Tokenization and valuation methodology

Any “real-world” assets (tangible and intangible — Corporate finance speaking) will be impacted by tokenization. Those who will emerge on top of all the noise are those who will find a real use for the end user coupled to amazing Ux/Ui.

Among those “tokenizable” assets turned into Digital Securities, you will find:

  • Interests: whether it is in private, public (beware depending on geographies), funds (Private Equity/Venture Capital/Real Estate)
  • Commodities
  • Business Debt/Loans/Credit (they are several kinds): Blockchain can make it more secure and auditable to borrow which would decrease the interest rates and control deviance. (Secure refers to the 143M Americans data hacked to Equifax, Auditable refers to the subprimes, decrease refers to the increase in competitiveness that the blockchain allow (geography being no constraint))
  • Royalty agreements
  • Investment contracts
  • Security futures
  • Any Income producing assets

Real Estate Example

There is no better use case. People are familiar with property ownership papers. The truth is that you actually can tokenise, not only ownership (partial equity), but simply rental income or rights to use the underlying asset (as I keep repeating in the case of Co-living use cases or hybrid co-ownership/co-living use cases).

  • Fractional ownership increase liquidity. As the token is divisible AND fungible, this ease the process AND accessibility of such instruments without underestimating the price of the underlying asset (it’s called “Liquidity Premium”, it usually represents up to 30%). (In the process of investment, you usually either by the asset or not. With Tokenised asset you would be able to buy a fraction as easily as in the legacy system)
  • Accessibility of such tokens allows greater diversification in terms of assets class (within Real Estate or not…) and across geographies. (I like to call this one: “Super-Diversification” even though it’s just diversification. In portfolio optimisation you usually optimise to the integer, with tokenised asset you have up to 18 decimals
  • Proof of ownership avoids the possible administrative costs and operational human errors of reconciliation, that’s the double spending problem. (Cf. Dole Foods — Bloomberg)

Private Equity / Venture Capital Example:

Traditional models include a lock up period for investors (LPs) from capital formation to liquidity event because the fund’s assets (Start-ups) burn the initial cash to develop themselves. Therefore, fulfilling redemptions would be extremely costly to the fund. With Digital Securities on the blockchain, the fund would be able to lock up the capital (maintain capitalization table) without locking up the investors because the secondary market unable by the properties of the token such as no double spending possible, Immutability of the record, compliance protocols..). The Investor in this kind of funds sees his number of options regarding the selling of his token increase on top of benefiting from the usual exits as it was possible in the legacy liquidity event framework. On the fund side, Digital Securities offer access to a potential broader pool of potential investors / Capital to gain exposure to this kind of investment vehicle considering the legal jurisdiction they are based on. Here again, Compliance Protocols will ease the process for capital formation by streamlining most of the operations for investors onboarding. Thus, allowing fund managers to have the ability to operate with a high degree of autonomy from their investors.

What about Disclosure?

Funds will need to inform investors of the Net Asset Value (NAV) and portfolio holdings (as Spice VC is already doing it quarterly). Since private markets are “private”, they were previously not forced to report anything. But now that they have an increased investor base from possibly all over the world following real time pricing on the exchanges, they must disclose NAV reports to investors. It’s a matter of accountability and credibility to allow greater transparency and democratization. (there is an opportunity to create the next Bloomberg here)

Valuation methodology

Digital securities are Securities. Therefore, depending on the underlying asset, various statistical methods can be used to model the valuation.

First, the off-chain variables play a major role in the valuation. The straightest forward is the valuation of the underlying asset itself. Whether it is real estate or private company’s equity, if there is an appreciation in the asset price then most probably it will be reflected in the real time pricing of the security token. Also, cash inflow and dividend are highly correlated to the price. Then, every valuation must take in consideration a risk factor of potential default in payment, specifically for debt or real estate lease. Finally, and specifically in the nascent field of Digital securities, the liquidity will certainly play a major role in the valuation method.

In portfolio optimisation, taxation and insurance models of the underlying are also taken into consideration.

Therefore, models like dividends discount model, residual income method, discounted cash flow should be familiar to you. (One more argument that proves that Digital Securities are not a new asset-class, even though the regulatory landscape is not necessarily adapted)

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