Future of Finance
How Asset Tokenization is Democratizing Capital
future of finance
Throughout history, access to capital — the lifeblood of business — has been limited to privileged individuals and companies. During early modern times, capital was controlled first by the church and royalty, by small private bankers and then by large financial institutions that provided loans only to chosen borrowers. Luckily, the capital markets in developed countries started to change two decades ago.
Many non-investment grade companies were in need of capital in order to expand their business operations which was recognized, and numerous non-bank financial institutions were established. Mutual funds, private equity funds, venture capital firms, brokers and mortgage companies provided funding through equity to those companies that traditionally didn’t have access to loans from large financial institutions.
Private equity investments made capital more broadly available to companies in need — creating the “first wave” of capital democratization. Economies have flourished since then. Due to their increased access to capital, new jobs and business opportunities have been created by non-investment grade companies.
On the other hand, access to many investment vehicles that invest in alternative asset classes is still limited for retail investors and I\in most cases, alternative investment funds are not available to retail investors due to high entry barriers such as high minimum ticket size and regulatory requirements for qualified investors.
What this means is that retail investors don’t have as big a choice as high-net-worth individuals regarding where to invest their money. Most retail investors end up being invested into traditional bonds and equity and they miss out on exceptional returns generated by alternative investments.
Today, we are witnessing the “second wave” of capital democratization.
Ever since the invention of Bitcoin in 2009, the world has been excited about the idea of eliminating middlemen, central banks and obscure bank fees. Next came the idea of asset tokenization, which enabled the liquidity of previously illiquid assets, improving the flow of capital in developing countries.
From fine art, buildings, commodities, and racehorses, to sports teams and agricultural goods, blockchain technology is not only making these assets liquid, it is making fractional ownership available to investors all over the world. Since tokens are highly divisible, investors can purchase tokens that represent a small percentage of the underlying asset.
Thanks to blockchain technology, investors can now access many asset classes which were previously inaccessible. At the same time, business owners unlock new funding sources by leveraging their previously highly illiquid assets.
Case study: Unlocking cattle ranching as an alternative asset class
Cattle ranching can be a lucrative business. It is widely recognized and familiar to most: as the majority of people will have consumed its end products — animal protein — at some point. What is probably new to common wisdom, however, is that cattle ranching is a low risk operation with a very solid outlook.
According to the Rabobank’s Beef Quarterly report Q4 2019, the demand for beef is growing in China and other Asian markets. Meanwhile demand also remains good in the US, and it is expected to stay this way in the upcoming future.
As global population growth shows no signs of slowing down, demand for food will continue to increase. For this reason, many consider agricultural and farming investments as being “recession-proof.”
Until recently, retail investors typically had limited options on how to invest in farming. They could do so by investing into:
· farming-focused REITs that buy the farmland and lease it to farmers
· publicly traded companies that operate in the farming sector
· agriculture focused ETFs and mutual funds
Paradoxically, there are no financial instruments available to retail investors that focus solely on cattle ranching.
This is now changing with blockchain technology. Asset tokenization makes it possible for ranch owners in any country around the globe to tokenize their farms or cattle herds and raise money from international investors.
The first such use case is the tokenization of the cattle herd at La Pradera ranch in Bolivia. La Pradera is a mature cattle ranch based in Santa Rosa de Roca, Santa Cruz, Bolivia. Established in 1999, The ranch has been in operation for more than 20 years and is composed of 3,200 hectares of pristine land.
The Finka Token, a security token, is supported by the cash-positive operation of a herd of 4,000 cattle. The token grants its holders a right to the profits derived from cattle ranching.
Investors are thus able to directly participate in revenues generated by animal production. Based on historical returns, there is an expected IRR of 5–8% over the lifetime of the investment for the Finka Token.
The Finka Token also serves as a good example of an impact investment. Until recently, there were many barriers that people from developing countries had to overcome in order to benefit from financial services. In the example of the Finka Token, we see how Finka is leveraging blockchain technology to enable financial inclusion by increasing cross border capital flows and enabling fractional investing.
Finka Token provides multi-jurisdictional capital access to the sustainable cattle ranching operation at La Pradera. Investors from any jurisdiction are able to invest in the Bolivian ranch by investing into the Finka Token.
The same model can be applied to any other cattle ranch around the globe.
Tokenization of assets, and blockchain technology in general, have significant effects on capital markets, entrepreneurship and fundraising. However, there are still some challenges to this technology. These include liquidity, resistance to change and lack of institution grade digital asset management infrastructure.
Simply tokenizing an asset does not mean that investors will be attracted to the investment organically. For investors to feel more confident to hold digital assets, there has to be a clear and aligned regulatory framework across multiple jurisdictions.
On the other hand, tokenization of traditional assets is guaranteed to cause resistance to change by the current major players in the financial industry.
Lastly, for the tokenized economy to flourish, we still need to develop a comprehensive digital asset management platform with similar levels of performance as traditional asset management systems.
These challenges remain to be resolved on the way to achieving mass adoption of asset tokenization.