The Tokenization of Alternative Investments
Alexandros Violetti, Analyst at the LSESU Trading Society
Has the thought ever occurred to you that the vast majority of portfolios are comprised primarily of stocks, bonds and derivatives? Have you ever thought of what it would be like to own a stake in a famous artwork or earn a dividend from the operations of a wind farm? That is exactly what tokenization will be able to achieve!
Tokenization is an application of blockchain technology and refers to the issuance of digital tokens representing units of ownership. When an asset is tokenized, it is recorded on an immutable digital ledger, which allows tracking data on previous owners and the date of ownership.
JP Morgan has already started tapping into the potential of tokenization through Quorum, their blockchain network, which tokenizes gold bars. Alternative investments, which are investments in any non-stock and non-bond assets such as hedge funds, commodities and collectables, are projected to grow by 53% by 2023 to around US$ 14tn, which opens up enormous opportunities for portfolio managers to diversify their holdings.
If we take the example of an artwork, at present, if the owner is in need of cash and wants to liquidate its value, then they would have to go to an auction house and accept the price agreed upon in the bidding process whilst also sacrificing a substantial percentage of the sale price to the auction house. Tokenization will revolutionize this procedure by removing the middleman, the auction house, all together. The issuer would be able to divide ownership of the artwork into art tokens. The price of each token (and subsequently, the total price of the artwork) will be determined by the entire market rather than a small group of high net worth individuals. This dramatically increases the liquidity of traditionally illiquid assets.
One of the key benefits of tokenization for the investor is increased transparency. The biggest problems that alternative investments face is fraud. Many fraudsters are making a living selling counterfeit gold, wine and art primarily because such tangible assets cannot be easily determined by the average individual, which dissuades potential investors. Through tokenization, the creator of artwork, for example, can record their data on the blockchain network so that its future owners can verify its authenticity by merely scanning a QR code.
Likewise, tokenization will significantly reduce barriers to entry into many alternative investment markets. Using tokens, Investors can buy and sell the ownership of tangible assets such as oil, precious metals, real estate, and collectables, erasing the massive transportation and storage costs associated with owning such assets.
In short, the disruption that will be caused once tokenization becomes the mainstream will dwarf the drastic changes that bond markets experienced in the 1970s due to Lewis Ranieri’s invention of the mortgage bond. Blockchain will open up countless alternative asset markets to even the smallest retail investor who would conveniently and authentically be able to purchase ownership of artworks, precious metals, earn dividends from solar farms, and coal mines. Portfolio managers should undoubtedly keep the potential of tokenization in mind when considering future diversification ventures.
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