There was plenty of reason for excitement when the JOBS Act was passed in 2012, opening the door for investors previously considered “non-accredited” to participate in private placements. The legislation was aimed at providing more startup capital to new businesses and creating millions of jobs. Naturally, the fertile imaginations of product sponsors and financial advisers were buzzing with notions of a whole new class of Americans plowing money into investments of the alternative, hard asset and illiquid varieties.
But obstacles have persisted, including squeamishness among investors about tying up their money for years at a stretch in crowdfunding plays, nontraded REITs, business development companies, hedge funds and other investment strategies. Many financial advisers were not so hot on the idea either, especially if the client had modest means and might need access to ready cash if other parts of their life went awry. And, let’s face it, investors and advisers are almost always going to favor liquidity over illiquidity, despite promises of the “illiquidity premium.”
What became clear is the new market of investors created by the JOBS Act would need some type of secondary trading market for the illiquid and nonlisted securities being proffered. It has been difficult to trade these types of securities. In most cases, when someone buys nonlisted securities during an initial offering, they are looking down the barrel of a seven- to 10-year lockup period. The person investing in a nonlisted REIT, for example, did not have many opportunities to liquidate if they wanted or needed their money back, unless they were willing to sell at a significant discount compared with the stated value.
Along came online trading platforms that facilitate secondary market transactions of nonlisted alternative investments, easing the burden borne by investments in illiquid products. The online platforms gave accredited and non-accredited investors and their advisers the ability to sell their securities to buyers.
Using the platform was simply a matter of creating an account. Once approved as a buyer or verified as an authentic seller, one could begin trading the assets. Even then, it would take three or four weeks for transactions to be consummated, which was especially problematic for managers handling institutional dollars that needed to move in and out of deals quickly.
Then along came blockchain and its reputation for speed and security. Now trading platforms such as CFX Markets (part of the OpenFinance Network), SharesPost, Templum and tZERO are integrating blockchain into their trading platforms to supercharge the secondary market for alternative assets. Those four organizations, and perhaps others, are building tokenized trading platforms capable, in theory, of taking the standard clearing and settlement process from weeks down to three or four minutes. Given that kind of speed and liquidity, there is reason to believe blockchain-based trading platforms will facilitate more investment in alternatives and real assets.
“Part of the reason people don’t invest in alternatives is because they fear they won’t be able to get out of them if they need to,” says Tobin McComas, chief revenue officer at CFX Markets. “The first question they ask is, ‘how can I sell this asset?’ In most cases, you really can’t sell. Now with a tokenized representation of the asset and a trading platform on which to execute, these investments become much more liquid and, therefore, far more appealing.”
Brandon Thomas, managing partner of Blockchain Intel, explains that a token, as in a tokenized security, refers to assets built atop a blockchain that are used to perform some function, such as a security. In his column on page 28 of this edition of the magazine, Thomas writes that work is under way to develop blockchain infrastructure that is compliant with existing securities law.
“This is no doubt happening globally, but, in particular, efforts in the United States are fervent,” he writes.
Blockchain technology, applied to investing platforms, could make financial commitments to oil, real estate, timber, collectibles and other real assets practical for everyday investors. That also enhances the ability of investors and their advisers to diversify portfolios more broadly than currently practical.
“That is what we are seeing now, this movement toward an asset-backed token,” McComas says. “Think about things that are well-suited for fractional ownership, such as real estate. We know of dozens of projects where people are fractionalizing the ownership of real estate portfolios, which historically have been very illiquid assets, in the form of tokens that are much more liquid — and, in theory, more valuable because you can actually trade it now.”
When traditional alternative assets are tokenized, rather than issued as a paper-based security, the investor is given a digital token in a “wallet” that represents ownership of the asset. Given the liquidity created by the ability to buy and sell tokens on blockchain-fueled trading platforms, there is little reason why advisers would not consider tokenized alternatives when building client portfolios.
Again, in theory. Old habits die hard and inertia can be a powerful state of being. But liquidity creates momentum, as we have seen with listed equities and computerized trading systems. Blockchain-based trading platforms might just be the technology that radically changes the liquidly profile of alternatives and real assets and puts them in real motion.
Mike Consol (m.consol@irei.com) is editor of Real Assets Adviser. Follow him on Twitter @mikeconsol to read his latest postings.