Disruption in Alternative Assets Through Tokenization

Alternative investments are fetching more investors than ever. As per the Chartered Alternative Investment Analyst (CAIA) Association: between 2003 and 2018 the volume of the global investment market has doubled, while alternative investments almost tripled to USD 13.4 trillion. This indicates around 12% of all worldwide investments were channeled to alternative investments. CAIA Association members anticipate this allocation to increase to 18–24% of the global asset market by 2023.

Understanding Tokenization

Tokenization is defined as a process of creating a digital version of a non-digital asset, implying the digitization of an asset. The underlying assets could be anything from stocks, bonds, private equity, hedge funds, infrastructure to natural resources. The use of blockchain technology as a distributed ledger opens up several opportunities to create, record, and transfer assets. Broadly tokens can be distinguished into three categories:

• Security tokens — represent ownership or interest in an underlying asset
• Utility tokens — provide access to specific rights and privileges to token holders
• Exchange tokens — can be used as a mode of payment

Further tokens are also classified according to their fungible and non-fungible (NFTs) properties. Fungible tokens are those that can be switched, traded, or substituted like exchange tokens. NFTs are non-interchangeable. Each one is valued uniquely, representing fractional ownership in a single piece of art, paintings, sculptures, photographs, or collectible items.

Challenges of Alternative Investments

Alternative investments encompass hedge funds, private equity, venture capital, and private debt as well as tangible assets such as real estate, infrastructure, and natural resources. The aforementioned asset classes are normally less liquid, less accessible, and less transparent in terms of information compared to traditional investment assets, appearing to be a perfect target for tokenization. In this regard, tokenization via blockchain technology may have a significant profitable impact on all investors and managers of alternative assets.

Tokenization enables the democratization of alternative investments by providing access to more investors while facilitating asset managers to innovate by creating alternative assets tokens. Thus fuelling the expansion of their potential product mix. The tokenization process involves multiple steps. These include deal structuring, digitization, primary distribution, post-token management, and clear regulatory standards enabling secondary market trading. Investor education is the most important wrapper in rendering any innovation sustainable.

Tokenization addresses some of the inherent issues — for both investors and asset managers — of the alternative asset classes by:

• Improving Liquidity — Traded tokens on secondary markets
• Enabling Quicker, Cheaper Transactions — Lower complexity and higher operational efficiency reduce transaction and lifecycle costs
• Enhanced Transparency — The token holder’s rights, legal responsibilities, and certificate of ownership can be encased within the tokens
• Widening access — Tokens provide access for more investors to a previously unaffordable or insufficiently divisible asset class

However, technology is not the absolute solution for all the range of challenges of alternative investments. The creation of a secondary market does not automatically lead to liquidity, but it may be the first step. Some constraints continue to linger. For example, in the area of hedge funds, private equity, and natural resources, where a sizable avenue is required to be able to create a portfolio of tokens for diversification.

In the case of venture capital and private equity, the tokenization process will not necessarily smoothen the due diligence process the way it can in the private debt and infrastructure markets. In real estate investment, many glitches have been identified, being currently one of the most tokenized assets in the alternative sector. The major challenge here is that real estate developers are seeking tokenization asset by asset, so there remains the issue of scalability to be handled.

Coming to private debt, coding covenants into smart contracts are hard to come by, potentially posing a challenge in the lifecycle management of the tokens. Again, infrastructure assets are heavily regulated, making it more difficult to write into a smart contract.

Tokenization of alternative investments

Tokenization is a way to “democratize” an alternative asset. This means to enable better access to a wide range of investors, addressing the issues like barriers of entry by providing greater transparency, more inclusive access, faster/cheaper transactions, and better liquidity.

The chart below lays down risks/constraints entailing individual assets within alternatives.

Tokenization and HashCash

HashCash offers Security Token Offering (STO) on alternatives. HashCash road map to STO covers a Pre STO Launch service, including

• Legal services
• Landing Page construction
• White paper draft

This is followed by the actual tokenization which includes:

1. Deal structuring — This is the comprising the most important part, where decision-makers must compile key aspects such as business objectives, share class, valuation and pricing, fee structure, capital commitment, regulations, and taxes. The result is then formulated into the project complete with determinant smart contracts.
2. Digitalization — On the finalization of deal structuring, the underlying asset can be tokenized. The asset can be fragmented into as many tokens as possible, thereby reducing the value of each token. Blockchain technology is implemented as a distributed ledger, and tokens are then sold or issued to investors.

This process is followed by listing the tokens on an exchange and Custodian Integration.

HashCash Post- STO Launch services include STO marketing and providing technical support services.

Benefits of tokenization

Benefits of tokenization include the following:

• Greater access via fragmentation — An asset can be divided into any number of smaller parts, lowering the bar for entry of retail investors of any capacity.
• Shorter settlement time — Tokenization enables a 24/7 trading facility in an exchange and real-time settlement unlike T+2 or T+3 settlements.
• Flexibility — An asset can be modified into infinite share classes
• Data transparency — Data may be stored on a blockchain
• The accomplishment of transformational value through operational efficiency — Enabling drag-along actions, like corporate actions, that can be automated
• Increased liquidity — Tokens could be easily traded in the secondary market, improving the overall liquidity
• Moreover, there are no geographical barriers, or middlemen, and swift, hassle-free transactions.

Wrapping up

As complex as an alternative asset can be, treating it with appropriate technology can disrupt its normal course by inviting a wide range of investors of varying capacities to invest in it. This is achieved by lowering barriers to entry in turn made possible by fragmenting the assets into their smaller values represented by tokens.