2 NFT or not 2 NFT
Tools for thriving in the Intangibles Economy - Part I
Value in the Era of Intangibles
Today intangibles constitute over $25 trillion of market value and represent almost 90% of the net worth of Fortune 1000 companies. This figure has grown steadily since the ‘70s as the network effects from intangible assets began to grow exponentially driving attendant returns for such intangible rights as brand, reputation, and intellectual property. Together with other forms of so called “alternative assets” such as real estate, mined materials (including their extraction rights), fine art, music rights, carbon credits, data rights, and even productive capacity, these assets have typically had liquidity challenges, been hard to value and authenticate, and had price dynamics that are “hidden”. As a result, they have been accessible for investment to just the wealthiest 1% of humanity.
Tokenization opens the possibility to democratize ownership of alternative assets while benefiting the cooperating token holders. As the creative industries flourish in the post-pandemic era and more creators rely on incomes from their creative assets, the need to develop new financial instruments, trading systems, and risk cover for such alternative assets is going to become a societal imperative.
The chart below contrasts ecosystems based on the emerging “Intangibles Economy” of asset-linked tokens and contrasts it with traditional economic structures based on ownership-linked shares:
Much as software tools revolutionized infrastructure for equity and debt market transactions, we expect that token market data, analytics, software tools, optimization algorithms, and trading systems will usher in new financial instruments, hedging, and transaction strategies for tokens.
Here are three illustrative examples:
(Semi) Fungible Fashionistas
Before the pandemic, Lorna was a quant at a major investment bank. Even though she labored under the stresses of bosses who worked aspiring fund managers to a bone, the “chin-up-soldier-on” discipline -- that had been inculcated starting at her private boarding school and that had helped her overcome the rigors of an MSc in Physics at Imperial College -- continued to pay dividends as she worked through the demands of tuning hedging strategies in choppy markets.
But something changed with the pandemic. Forced to hunker down in her one-bedroom flat near London’s formerly bustling Canary Wharf area, Lorna began to take longer breaks during her workdays as trading activities slowed from their frenetic pace. She began to dabble again in fashion design - an avocation for which she previously had little time.
Soon she realized that by creating fashions for characters in digital gaming platforms she could escape the strains of the pandemic. What she hadn’t expected was that she could monetize her designs for the sword sheath worn by a villainous king or for the shoes worn by the femme fatale characters in warcraft and other gaming genres! She opted to join the fast-growing legions of creators unleashed by the pandemic’s vortex.
After becoming vaccinated Lorna decided to join the Great Resignation and take the plunge to become a gaming fashion creator. However, water does find its own level and Lorna realized she missed the quantitative dimensions of her past life. So, she sought to extend her newfound vocation by also serving as a “Token Designer” to a digital fashion company that was operationalizing asset-backed tokens as part of a fashion supply chain.
Lorna’s days now started by formulating how a range of fashion accessories could be pieced together through semi-fungible tokens that represented components such as particular fabrics or certain branded merchandise. A digital Gucci buckle could be combined with pashmina cloth to create a loose-fitting tunic for a gaming hero; a Takashi Murakami installation from the ‘90s could become the inspiration for “Project Ko” tokens that were tradeable on various NFT manga sites.
Trading Songs as Stocks
If a music distributor could tokenize rights to the lyrics and songs from its stable of music artists to generate cash flows that are not exposed to the convoluted cycle of payments in that industry, it could gain more resources to back emerging talent and enhance its competitive advantage. Token holders get participation in the music distributor’s incomes from licensing its catalog. This can enable participation in the long tail incomes that some rights can generate.
By tweaking smart contracts, such participation could extend to revenues from, say, merchandising or from the release of a song in new formats (as a soundtrack for, say, a movie or a game). Because such future benefits are smart contract driven, they could be customized to trigger in certain situations (such as the negotiation of a contract for remixing the music in another language).
Accordingly, such incomes can provide effective hedges in certain diversification strategies. As a result, a market maker bundling music tokens may be willing to offer financial terms that are more cost effective than a lender underwriting a factoring line against accounts receivable.
Funding Farmers through Crop Tokens
By working with farmers and crop data gleaned through IoT and related instrumentation systems, it is possible to create yield models for agricultural produce and tokenize assets and derivative securities built on the expected yields of soy, corn, rice and other agricultural staples. Farmers gain cash for investing in innovations (such as vertical farms, new seed hybrids, …) without having to raise capital through debt or equity offerings. Token holders gain opportunities to participate “directly” in the revenue stream and contracts for projected gains from increased investment in farming automation or crop traits that may be offered by a particular token issuer. These are distinct from shareholders who are exposed to market risks, operating leverage, dividend policy, and other factors that can influence share price.
A representative data feed of tokenized exchanges from the near future for rice farmers in California and South Korea might look as follows:
The Profits and Pitfalls of Tokens
These examples illustrate the ecosystem benefits of tokenizing alternative assets --democratized access for investors to a more diversified portfolio of asset classes; liquidity for creators and producers; and fair, transparent exchanges for all. Such benefits could be designed to extend far beyond the patronage of a particular artist or the token community around a corporate entity. For example, carbon credits and offsets or social impact contributions can be programmed to trigger when, say, the token velocity or other parameters reach certain thresholds. These benefits offer a new dawn for cooperatives that can combine and distribute equitable incomes. For example, an architects’ collective monetizing the designs of its members or a co-op of aerospace parts producers creating liquidity for 3D printing capacity can find market makers who would be willing to underwrite new financial instruments that link their assets to token ecosystems. [In other articles in this collection I have written about the emergence and value of such co-ops.]
Generating such bundles of rights and royalties that can be securitized has long been the domain of pure play companies such as Royalty Pharma [Nasdaq: RPRX] which went public last year and has a market cap of around $25B. With tokenization, numerous other companies with robust innovation portfolios will be able to turn to market makers who specialize in building decentralized token economies for accessing pools of investors interested in participating in their innovation streams.
Of course, tokens — even those associated with such “captive” asset-backed ecosystems — come with risks particular to cryptocurrency systems too. Most notably, they are susceptible to malicious attacks from “rogue” agents. This requires meticulous designs of incentives to pre-empt attacks and bounties that reward collective action against infringement and malicious behaviors.
In part 2 of this series, I’ll elaborate further on this dynamic between the value that NFTs and tokenization can unlock and the potential disruption they can also unleash. Somewhat tongue in cheek, to NFT or not to NFT is going to be the quest for the coming 5 years and beyond!
Raj Malhotra is Founder and CEO of Inventrust which combines AI smarts and human expertise to deliver transparent, objective, and thorough appraisals of digital assets. Using Inventrust’s infrastructure, buyers and sellers can have assets appraised through fair and transparent expert vetting for quality, price, and value. Marketplaces also embed Inventrust APIs to appraise listed assets and provide such analytics and insights to clients and subscribers. The Company is presently engaging with flagship customers and sponsors in industries ranging from financial services to innovation, including influential financial services groups, leading stock exchanges, insurance, and industrial enterprises.
The writer wishes to acknowledge contributions to this article from conversations with John Young, Pete Swearengen, Sekhar Serukkai, Charles Cella, and Lou Kerner and inspiration from conferences at Diffusion Digital ’21 hosted by Jamie Burke, Andrew Keys, among others