A Taxonomy for Understanding Tokenized Illiquid Assets and Security Tokens
I have been doing some work and thinking in the security tokens space recently and I found it incredibly fascinating. The increasing popularity of security tokens is partially being driven by another trend: the tokenization of illiquid assets. Crypto purist will argue that from houses to public equities every asset in the world will be eventually tokenized. From that point of view, the vast majority of tokens that represent illiquid assets are likely to be classified as a securities by different regulatory arms which have triggered a frenzy towards building platforms that can better support the issuance and trading of security tokens. If you would like to understand more about the tokenization of illiquid assets and security tokens, I recommend this phenomenal article by University of Oregon professor Stephen McKeon
Talking to a dear friend and a thought leader in the crypto space over the weekend we sort of arrived to the conclusion that there is a lot of confusion surrounding the asset tokenization space and that the theory and rules of the market are still to be written. In that sense, I decided to start writing a series of articles that detail some of my ideas about security tokens and tokenized assets that can, hopefully, help with the debate.
A good way to start understanding tokenized assets is by analyzing its different forms and variations. In my opinion, part of the confusion in the market is due to the fact that most people talk about tokenized illiquid asset in very generic terms without real financial or mathematical rigor behind it. When you start diving into the space, you quickly realize that not all tokenized assets are equal from an investment perspective.
There are several ways to classify tokenized illiquid assets, a taxonomy that I find efficient is factoring in both the appreciation of the underlying asset as well as the ability of pay a regular dividend to token holder. From that perspective, some tokenized products are better equipped to generate a regular dividend while others appreciate better over time. The following diagram helps to illustrate that concept.
Following the concepts illustrated in the previous figure, we can segment the world to tokenized assets and security tokens into several key categories.
Dividend Generating Security Tokens
In this category we can place security tokens that generate regular dividend payments to token holders. This type of tokens typically leverage protocols in which token holders need to regularly redeem part of the tokens in order to receive a regular dividend. Larger payments are issued to token holders in cases on which underlying asset is sold or another large liquidity event takes place.
Value Appreciation Security Tokens
In this group we can place assets that don’t typically generate a regular dividend but their value needs to appreciate over time. Security tokens that follow this model need to rely on protocols that carefully correlate the value of the underlying asset with the value of the token holdings. Tokens that represent shares of private companies, art of diamonds are examples of products in this category.
Hybrid Dividend-Value Security Tokens
There are security token models that can represent a combination of dividend-generating assets and value appreciation assets. Token holders that invest in this type of security token can receive a regular dividend while still have a participation in the equity generated by the underlying asset.
Uni-Class vs. Multi-Class Security Tokens
Most security tokens in the market are correlated to a specific asset class such as art of real estate. In the future, it is conceivable that we will see security tokens that represent multiple asset class that hedge each other under specific market conditions.
Single-Asset vs. Multi-Asset Security Tokens
Many of the initial efforts in the security token space have focused on tokenizing individual assets such as a painting or a real estate property. In that model, the asset owner will receive tokens that are the equivalent of the valuation of the underlying asset. Without getting into the benefits or challenges of that model, it is important to know that there are alternatives in the market. Security tokens can represent a pool of assets that trade as a single crypto unit. This model follows some of the principles of passive investment vehicles in public markets.
