Putting the Fun back in Fractionalisation
After the long post on my future vision and tokenisation, and after a number of good conversations of twitter (thanks @polemitis and @pascalbouvier) today a more focused post on what the value proposition of fractionalisation has to be for investors so that fractionalisation will take off.
In my last post I wrote about how we need to first and foremost convince institutional investors in order for tokenisation and fractionalisation can take off. I still stand by this, but Antonis challenged this narrative so I’ll lead with our conclusion:
Fractionalisation will be driven by retail investors, but it will need to be enabled by institutional investors.
What this means is that we should never forget that our core value proposition in the fractionalisation market is to retail customers, and ultimately whether or not fractionalisation will succeed depends on whether we can make it sufficiently interesting for them. However, neither should we forget that we can not build this market quickly without the help of institutional investors. How we will get institutional investors to disrupt themselves will be the subject of a later post – I’ll focus on retail investors here.
Utilitarian considerations
In the last post I have emphasised the utilitarian considerations of tokens, ie how they are different from and often superior to traditionally registered securities in a number of areas. Here a brief reminder:
Operations. Operations with tokens are easier and cheaper than those in the traditional system, and they are less error prone. This is mostly because everything can be done on-chain (payments, authentication, communication, voting). This in turns reduces complexity, error rate and cost.
Custody. Token custody is key custody which, as explained in the previous post, means that there is no need for a chain of trust between the investor and the ultimate custodian / depositary.
Cross border. The way both payments and custody work on-chain makes tokenisation particularly useful for cross-border investments as there is no need for long custody and correspondent-banking chains.
Cognitive load. For fractionalisation to work the cognitive load on the investor must be reduced. In the current system it is not possible for a retail investor to invest say $10,000 in junks of $50. There are various strategies how this cognitive load can be alleviated, most of them involving some kind of automated investment discovery and analysis (“robo advice”)
Liquidity. Retail investors must be able to liquidate investments in case of need, say if they want to buy a new car or have to meet unexpected bills. Those liquidations must happen at a fair price. This means that for many investments there must be someone actively making markets, possibly in an automated manner (“robo market maker”).
Now those are all very important points that determine the overall user experience, but they are at best necessary conditions for tokenisation and fractionalisation to become successful, not sufficient ones. For tokenisation and fractionalisation to really take off it must be sufficiently different from traditional investments in a fun way, so we will be looking at the fun aspects of investing in what follows.
Competitive investing
The first area where investment could be fun is what I’d call competitive investments as described in the tweet below:
Essentially in this case investment has a gaming or betting character, and people compete as to who can make the highest returns. For this to work the investments must be highly liquid, and there must be very small bid-offer spreads so that people can enter and exit the markets, possibly a number of times a day, without too much drag on their overall performance. This means that investments in this category are in practice restricted to equity indices, a number of highly liquid equities, forex and commodities. Those investments could be outright (“delta one”) or they could be derivates, in particular options, or option-based strategies.
If we restrict the investments to long-only shares then this is essentially what Robinhood or Charles Schwab offer as fractional shares and their apps might be a very good way of distributing this product. With tokenisation it might be possible to somewhat streamline the distribution. However, not all regulators are too keen on retail investors having access to highly leveraged stratgies or short strategies. Some regulators might not look too kindly on the manufacturers of “competitive investment products” especially if marketed cross-border.
Perks and fringe benefits
A category where tokenisation and fractionalisation can be genuinely innovative is when the issuer if able to offer perks and other fringe benefits. They sky is the limit here and we have arguably only scratched the surface of what is possible. Here are a few example of investments that would fall into the perks and fringe benefits category
a football club builds a new stadium and finances its construction with money raised from fans; in addition to the interest and principal repayment investors have certain privileges (eg early booking, invitation to certain events, extra entrance, investor lounge access, …)
a football club finances the acquisition of a new player via tokenisation; investors get autographs or commemorative photos (physical or in form of electronic collectibles) and participate in the transfer gains (and losses) should the player be sold
a shopping mall that is being partially financed via tokenisation offers free parking or special events (“early christmas shopping”) to its investors
a museum tokenises a work of art it acquires; on top of periodic (and possibly perpetual) interest the investors get “visiting rights”; if the work is sold investors participate in the profit (or loss)
a company producing healthy food, or an organic farm, offers its investors specials deals on their products or produce.
This is only a small selection of the things I could think of in this category. Key here is that in one of the models, retail investors are willing to accept lower returns because they receive non-monetary benefits, and companies can provide those benefits more cheaply than what they’d have to pay on the financing. In the second model retail investors also become more loyal customers of the company.
Bragging rights and other feelgood factors
Instead of tangible benefits investor might also receive intangible benefits such as bragging rights, and other feelgood factors. Again here a selection of things that I could think of that fall into this category
A solar plant delivers the green electricity certificates it produces to its investors who can use them to offset their own electricity consumption. The whole process is documented in a manner that is easily communicated to the investors’ friends.
In the case of the museum already discussed above the museum recognises the investors as “patrons of art” and for example thanks them next to the work of art or its representations, or via more modern means (eg Facebook badges, collectible non-transferable tokens)
Early investors in a startup company get lifetime bragging rights from the company. Monzo actually did this when they issued “investor cards” to the investors that participated in their early crowdfunding rounds.
Some prestigious real-estate investments – say located in a very well known spot, designed or endorsed by a celebrity, or otherwise remarkable or outstanding – are sold to retail investors which gives them bragging rights because of the standing of the object.
Again this is only a small collection of investments-cum-something that are possible with tokenised and/or fractionalised assets and that make them exciting for retail investors in a way that traditional or pooled investments are not.
Conclusion
In the 10-year-vision post I described a world where pooled investment vehicles are disrupted because people choose their investment advice more granularly. For example people use automated “robo-advisors” or the equivalent of commodities trading advisors who provide advice but where the asset custody part is fully separated from the asset management part. In this case people can self-custody their assets, or they can custody them with a (key) custodian of their choice.
However, this world will take a long time to develop and it will require a certain critical mass. This in turn requires some boot strapping: investors will only really invest in that manner when the infrastructure (robo advisors, robo liqudity) are around and working. The infrastructure will only be developed on the other hand when a sufficient number of investments is around so that it can be successfully deployed.
In the last post I pointed at one solution to this conundrum: institutional investors who invest in the same “boring” investments they always invest in, but they allow for a small tranche of this investment to go into retail tokenisation. They also provide services like anchor investing, underwriting, and market making that allows them to earn extra income from their investment expertise.
The second route to solving the conundrum is the one I described here, which is that the tokenised investments are “fun” because they come with additional features such as perks or bragging rights. Those features make investments special and attractive to retail investors in a way that traditional pooled investments aren’t. This in turn makes them attractive to issuers who can pay smaller returns in exchange for cheap-to-produce benefits, hence overall they save money.
Thus far no-one has really cracked this conundrum. One reason is that traditionally there is a clear separation between marketing and finance. In the new world issuers require skills in both areas to launch a successful retail tokenisation and fractionalisation product. I however am confident that we’ll get there soon – a lot of people are thinking along those lines and once there is a product that works everyone will jump on the band wagon.
image credit: Element 5 on pexels