As Blockchain technology gains widespread, real world adoption, we will see significant changes in many industries, including how investors buy and sell assets. Specifically, Blockchain allows for tokenization-- turning anything of real value into a tradable asset by creating a digital unit of ownership known as a security token. Tokenization of traditional assets offers several potential benefits: greater liquidity to asset owners, 24/7 markets, lower transactions costs, fractional ownership, automated and quicker settlement, improved compliance checks, and intriguing possibilities with smart security contracts. One industry that stands to benefit significantly from tokens is venture capital.
Cryptocurrency and Blockchain make it cost effective to securitize or tokenize common assets. Venture capital funds have been notoriously illiquid as investors must wait many years before they see a return. A tokenized venture capital fund could allow investors to purchase fractional portions of the portfolio and sell those investments much faster than traditional funds. As a result, more people can participate in this asset category because funds would not lock up their money for the historical 5 to 10-year horizon.
CityBlock Capital is a venture capital firm connecting traditional venture capital with Blockchain technology. The company recently launched its first tokenized venture fund – the “NYCQ fund,” which exclusively makes investments in early-stage Blockchain infrastructure companies which CityBlock believes will replace the technology platforms behind capital markets. All NYCQ investments are either equity or digital equity; the fund will not invest in protocols or cryptocurrency. The NYCQ’s investment team is headed by industy veterans Nikhil Kalghatgi and Ateet Ahluwalia, who boast decades of experience in investments and asset management. The two men also respectively serve as Partner and Managing Director of CoVenture Crypto, a multi-strategy cryptocurrency asset management firm backed by Softbank. The firm is helping build key components of tokenized finance including a cryptocurrency index fund designed to make it easy for more traditional investors to gain exposure to top digital assets.
The funds’ investments illustrates its desire to operate at the intersection of capital markets and Blockchain. CityBlock believes the next evolution of capital markets will occur on the back of Blockchain and is investing in companies developing such technology. Thus, the NYCQ Fund is targeting the $160 billion in annual revenue generated by companies that currently make such infrastructure for the financial services industry. The equity piece of the equation is critical to CityBlock’s value proposition. Whereas current existing Blockchain-focused funds include some exposure to cryptocurrencies, the NYCQ will not invest in these assets. So NYCQ investors can access the Blockchain ecosystem without the risk of cryptocurrencies and their volatility. The fund is planning to invest in startups focused on products using Blockchain technology applied towards following functions within the capital markets supply chain:
CityBlock operates in a relatively nascent space with limited directly comparable funds. Two tokenized funds currently exist – SPiCE VC and Blockchain Capital, whose BCAP token has already begun trading on limited exchanges.
As the industry grows, we expect more tokenized funds to emerge. For example, ICONOMI and Taas are two projects both attempting to digitize shares in private equity funds. However, we have not grouped them with BCAP and SPiCE because we’re not sure if these projects actually issued security tokens.
Taas, a hedge-fund focused on trading cryptocurrencies, raised over $7 million in their 2017 initial token sale but like ICONOMI, the tokens’ legal status is not clear.
In theory, investors face risks from both the venture capital side of the token, as well as the technology-specific side. Since the tokens’ value should fundamentally reflect the performance of the underlying portfolio companies, a stumble at any one of these firms could, in theory, reduce the net asset value (NAV) of the entire portfolio. The token would thus command a lower price. Furthermore, we haven’t as yet witnessed complete lifecycles of venture capital funds focused on Blockchain technology. Effectively, there would a risk associated with investing in a new asset category or a new class of investments.
From a technology perspective, tokens would require a compliant and secure trading exchange to facilitate secondary trading. And without exchanges, investors will see a lot less liquidity for their tokens, which was the technology’s primary purpose in the first place. Additionally, market volatility and pricing pressure in cryptocurrencies could affect fundamentals of underlying portfolio companies, which in turn would create headwinds for the NAV appreciation.
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