Here is how Digital Assets will Take Over Your Asset Allocation
Over the last 10 years, there have been four separate themes for blockchain-based assets.
The first, Bitcoin, is a global macro motivated play with aspirations to power payments and store inflation-protected value. Conceived by cypherpunks and techno-utopians, Bitcoin has dozens of millions of users and has run a production-level platform for a decade. Whether we like it or not, it works, and $7 trillion of traditional gold investment is at play.
The second, enterprise blockchain, is a cost-cutting effort by an oligopoly of financial firms to mutualize processes and costs around the back office. Nearly $250 billion of industry cost across payments, banking, capital markets and insurance is available for transformation. That’s a net present value of $3-5 trillion, but requires competitors to co-operate.
The third wave, Initial Coin Offerings and Decentralized Applications, posited scarce and functional digital objects into digital economies. Tokens, like a coin at an arcade, power up the use of consumer applications and serve as a proof-point that blockchain-based assets can be involved in economic activity. Over $20 billion has been raised in this way.
And fourth, the Security Token wave is re-running the crowdfunding theme through token-based securitization on public blockchain rails. While original crowdfunding platforms like Kickstarter and SeedInvest captured some public imagination, the crypto version of the same is both far more global in capital and much more functional in its infrastructure.
We do not have to believe any one of these particular themes to accept and believe in another. For example, you may think that the only true cryptocurrency is Bitcoin and that all the other innovations will fail given the network effects off the original. Or perhaps, you may think that digital assets are a technology solution looking for a business problem, and only inside large financial organization can that problem be solved.
The real question for today’s asset allocators and investors is how to treat blockchain technology within the existing allocation framework. The narrowest approach is to see it as any other technology theme sold into financial incumbents, and invest into the private equity of Fintech companies delivering such platforms. This would imply an investment into a venture capital fund that targets Fintech companies.
One step broader would be to treat these new digital assets and currencies as alternative commodities, looking to endowment investment strategies for inspiration. Such large investment mandates for decades have kept 5-20% of their portfolios in private equity, commodities, hedge funds, and other esoteric bets. Crypto is no more esoteric than pork bellies.
Yet another level would be to understand that securitization as married with tokenization allows for fractional liquidity across all asset classes. This implies that everything from interests in commercial real estate to valuable art can be sliced into digital pieces, and held publicly by the crowd. Exchanges like Binance and Huobi already facilitate trading in hundreds of digital tokens, and adding an asset-backed one is not a meaningful technical challenge. They can also be bolted onto a roboadvisor and directed at a consumer.
Such tokenization can extend further to the entire portfolio, including the core holdings of equities and fixed income. As an example, the Australian Stock Exchange is working with Digital Asset to swap in a blockchain-based trading chassis that will power over a trillion of equity value. Similar efforts are under way with the world’s largest custodians. It is only a matter of time until such chains are interoperable with the public ones, under common standards, with machine regulation. Until then, adjust your risk accordingly.