Digital assets
6 min

Tokenisation: Understanding digital assets simply

The emotional hype surrounding the so-called blockchain is over. Within the financial industry, a consensus has long since emerged - despite lingering residual doubts - that the technology is forward-looking and real. An interesting application of the technology is the so-called tokenisation of assets. In the following article, we explain what is meant by this and what private investors in particular can expect.

Mona Feather

What are digital assets?

Digital assets arise from the conversion of tangible or intangible assets into a digital token. This token is a digital representation of the corresponding asset and can be held, used or transferred by the holder via the blockchain. The sale of a token can be realised without the need for intermediaries such as notaries, banks or custodians.

If this definition is still too theoretical for you, we have a practical example: You have recently read that venture capital as an asset class offers significant advantages over the equity market, which you would like to use for your asset allocation.

The problem of the old economy: direct access to venture capital has so far been a privilege reserved only for high-net-worth or institutional investors. This is precisely where digital assets are the game changer. Digital assets can represent ownership-like rights in a company that invests in venture capital. Those who own tokens of the respective company benefit indirectly from the distributions from the investment portfolio. Tokenisation democratises an asset class that is difficult to access for private investors. Welcome to the New Economy.

Remember: Just because you can invest in new asset classes in the future, you should not do so directly. Private equity certainly offers interesting potential for value appreciation, but it also harbours high risks. Many investments turn out to be unsustainable after funding. Total losses are possible at any time. The same applies to all asset classes that become accessible - new is not always sensible for your portfolio. Always keep the risks in mind.

What can all be tokenised?

Almost all assets can (theoretically) be tokenised if the legal framework is in place. The regulatory environment has a decisive influence on the practical implementation.

Prominent use cases to date are works of art, real estate, exotic cars and corporate investments. Most projects require the establishment of a special purpose vehicle (SPV). Sounds complicated, but it is not. At the end of the day, an SPV is a special purpose vehicle set up by the parent company for the purpose of holding assets (e.g. private equity funds). By outsourcing to an SPV, the risk of default is insulated. In the event that the parent company becomes insolvent, the assets are not considered a liability asset.

Important note: Investors do not invest directly in the companies of the Company. You usually invest in a tokenised bond (in short: "tokenised bond") that is issued by the SPV. The SPV allocates the proceeds of the issue to corresponding projects (e.g. venture capital funds or real assets). The token grants you a variable interest rate over the entire term, which depends on the performance of the target investments. Variable interest also means that losses can occur. You are not guaranteed a specific target return. In the worst case, you lose your invested capital.

After purchase, many tokens can be traded without high costs on decentralised, blockchain-based trading platforms (exchanges). As an investor, you are no longer bound to the entire term of the investment - but there is usually a lock-up period of one year during which you are not allowed to sell your tokens.

Digital assets create more transparency and efficiency than traditional capital markets

Digital assets are characterised by three key advantages: Firstly, they create a high degree of transparency and streamline the process of transferring ownership by dispensing with certain intermediaries. This in turn leads to a significant reduction in administrative and transaction costs and has a positive impact on the profitability of all parties involved in the process. The safekeeping of digital assets often still poses a challenge - especially for newcomers. Without a suitable wallet, investors risk having their holdings stolen by cyber attacks (e.g. hackers). Due to the sometimes high complexity of choosing a crypto wallet, many beginners opt for simple - but also insecure solutions. There is still a need to catch up here.

The use of digital assets leads to an increase in the liquidity of assets. The market for tangible assets is known for the fact that goods are only tradable to a limited extent and at specific times. Tokens, on the other hand, are - in theory - tradable at any time - regardless of place and time. In practice, only a few secondary markets exist to date, so the statement is only valid to a limited extent. However, the time span for liquidation of digital assets is already much shorter than for traditional assets. 

A token is sold within a few minutes - if there is demand and a marketplace exists. If you want to sell your property in the traditional way, you have to plan at least one week for the entire process (best-case scenario). Before buying, private investors should make sure that the provider offers a corresponding trading platform (or interface to external providers). As of today, this is only the case in a few cases.

The increased liquidity is not only an advantage, but also a risk for investors. The tradability also increases the probability that investors will trade more frequently. In the long term, this can reduce the returns that often result from long holding periods, especially in the case of tangible assets.

For private investors, tokenisation creates new opportunities

The hope that inflation would decline has proved deceptive, at least at the beginning of the year. In January, it will settle at 4.9%, slightly lower than in December 2021. Many economists had expected a noticeable decline now that the VAT effect will not materialise in the new year. The high level of energy prices is due to the recent increase in CO2 prices.

What does that mean for investors? Nothing good. High inflation means that the assets in the savings book, current account or call money account lose massive purchasing power at the current interest rate level. Many investors are not aware of this. Others want to invest in shares and ETFs on the stock market. But things are also turbulent on the stock market at the moment: what options are left then? How about private equity, for example?

Off-market investments in the form of private equity have historically performed above average - even in times of crisis. Due to the financial strength of the funds, equity is made available to investment companies at short notice in such times. This makes a big difference, especially in special situations like the Covid 19 crisis, when demand suddenly collapses. In addition to financial support, private equity managers act as strategic partners in such market phases and steer companies through the crisis with their long-standing know-how. No wonder these companies perform better on average than listed corporations. But even private equity managers can make mistakes and decisions that are detrimental to the companies. PE companies often pursue financial interests that are not always in line with the interests of the company management. This can lead to measures that deliver short-term success but weaken the company in the long run. Examples of this are hasty expansions abroad or layoffs in order to save personnel costs.

Like exclusive art or luxury goods, private equity is an asset class that has remained difficult to access for private investors. Often, at least €200,000 of capital must be invested to get started - this is not a use case for private investors. 

Digital assets are democratising the market and opening up new asset allocation opportunities. Investors can diversify more broadly within their portfolios by adding more asset classes. The more diversified private investors are with their portfolios, the less exposed they are to cluster risks.

Risks should not be underestimated

New investment opportunities offer possibilities for diversification within the portfolio. The tokenisation of assets, i.e. the digital representation of the corresponding asset via a token, enables indirect participation in value appreciation in various areas, such as the art and real estate markets or private equity. 

Nevertheless, alternative asset classes are still risky investments with real default risk. Stock markets or real estate, for example, can be classified much better from a risk-return perspective than alternative assets. For private equity investments or other alternative asset classes, there is only limited public data, let alone a price history. A risk assessment is de facto impossible or fraught with great uncertainties.

In addition, exposures in the art and luxury goods market, for example, only make sense if private investors have specialised expert knowledge and deep market expertise. Real value creation does not exist in this asset class. For this reason, the valuation model, which is based on matching supply and demand, changes. Demand (e.g. for a painting) depends on individual and emotional factors. A work of art can double in value within a very short time - but it can also lose value.

The performance of the Token may be affected by various other risks and uncertainties that are currently unknown. Investments in tokens reflecting the above-mentioned forms of investment are associated with risks and, in addition to returns, may also lead to significant losses of the capital invested.

Tokenisation & Digital Assets: Conclusion

Especially in the area of strategic asset allocation, we see great potential for the private investor who wants to add further building blocks to his portfolio. Those who add alternative asset classes to their portfolio can benefit from a higher immunity to negative stock market phases if these values develop contrary to the overall market. Immunity is not guaranteed.

Important note: There is also a default risk with alternative asset classes. Art can lose its value in the same way as a corporate investment. A high degree of diversification can reduce the overall portfolio risk - but it can never be completely eliminated.

The fact that certain asset classes are only accessible to an exclusive group of people is no longer in keeping with the times. Companies also benefit from digital assets. By opening up the market to private investors (low entry barriers), more liquidity is available for financing rounds. At tokenstreet, we rely on a professional and comprehensive selection process for our target investments in our function as issuer. We are supported by an investment committee with many years of experience, which identifies attractive investment companies for you.

Mona Feather
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