A problem of access
To understand the promise of real world asset tokenisation, consider the world around you. Everywhere you look, and everywhere you turn, there are companies. You likely work at a company – you may even own one. The car you use to get to the office has been made by a company, as too will have been the train, tram, or bicycle that might otherwise propel you there. Your company likely leases its physical space from another company; should you work from home you will rely on the product of Zoom, Google, or Microsoft to speak to your colleagues and customers.
The food you eat, the lunch spot you eat it in, and the logistics organisations that supply that food are all procured and structured through companies. If it is at all modern, the house you live in was likely built by a property development company; The urban housing situation such as it is, you probably rent that house from another company in turn. Returning home hungry and a little bored, you order food through one company’s app and peruse potential mates on another; an entire supply chain of tech companies, meanwhile, has conspired to design, make, and market the smartphone you use to do both.
Many of these businesses are public companies, their shares trading on the open market; most will be private, their shares held by only a few individuals and entities. Investing in these shares is one of the main ways individuals and institutions hope to accumulate wealth. That wealth, however, is poorly distributed, and the process of wealth accumulation is weighted in favour of those who already possess it.
This difference arises in no small part due to the varying types of investment opportunity that the mass affluent, high (and ultra high) net worth individuals, and institutional investors have access to. Investing in equities – shares in public companies - is one of the main ways that ‘mass affluent’ retail investors may hope to accumulate wealth. Individual investors, possibly with the assistance of an advisor, invest their money in public companies such as Amazon, Shell, Tesco or Walmart. Many of the most interesting investment opportunities, however, are not to be found on the public markets. Take private equity funds and venture capital funds - they exist to invest in companies that are not publicly traded, and in doing so they find higher returns than that to be had on the open market. Consider the S&P 500 index of publicly listed US businesses - it had an average annual return of 5.91% between 2010 and 2020; US private equity, by contrast, showed an average annual return of 10.48% in the same period.
Various factors conspire to mean retail and the bulk of high net worth investors are locked out of these private market investments. To the average investor, they are expensive, inaccessible, and illiquid. It can require millions of dollars to meet the minimum investment criteria of the largest funds – $10 million, $25 million - meaning only the very richest individuals can participate. Even for the lower priced funds, access and sourcing are difficult; markets are opaque, meaning such opportunities are difficult to find. At the same time, these investments are long term – the typical VC fund may require capital to be locked up for a decade.
Investment in alternative assets is thus very correlated with wealth. Bain found that ultra-high-net-worth individuals - those with $30 million or more investable assets - allocated approximately 18% of their portfolio into alternative assets. Those with $5 to $30 million invested less than 5% on average, and those with $1 to $5 million, less than 2%.
This problem of access is especially relevant when, like in the USA and UK, fewer and fewer successful businesses are choosing to have an IPO. In 1996, there were 8,090 companies listed on US stock markets. In April 2023, CNN reported this had fallen to a mere 3700. In the UK, meanwhile, there has been an approximately 75% drop in listed companies since the 1960s. Unable to easily access high-value alternative assets, retail investors are thus trapped with a diminishing supply of lower-return investment opportunities.
The token solution
There is, however, a solution – tokenisation. Specifically, the tokenisation of real-world alternative investment assets such as investment funds, real estate, and art. Tokenisation means choosing to represent ownership of a thing via a programmable piece of code – a smart contract – recorded on the blockchain. Practically speaking, tokenising a PE fund or other form of alternative asset means tokenising not ‘the fund’, but the corporate entity that owns the fund. The tokens represent ownership rights over the shares of the corporate entity.
Tokens have a range of benefits. In particular, they are programmable, meaning they can be developed to provide a wide range of rules, rights, and obligations upon their owners, independently verifiable, meaning that anyone can inspect the token to understand what it is and who owns it, and liquid, meaning that they can be easily and widely traded.
This offers a range of opportunities for fund managers, administrators, and investors. Tokenisation massively reduces the costs and coordination challenges involved in soliciting and managing fund investments. Tokens replace the need for centralised registers of membership, as that information is encoded into the tokens themselves. They also reduce the need for complex onboarding processes between different institutions and individuals, as each party must simply abide by the rules of their shared blockchain platform and set of smart contracts. Lower costs, in turn, mean fund managers can afford to offer lower minimum thresholds for those seeking to invest.
Unlike shares in private companies, tokens are highly liquid and tradeable. This means that fund tokens can be traded among a wider audience, and that they are not constrained by the physical and administrative limitations of buying and selling private shares. Their liquidity also offers the prospect of fractionalisation, meaning that a wider pool of individuals who will be able to benefit from the wealth generation opportunities that such investments province.
Alternative asset tokenisation: $400 billion dollar opportunity
This is a huge opportunity for both investors and fund managers alike. In the context of widespread alternative asset tokenisation, managers of tokenised funds will be able to market their fund to a far wider pool of potential investors, massively increasing their fundraising abilities and potential earnings, and
Estimating that alternative asset tokenisation could increase portfolio allocation from approximately 5% to as high as 20% across individuals in the high, very high, and ultra high net worth categories, Bain estimates that tokenisation represents a $400 billion opportunity. In truth it may be far more - this figure does not include the potential opportunity among mass affluent investors.
Blockchain and the democratisation of finance
The tokenisation of alternative assets illustrates how tokenisation will democratise finance, removing institutional barriers that prevent many investors from accessing high-yield assets. The opportunity goes far beyond fund assets alone. Personal homes, the revenue streams of private companies, art, royalty revenues – all are potentially subject to tokenisation. BCG estimates that by 2030 as much as $16 trillion in previously illiquid value could have been tokenised, a figure equivalent to 10% of global GDP.
The change is already happening. Companies such as Tokeny, Blocsquare, and Addxare already helping financial institutions tokenise and market their assets, bringing them within reach of mass investors. Major asset manager such as Blackrock, meanwhile, have begun offering tokenised funds.
by James Kingston, james.kingston@otonomos.com
How Otonomos can help
As specialists in Web3 incorporations, Otonomos has helped many projects tokenise real world assets. If you wish to learn more about our services and how we can help your token ambitions, schedule a call today.
