How tokenised ‘toys’ could change investing

Tokenization and Non Fungible Tokens (“NFTs”) have the potential to grow the investible universe of investable assets exponentially, but there will be a need to be wary on the way there.

So what are Non Fungible Tokens?

An asset that is “fungible” is something that is identical and interchangeable with another similar item. For example, a $1 bill is fungible with other $1 bills. One bitcoin is fungible with another bitcoin – trade one for and you’ll have exactly the same thing.
 

Something that’s “non-fungible” means that it’s unique and can’t be replaced with something else. A simple example of this is a rare piece of art – trade it for another piece of art or money and you’ll have something completely different.
 

As such, a non-fungible token is a unique, digital asset that is stored on the blockchain, with the blockchain serving as the system of record as to who owns the asset. Interestingly, this opens up the potential for a new world of digital assets that previously has not existed before.
 

Just a toy, for now…

In his blog ‘The next big thing will start out looking like a toy’, entrepreneur Chris Dixon, Partner at Andressen Horowitz,  highlights late Harvard Business School professor Clayton Christensen’s disruptive technology theory, noting that new technologies are often dismissed as “toys”. These technologies undershoot users’ needs initially, but become more valuable as their functionality improves.
 

NFTs and tokenization could be considered a ‘toy’. But the technology has many potential uses in the long term, even if some of them are not yet obvious. As revenue models become increasingly decentralised, value is moving from aggregators of content – music platforms such as Spotify – to recording artists and other creators of content. This could have significant implications for investing.

Not all NFTs have value

We had an interesting experiment of our own over the Holiday period. We ran our usual Holiday quiz (a match the baby-photo competition, if you were wondering). We mixed it up with our choice of prize: the winner could opt for a paper copy of a specially commissioned research report or for that report to be turned into an NFT.
 

The winner chose to have their report turned into an NFT, and we found that interesting for a couple of reasons. Firstly, electronically, there is little difference between a PDF of the report and a tokenised version in terms of how it is distributed.
 

However, through another lens, the winner was being smart. It cost me money to turn it into an NFT and once in NFT form there is chance that somebody else will ascribe value to it as a 1 of a kind asset and seek to own it.
 

In a real world sense there is probably no value in this as an NFT. Not because of its content – which was very good – but market dynamics. Interested parties do not need to possess the NFT to read the report and will probably ascribe no value to having the original.
 

It’s an interesting example to keep in mind when you look at the media buzz around non-fungible tokens (NFTs). An ever-greater range of NFTs are emerging for a widening range of purposes and, while many are targeted at the retail market, institutional investors are starting to sit up and take note.
 

The digital assets market is already valued in trillions and tokenization is likely to be a key investment theme in the coming years. NFTs are already enabling more direct relationships between creators and consumers.
 

Tokenization and NFTs are nascent technologies, so there are good reasons to remain cautious. Nevertheless, it is such a fascinating and innovative part of the market and our clients are asking how these technologies can be used in providing access to asset classes.
 

Unlike cryptocurrencies such as Bitcoin or Ethereum, each NFT is unique. In the collectables market it is likely that it is this scarcity that appeals to investors. Leonardo da Vinci’s Mona Lisa is worth hundreds of millions of dollars because of its scarcity. A perfect replica could be created, perhaps even printed from a data file, but it would not have the scarcity of the original in the Louvre. The same principle could hold true for NFTs – if you ascribe value to the asset in the first place.

Challenges and opportunities

Tokenization could have a considerable impact on the fundamentals of investing and new opportunities are likely to arise. The market for NFTs is currently dominated by digital art and collectables – but tokenization could make it easier to trade private market assets than through existing limited partnership arrangements.
 

There are still challenges to be overcome, particularly when it comes to regulation. For example, the blockchain element of tokenised assets – which can record all transactions within a chain – does not solve the problem of KYC or anti-money laundering regulations. Likewise, the considerable attention paid to NFTs in recent years, combined with rapid rises in valuations, raises concerns over whether the market has become overhyped.
 

We believe this could be a significant development in the evolution of markets. Tokenization is likely to play a big role in investing in the coming years – in terms of investment rationale and the democratisation of markets. But it is still at a very early stage.
 

As new technologies emerge, it can be difficult to both understand them and to envisage how they can change our lives. A fantastic example of this is Bill Gates explaining the internet to David Letterman in 1995. In those early days, it’s clear that not even Gates fully knew how the internet story would play out in the fullness of time.
 

In a similar vein, we will continue to monitor and react to developments in areas such as decentralised finance and help institutional investors to navigate the opportunities in this space.