What should be tokenised (Tokenisation Part 2)

 

In an earlier post  (see Part 1) I discussed how cryptocurrency based tokenisation  opens up new ways to representing and trading assets worldwide. In this post I will discuss what types of assets are best for tokenisation.

The Link Between Assets and Tokens

When considering buying a cryptocurrency token based on assets, one of the first question that springs to mind is – how are the target assets tied to the tokens I have purchased?* From the perspective of a company’s owners the issue of how much security to give token-holders is a thorny one. This is because laws in different countries that protect investors, also protect companies, in providing them a framework in which they give to and take back control from investors.

No overarching law means it is very much the wild west for both sides and investment and return are very much about doing your homework both as a token issuer and as a token purchaser.  On the investor side the concern is all about the structure of the company running ICO, and its intentions as to how to use the raised money and on the company side, about the types of money taken, the ways in which money is taken, from whom it is taken, and what promises are given for taking it. The management of a company that issues shares can as easily run off to far-off destinations with the money as the one that issues tokens. Both will be breaking the law. There is no blank cheque for token issuers that doesn’t exist for share issuers. On the company side, giving tokenholders the same rights as shareholders is an open invitation to so much liability that token-issuers have to look at other ways to provide comfort to potential token purchasers.

Generally, it’s always a risk-reward balance. You could find ways to secure funds on a cryptocurrency blockchain, before the money gets to the company and to the asset that is being bought with the tokens. Similarly in the non-cryptocurrency world you could handcuff the management of the company you lend to … but less risk will always correspond to less reward, whatever anybody may promise.

The issue of risk versus reward appears at the token target asset level as well. Is the potential return that is being promised as likely to go to zero (0) as it is likely to multiply by 100?  When it comes to tokenisation, the intended  asset target must provide some base value protection, otherwise the token moves from the domain of investment to pure gambling, and there are enough gambling opportunities that do not need tokenisation. Let us therefore consider fixed assets, income streams derived from fixed assets, and then tokenisation of entirely speculative ventures.

Assets versus Income Streams

There’re many kinds of assets that generate returns. You could invest money in a company developing a product and hope to benefit from the returns on that product. You could buy tokens from a company that provides a regular income stream from its services or assets. The company could be providing consulting services, licensing software or it could be lending out money. Or you may also choose to buy tokens from a company simply acquires assets, say land near a city that is growing outwards. The tokens could represent anything of value that you, in your present location or economic state cannot directly invest in. The question is what the target should be. Should the tokens be invested in something that simply hold its value, increases in value, generates returns now, in the future, or only in the future?

In my view, whatever the target, the assets must easy to value so you have some notion of what value you get with your tokens. Fixed assets are better for that than income streams or cash flows. Yes, income streams of cash flows can be discounted backwards in order to value them. However the degree to which you can calculate backwards to get to a fair value decreases with the amount of time you calculate over. An asset of $1000 today could be slightly more fixed than an income stream over the next 10 years that gives you a $1000 asset today.  It is like comparing that is $100 (dollars) today against a stock is $90 today with a expected income stream whose discounted present value combines with the purchase price to give you $100 (dollars).  Naturally the value of assets, are never “fixed” enough- all one needs to do is look at the value of gold. The people you lend to may go broke…  the building you may also burn down. Stuff happens.

However, if you wanted to invest in real estate you would prefer to own a real estate asset rather than be the holder of a mortgage provided to the owner of the asset. You would want to own the building rather than have a right to the rent it generates (for example by financing the purchase of the building by someone else). This is not just because owning the asset allows you to leverage your investment using financing, it also allows you the flexibility to make such decisions, to improve the asset. If you want to invest in agricultural commodities you may prefer to own the plantation rather than the income stream from the plantation over the next 10 years.

Of course some may say that investing in a banana plantation is almost the same thing as investing in the income stream from the banana export from it. However the distinction to draw is- Is the company issuing the tokens, issuing them against the plantation it has purchased or just the funds it receives on an annual basis?

Others may say it is a bigger headache to own and manage the asset than to provide financing. However it is important to distinguish between the interests of the token issuer and the token-holder/purchaser. The token issuer benefits from less management, the token-holder benefits from greater value and growth from owning the underlying asset and benefiting from the income stream.  Managing the underlying asset may give the asset manager additional flexibility (and headache) and presumably the investor additional return. The asset can be leased to provide an income stream as well as provide underlying growth. The asset can be purchased using leveraged financing so that returns are magnified.

A token representing the underlying asset rather than the returns from the underlying asset is inherently less speculative in its valuation. It all depends on where the variability in valuation is represented, at the asset or token level. If the token represents a jump from a future income stream to present asset value before we get to the blockchain, the value of the income stream token is inherently less predictable as it depends on the proper calculation of the discounted present value. This is not meant to say all income streams are bad. There are dependable income streams and there are speculative income streams. An overleveraged asset purchase may be as bad as depending on an income stream from a dodgy borrower. But in my view you are better off betting on the slightly surer asset ownership than the contracted for income stream.

Other targets for Tokenisation

So far I’ve drawn subtle distinctions between assets and income streams derived from those assets. However it is important to address what most tokenisation initiatives are promising. There are still very few issued tokens out there that actually tokenise assets or income streams. Many tokens issued and being issued are attempting to provide value in the future to token-holders using the “network effect”, the hail-mary, a.k.a the ponzi scheme, i.e. let’s hope every body gets our tokens and feels like using them to exchange for goods and services, believes it is going to go up in value, and gets other people to buy in. This is basically attempting to replicate the success of the big cryptocurrency names in the market by trying to get as many users as possible and much of a speculative driver underlying the asset as possible. All I can say is lots of people tried to ape the Beatles, no one got their success.

The Tokenisation Of Hope

There are other slightly less sketchy tokenisation initiatives that are being used to finance software development. Although such tokenisation allows financing that may be cheaper for the company than conventional debt or equity financing, which may in turn lead to greater returns for investors, beyond that benefit over every day corporate administration headache and expense, there is very little to recommend these efforts in terms of providing intrinsic value. If the company issuing tokens is betting their economic future on them successfully designing something , successfully producing it, successfully selling it better than its competitors, what they are tokenising and selling to you is not assets but hope.

*[As an aside, all investment is a leap of faith, notwithstanding what people complaining about the uncertainty of returns from cryptocurrency token sales. I’ve seen enough private financings based on hope and subterfuge, and any one involved in IPOs for early stage mining companies would very much know the difference between what is promised and what is returned.]

Conclusion

In this post, I have analysed the differences between assets, income streams, and other targets for tokenisation. In the next post, Platform Or Not?, I will look at token offerings that focus on building platforms versus focussing on direct investment. In the post after that, I will look at the storage and use of funds raised through ICOs.