new initiative to create an integrated infrastructure for the digital asset value chain back in July. “Take an art gallery or museum, today the museum has to go to the government to ask for money, tomorrow the museum can tokenise a part of its collection and the public can buy it. You can have a token against it and that token can be traded and integrated in your portfolio, you own a share in something you would not have been able to have to this extent in the past.”

While this may sound similar to the way shares are traditionally bought and sold, it’s the underlying technology which sets it apart. Ledger technology allows any form of value to be transferred at low cost, in real-time and in a trustless environment, with know your customer and anti-money laundering issues taken care of through smart contracts. It also removes many of the intermediaries and complexities in the process, opening up these asset classes to new customers and blurring the lines between public and the more traditionally bilateral private markets. Ownership information, rules and enforceable rights are coded into the distributed ledger in the form of smart contracts. Through DLT, movements and authenticity can be reliably and securely tracked and verified.

“We can build compliance into these smart contracts, so that you don’t need a headcount of hundreds or thousands and financial institutions and you can specify how different instruments can trade and then there will be no reason why I can’t buy Apple stocks with my Beyoncé ticket at some point in the future,” adds Lubin, known as one of the founders of Ethereum.

Matthew Pollard, a co-founder and chief financial officer of Archax, an institutional digital asset exchange, writes that through tokenisation “the act of transferring an asset from seller to buyer is simplified”.

“Transactions on a distributed ledger lessen or remove the roles of the intermediaries historically used to facilitate the transaction,” he adds. “It reduces costs, increases transactional velocity and helps price discovery on assets that may have historically suffered from liquidity discounts. Put simply, as an issuer, this technology should drive down the cost of capital and reduce liquidity discount.”

Custodians are backing tokenisation as the future, with support for the notion already voiced by the likes of Standard Chartered, State Street and SIX Securities Services.

“There are a lot of assets that are not very tradable and not very liquid, because by their nature they are ‘old world’ assets, real estate for example,” explains Margaret Harwood-Jones, global head of securities services, Standard Chartered. “If you can create them in a digitised form, then in terms of marketability and tradability they move to a very different league.

“We are working with the financial markets business at the bank on another such opportunity where they have structured finance products which we are turning into digitalised form to allow for more effective trading around those instruments.”

So in its most simplistic form you take an asset, tokenise it and then create a digital representation through distributed ledger technology, with the clear benefits being a lower barrier to entry, a secure and efficient underlying technology and a liquid asset.

Whether this will take place through an existing market infrastructure or pave the way for disruptors to truly carve out a space for themselves in modern finance, only time will tell. Both will likely bid for their places in this new ecosystem, as we await to see who will issue these tokens in question.

A real-life example of tokenisation occurred with Andy Warhol’s 14 Small Electric Chairs artwork, which was sold to qualified participants on Maecenas, an art investment platform built on blockchain, in the private beta launch of the platform. The multi-million dollar piece attracted over 800 sign-ups within weeks and the auction raised USD1.7m for 31.5% of the artwork at a valuation of USD5.6 million.

Maecenas tokenised the Warhol work by converting it into tamper-proof digital certificates or “fractions” based on the Ethereum network. Buyers then purchased fractions of 14 Small Electric Chairs with Bitcoin, Ether or the ART token, a cryptocurrency created for Maecenas

Tokenisation is not confined to these non-traditional assets either, with equities, bonds and commodities also primed for this feasible system of the future. “The numerous benefits for tokenising assets on distributed ledger technology are generally speeding-up transaction times, improving transparency, streamlining business processes, and reducing costs,” explains Michael Tae, corporate vice-president, corporate strategy, Broadridge Financial Solutions.

“Specifically for institutional investors, I would break down the benefits into three key areas,” he says. “First, investors gain significant operational efficiencies into the markets across the trading and post-trade lifecycle of the securities industry. Secondly, increased portfolio liquidity and velocity of alternative assets via improvements in areas such as collateral management. And lastly, from the creation of new avenues for capital generation.”

But unlike the Warhol example, in the case where you have tokenised an existing tradable asset such as an equity or bond, how do you settle in a fiat currency across multiple markets and time zones?

“On the one side you have a token for the digital asset,” explains Tom Zeeb, chief executive exchange services, SIX. “If you digitalise the fiat currency, create a token out of sterling or euros or Swiss francs or dollars by segregating the underlying currency in a CB account, then you can settle real time, instantly, without having a liquidity gap and you can also go across time zones.” This is similar to the broad principle underpinning depositary receipts, the difference being that the account holding the fiat currency is under the control of the central bank and the resulting tokens would be used purely for settlement purposes and not tradable in their own right.

Tokenisation is also being used to raise capital as an alternative to a costly and complex initial public offering (IPO). With initial coin offerings (ICOs) coming under scrutiny from regulators and feeling less familiar to traditional investors, suddenly security token offerings (STOs) have become the latest revelation born out of the cryptocurrency world. Unlike ICOs, these security offerings are tied to something with intrinsic value, something easy to explain to an institutional investor, and also a regulator. Like their ICO counterpart, it’s still a process of producing a token through a public offering to enable funding, but more akin to the real world of purchasing a share as it is backed by a ‘real-world’ asset while it can also carry voting rights, decision making, or even dividends.

“STOs hit that sweet spot in the middle, they make the market more efficient and it means there are fewer middle men,” explains Hirander Misra, chief executive of GMEX. “You’re creating asset packages with different STOs: think of it as an ETF backed by assets, you create a NAV on the fund on the value of those assets that are underlying. Equity-related STOs are one component, the other is gold, the other is stablecoins. Based on high-risk, low-risk, medium-risk you can package them accordingly. You get a diversity of assets.

“Family offices aren’t FinTech guys, they don’t know the difference between good and bad ICO. They do understand equity and value… When you talk about the merits of STOs and link it back to private equity for example, you are talking a language they are understanding.”

Evidently one of the major benefits is being able to mobilise assets that have been traditionally difficult or complicated to move, with some of the aforementioned new asset classes exemplifying this.

A consortium of banks, custodians and market infrastructure providers are also looking at applying tokenisation to collateral, to solve some of the widespread costs of collateral mobility.

The system using tokenisation to reduce eye-watering costs of moving high quality liquid assets (HQLA) could even be ready in Q1 2019, following a successful securities lending transaction on the platform at the start of March last year. HQLAx is a securities lending platform using R3’s blockchain technology, supported by Deutsche Boerse and six banks including Goldman Sachs, Credit Suisse and ING. The initiative allows collateral to stay fixed with the legal entitlement moving and being held for safekeeping by a custodian.

Mobilising high quality liquid assets has become a huge burden and cost for the securities services industry, but those involved in HQLAx believe that by creating a token so that the securities don’t physically move themselves will solve widespread problems, along with creating a tradable new asset class.

What place Bitcoin and cryptocurrencies have in the financial markets of the future is uncertain, but the underlying blockchain technology is ushering in a new era for the capital markets. Custodians are readying themselves for this wave of tokenisation in a sign that this could be the future, and one they want to be a part of.