In January this year, Larry Fink, the CEO of BlackRock, said that “the next step will be the tokenisation of financial assets, and that means every stock, every bond … will be on one general ledger.”
Last month, crypto asset exchange agency Mesh.trade launched its first public offering of tokenised preference shares for South African finance company Water Financial.
This allows investors to purchase a Water Financial preference share in the form of a token, on Mesh, which will pay investors a monthly dividend.
Water Financial has issued the preference share to raise R30 million to fund its lending business. If all this jargon has your head spinning, you are not alone.
While most people will be familiar with bitcoin, a crypto asset or token created through the bitcoin blockchain, what few people are aware of is the ability to use blockchain to tokenise mainstream financial assets.
TOKENS REPRESENT ASSETS
Using an explanation provided by global consulting firm McKinsey, tokenisation is the process of issuing a digital, unique and anonymous representation of a real thing.
Tokens can represent assets, including physical assets such as property or art, financial assets such as equities or bonds, intangible assets such as intellectual property, or even identity and data.
It is sort of like a piece of paper saying that you own a specific asset, maybe a gold bar. You don’t want to carry the gold bar around to prove you own it, but the piece of paper confirms your ownership.
However, tokenisation is so much smarter because the digital token can be programmed with code which controls the token. This is known as a smart contract.
This contract means the token knows who its owner is and can execute actions.
Once a transfer takes place, the smart contract can update you on its new owner. It also knows what it needs to calculate.
For example, a token knows when to pay out a dividend or when a contract has expired.
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It effectively automates many of the administration processes that a fund manager or administrator would undertake.
It is a lot safer than a piece of paper, which can be stolen or fraudulently amended to change ownership.
A digital token can only be created and changed through a blockchain – a network of computers that independently verify all transactions through what is known as a digital decentralised ledger.
There is no single entity in charge of updating the information. As new data is added to the network, a new block is created and added permanently to the chain.
This means no one can remove that data. All nodes, or computers, on the blockchain are then updated to reflect the change.
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As Connie Bloem, the managing director of Mesh.trade explains, if something happens to Mesh.trade or someone acts not according to how they said they would act, the blockchain would retain all the information and keep the transactions transparent.
The financial record is no longer reliant on a single entity. In summary, a token is a piece of computer code that tells someone what the asset is, who it belongs to and what the asset can and cannot do.
This code can never be deleted. This could bring great efficiency and cost savings to the investment world. While tokenisation of financial assets is still in its infancy, fund managers such as BlackRock and Franklin Templeton are already using tokenised money market funds.
According to analysis by McKinsey:
Tokenised market capitalisation could reach around $2 trillion [R35 trillion] by 2030 (excluding cryptocurrencies such as Bitcoin and stablecoins such as USDC).
“Specifically, we expect that organisations working with certain asset classes will be the quickest adopters; these include cash and deposits, bonds and exchange-traded notes, mutual funds and exchange-traded funds, as well as loans and securitisation.”
While tokenisation can improve efficiency for mainstream financial instruments, its appeal will lie with those entrepreneurs who want to raise capital for expansion or growth.
Listing instruments on the traditional markets is extremely onerous and expensive, and crowds out smaller capital raisings.
“The South African economy needs its entrepreneurial base to keep on growing because that’s the base that generates jobs and also increases or empowers the economy. So that is our segment, but it’s not being served by the traditional network,” says Bloem.
It is good news for smaller companies and, for investors, it could bring a whole new range of investment opportunities to the market.
The preference share issued by Water Financial is a good example. In this case, the token is the financial instrument so, when you buy one preference share, it equals one token.
Bloem explains:
What we have created is this relationship between the legal agreement, which in this case is a prospectus, with the unit that is a token, that allows you to transfer, trade and show ownership.
Water Financial offers homeowners over the age of 70 the opportunity to release the equity in their homes in the form of a loan, without having to repay a monthly instalment.
This is known as reverse mortgages or equity release and is very big business in most developed markets.
Many retirees are asset-rich but income-poor. They have an asset in their home but struggle to meet monthly expenses.
Through their product – Financial Freedom – Water Financial provides them with a loan, paid as monthly income, which is settled on the sale of their property sometime in the future.
To provide these loans, Water Financial needs to raise ongoing capital.
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Traditional debt markets such as banks and large institutions are traditionally conservative, are not open to alternative investments and often have very high minimum deal levels.
By using tokenisation, Water Financial CEO Chris Loker says he has found a cost-effective way to bring his preference share to the market.
The preference share pays a dividend equal to 87% of the prime interest rate. Currently, the dividend pays a rate of 10.22% per annum and the income is paid monthly.
Bloem says they are in discussion with several companies and expect to bring more investment opportunities on to their platform.
Bloem says:
We are going to be putting out more debentures, more bonds, more debt kind of instruments with more of our clients. We’ll do more equity in the next three to four months.
Tokenisation will grow over time and, while one may not need to have a deep knowledge of blockchain technology, you do need to know which platforms to trust.
There will be many scams around tokenisation and the promise of returns. All regulated crypto platforms must be licensed financial services providers, so only ever invest on a platform that is registered with the FSCA.
Also ensure that the underlying asset is legitimate and regulated.
As these instruments will be issued by a registered company – do your homework on the company and its directors.
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