The challenge
As a portfolio manager, it's always been a challenge to keep up with the ever-evolving financial landscape. With blockchain tokenization, the hedge fund industry is on the brink of a major transformation. This innovative technology has the potential to streamline portfolio management, enhance liquidity and transparency, and open up new investment opportunities.
Here's a guide on how portfolio managers can leverage the power of blockchain tokenization in their business.
What is Blockchain Tokenization?
Tokenization refers to the process of converting real-world assets into digital tokens that can be traded on a blockchain network. These tokens can represent ownership rights in a variety of assets such as real estate, art, commodities, and even stocks.
By tokenizing assets, blockchain enables fractional ownership and efficient transfer of ownership rights, thus reducing barriers to investment and making it possible for a wider range of investors to participate.
Benefits of Tokenization
Enhanced Liquidity: Tokenization makes it possible to trade assets in real-time, 24/7, reducing the time it takes to complete transactions and increasing liquidity. This can be especially beneficial for hedge funds, which often hold illiquid assets that can be difficult to trade.
Improved Transparency: Tokenized assets are stored on a blockchain network, which provides an immutable and transparent ledger of transactions. This enhances transparency and reduces the risk of fraud and manipulation, making it easier for portfolio managers to monitor their investments and make informed decisions.
Diversification: Tokenization opens up new investment opportunities, enabling portfolio managers to diversify their portfolios beyond traditional assets. This can lead to greater returns and reduced risk, as well as provide new investment opportunities for their clients.
Cost-effective: Tokenization eliminates the need for intermediaries, reducing transaction costs and increasing efficiency. This can help hedge funds to maximize returns for their clients and increase their competitiveness in the market.
What can we tokenize?
Hedge funds can tokenize a variety of assets, including:
Real estate: Tokenizing real estate assets allows hedge funds to fractionalize ownership and sell pieces of property to multiple buyers, making it more accessible for investors.
Stocks and bonds: Tokenizing stocks and bonds can simplify the process of investing in these assets and provide more transparency and accessibility to a wider range of investors.
Commodities: Tokenizing commodities, such as gold or silver, allows hedge funds to offer fractional ownership in these assets, making them more accessible to smaller investors.
Art: Tokenizing art assets can help hedge funds provide a secure, transparent platform for investing in this high-value asset class.
Intellectual property: Tokenizing intellectual property assets, such as patents and copyrights, allows hedge funds to provide a platform for investing in these intangible assets.
Collectibles: Tokenizing collectible assets, such as rare coins or stamps, provides a secure and transparent platform for investing in these unique assets.
How to digitalize any financial instrument?
Traditional financial instruments, such as stocks, bonds, and real estate, are being transformed into digital assets that can be traded and settled on a secure and transparent platform.
So, how does it all work?
The process of digitalizing financial instruments involves several steps, starting with tokenization. This is the process of creating a digital representation of the financial instrument, where the ownership rights are encoded into a digital token on a blockchain (by created smart contract).
Next, a smart contract is implemented to automate the transfer of ownership and settlement of trades. Smart contracts are self-executing programs that enforce the terms of the financial instrument and ensure that trades are settled in a timely and efficient manner.
Once the digital representation of the financial instrument is created, a security token offering (STO) can be conducted. An STO is a fundraising event where investors purchase the security tokens being offered. The STO is typically conducted through a platform that complies with the relevant regulations and provides a secure and transparent platform for the sale of the tokens.
If the security tokens being offered are considered securities, they must be registered with the SEC in accordance with the Securities Act of 1933 and the Securities Exchange Act of 1934. This involves submitting a prospectus, offering documents, and other required disclosures to the SEC.
Once the STO is completed, the ownership of the security tokens will be transferred to the investors who purchased them. The tokens can then be traded on various secondary market platforms, allowing investors to sell or buy the tokens as they see fit.
However, it is important to understand the regulations and requirements involved in the process and to work with experienced legal and compliance professionals to ensure a successful digitization. The future of finance is digital, and the opportunities are endless.
What are current blockchain regulations [2023]?
In the United States, the regulation of tokenized assets is still evolving and largely depends on the type of asset being tokenized and the manner in which it is being sold. Currently, the primary regulatory bodies involved in the regulation of tokenized assets are the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).
For security tokens, which represent ownership in a company or an investment contract, the SEC applies federal securities laws, such as the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require companies to register their offerings with the SEC and provide potential investors with information about the investment, including financial statements and disclosures.
For commodity tokens, which represent ownership in a tangible asset such as real estate or commodities, the CFTC may apply the Commodity Exchange Act. This act governs the trading of commodity futures and options and is designed to protect market participants from fraudulent or manipulative practices.
It is important to note that the regulation of tokenized assets is still in its early stages, and new guidance and rules are being developed by the SEC and CFTC on a continuous basis. As a result, companies looking to tokenize assets in the US should consult with legal and compliance experts to ensure they are in compliance with all applicable laws and regulations.
How Goldman Sachs and JPMorgan Chase are Implementing Asset Tokenization and Blockchain Technology
These companies are two of the largest financial institutions in the United States, and both have been actively exploring and implementing blockchain technology and asset tokenization.
Goldman Sachs has been experimenting with tokenization in various forms, including the creation of digital securities and commodities. The bank has been working on a project to tokenize physical gold, making it more accessible to a wider range of investors. By tokenizing gold, Goldman Sachs aims to provide its clients with the ability to trade and settle gold transactions in real-time, thereby increasing efficiency and reducing costs.
JPMorgan, on the other hand, has been exploring the use of blockchain technology and tokenization in various areas, including payments and securities. In 2019, JPMorgan launched its digital asset platform, "JPM Coin," which is a stablecoin pegged to the US dollar. The aim of JPM Coin is to provide clients with faster and more efficient payments, as well as streamline the settlement process. JPMorgan is also looking into tokenizing other types of assets, such as real estate, and is working on developing a platform that will allow clients to trade and settle real estate transactions in a secure and efficient manner.
How to Get Started with Tokenization in Hedge Funds
Develop a Clear Understanding of Blockchain Technology: It's important for portfolio managers to familiarize themselves with the basics of blockchain technology, including how it works, its benefits, and its limitations. Good idea is to find a blockchain agency/consultant who can help navigate in this new world.
Partner with a Tokenization Platform or create your own: The easiest way to get started with tokenization, portfolio managers need to partner with a tokenization platform that can help them tokenize their assets and trade them on a blockchain network. It's important to choose a platform that is secure, reliable, and has a proven track record. Here is an example of company from New York which have complete toolbox for assets tokenization: https://www.digitalasset.com/ Evaluate the Feasibility of Tokenization: Not all assets can be tokenized, and it's important for portfolio managers to evaluate the feasibility of tokenizing their assets based on factors such as regulatory requirements, market demand, and liquidity. Build a Tokenized Portfolio: Once the feasibility of tokenization has been determined, portfolio managers can start building a tokenized portfolio by selecting the assets they wish to tokenize and then listing them on a blockchain network.
Example of asset tokenization (Solidity smart contract ready to use)
First step - create a blockchain smart contract.
What is smart contract?
A smart contract is a self-executing digital contract with the terms of the agreement between buyer and seller being directly written into lines of code. Smart contracts are stored on the blockchain and are automatically executed when certain conditions are met, eliminating the need for intermediaries such as lawyers or banks.
Smart contracts can be used for a variety of purposes, including tokenization, supply chain management, voting systems, and more. They provide a secure, transparent, and tamper-proof platform for executing transactions, making them a popular choice for businesses looking to streamline processes and reduce costs.
Smart contracts are powered by code and operate under pre-defined rules and regulations set out in the contract. Once the terms of the contract are met, the code is automatically executed and the transaction is completed. This eliminates the risk of fraud, censorship, or downtime, and ensures that all parties are held accountable to the terms of the agreement.
What functions has smart contract?
The process of tokenizing real estate and selling it to multiple buyers involves several steps, which are executed through the use of the smart contract:
- Initialization: The hedge fund that owns the real estate asset would initialize the smart contract by deploying it on the blockchain. This creates the contract and its functions, making it available for use.
- Tokenizing the Asset: The hedge fund would use the
tokenizeAssetfunction in the smart contract to tokenize the real estate asset. This function would store the asset's information, including its ID of real estate and value od the asset, on the blockchain. The function would also increment thetotalSupplyby 100, representing 100% ownership of the asset. - Dividing Ownership: The hedge fund would use the
transferOwnershipfunction in the smart contract to divide ownership of the asset among multiple buyers. This function allows the hedge fund to specify the ownership percentage for each buyer, allowing for fractional ownership of the asset. The ownership information is stored in theassetsOfmapping, which maps each address to an array of assets that the address owns. - Selling the Tokens: The hedge fund would then sell the tokens representing the ownership of the real estate asset to interested buyers. These tokens can be bought and sold on a token exchange, allowing for a secondary market to exist for the asset.
- Transferring Ownership: If a buyer wants to transfer ownership of their share of the asset, they can use the
transferOwnershipfunction in the smart contract to transfer their ownership to another buyer. This function allows for the seamless transfer of ownership without the need for intermediaries, making the process fast and efficient. - Retrieving Information: Buyers can use the
getOwnershipPercentagefunction in the smart contract to retrieve information about their ownership percentage for a specific asset. They can also view theassetsOfmapping to see all of the assets they own.
By using the smart contract, the tokenization process is automated, secure, and transparent. Buyers and sellers can have peace of mind knowing that the ownership information is stored on the blockchain and can be easily retrieved at any time.
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Example of smart contract that tokenize real estate, ready to reuse.
pragma solidity ^0.8.0;
contract RealEstateToken {
// Event for asset tokenization
event AssetTokenized(string assetId, uint256 assetValue);
// Asset information
struct Asset {
string id;
uint256 value;
uint256 ownershipPercentage;
}
// Mapping of assets to owners
mapping (address => Asset[]) public assetsOf;
// Total supply of tokens
uint256 public totalSupply;
// Get the ownership percentage of an asset
function getOwnershipPercentage(address _owner, string _assetId) public view returns (uint256) {
for (uint256 i = 0; i < assetsOf[_owner].length; i++) {
if (assetsOf[_owner][i].id == _assetId) {
return assetsOf[_owner][i].ownershipPercentage;
}
}
return 0;
}
// Tokenize an asset
function tokenizeAsset(string _assetId, uint256 _assetValue) public {
// Check if asset already exists
for (uint256 i = 0; i < assetsOf[msg.sender].length; i++) {
if (assetsOf[msg.sender][i].id == _assetId) {
revert("Asset already exists");
}
}
// Tokenize the asset
Asset memory newAsset = Asset({
id: _assetId,
value: _assetValue,
ownershipPercentage: 100
});
assetsOf[msg.sender].push(newAsset);
totalSupply += 100;
emit AssetTokenized(_assetId, _assetValue);
}
// Transfer ownership of an asset
function transferOwnership(address _to, string _assetId, uint256 _ownershipPercentage) public {
// Check if sender is the owner of the asset
uint256 senderAssetIndex;
for (uint256 i = 0; i < assetsOf[msg.sender].length; i++) {
if (assetsOf[msg.sender][i].id == _assetId) {
senderAssetIndex = i;
break;
}
}
if (senderAssetIndex == 0) {
revert("Sender is not the owner of the asset");
}
// Check if the ownership percentage is valid
if (_ownershipPercentage > assetsOf[msg.sender][senderAssetIndex].ownershipPercentage) {
revert("Ownership percentage is greater than sender's ownership percentage");
}
// Transfer ownership
Asset memory transferAsset = Asset({
id: _assetId,
value: assetsOf[msg.sender][senderAssetIndex].value,
ownershipPercentage: _ownershipPercentage
});
assetsOf[msg.sender][senderAssetIndex].ownershipPercentage -= _ownershipPercentage;
assetsOf[_to].push(transferAsset);
}
}