Over the last decade, consumer technology and the sharing economy has revolutionized almost every aspect of our lives. It has changed the way we travel, shop, interact with our friends and even date. Millennials have come to expect immediacy and sharing of experiences, including in their financial investments. As a venture capitalist during this time period, I’ve watched and invested in startups focused on disrupting their analog predecessors and provide the best on-demand service at fractions of the costs. While there have been major innovations in peer-to-peer and mobile payments, particularly in the emerging world, traditional finance has largely avoided total industry disruption — until now. With half of the world’s population under 30 years of age and the number of under 35 millionaires at an all-time high, financial services companies are going to be dealing with a lot of customers who do not understand why their money is ‘locked-up’ in a fund for a decade or why their home can’t be fractionally sold.
Blockchain technology, and the digitization of shares (also referred to as tokenization) is enabling this type of user experience. By digitizing an asset, and using a smart contract to automatically enforce the rules and regulations of that asset, owners are able to sell shares of private securities on SEC complaint exchanges on-demand In financial terms, we refer to this ease of creating a transaction as ‘liquidity’. In millennial terms, we might describe this feature as swiping left, unsubscribing and utilizing free e-commerce returns.
Disruption in startup investing already began with crowdfunding. The whole point of crowdfunding was to make access to the best deals available to a far wider audience. This it did. However, it fell short in aiming to address the inherent portfolio approach of a fund where you can spread risk across multiple portfolio companies, and it did not address the lack of liquidity. The digitization of funds is the next evolution of that vision, with professional investors at the helm doing deeper due diligence than what users can read on crowdfunding websites. The other advantage of these funds over crowdfunding is that you can get involved with later rounds of funding, since crowdfunding is usually focused only on seed stage.
This is transformative because trillions of dollars worth of the world’s assets do not have a liquidity feature, and as a result, they are bought or sold at a discount because transactions are done ad-hoc without global, highly accessible marketplaces. For instance, private equity and venture capital funds have typical lockup periods of 10 years or more because they wait for their portfolio companies to return and reserve funding for follow on rounds. If an investor wants to exit a fund interest, they find an intermediary, who then finds a buyer if they can.
The nature of private equity and venture capital requires fund managers to have the ability to operate with a high degree of autonomy from their investors.. The fact that the fund is digitized has nothing to do with the fund investment thesis and the level of risks the fund will assume in its investments. A digitized fund has more freedom to operate than a traditional fund. The fact that your investors have liquidity, allows you to take a much longer term view, if needed, in an investment since the pressure for liquidity of the LP interests is not there anymore. They can exit when they want to and sell their interest on a SEC compliant secondary exchange. If anything, liquidity can improve returns. First, you can exit the fund after, let’s say, 3–4 years rather than 9–10 greatly increasing your internal rate of return if the net asset value has grown sufficiently by reducing the investment period. Second, liquidity has a premium (the same way that illiquidity has a penalty) in terms of price so a liquid fund should actually be more valuable.
Some traditional VC investors are driving the ball forward in this arena. Rob Nance and Jon Avidor of CityBlock Capital recently told me about their NYCQ project – a digitized venture fund making equity investments into companies building the infrastructure for digital assets. As meta as this sounds, it struck me as one of the smartest applications of blockchain technology that I’ve seen, and one that also gives retail investors the chance to make a bet on the use of blockchain to tokenize legacy assets.
CityBlock sells shares of the NYCQ fund on their website and allocates the capital it to proven investors with track records of profitable exits. The value of the shares will change as the underlying equity holdings of the fund changes. It’s a diversified portfolio of equity in companies that are upending traditional finance, and it’s liquid. The company thinks of itself as the Airbnb or Uber of venture capital – an investment firm for the digital age focused on removing user friction and creating hyper-efficiency. Managing Partner Rob Nance said “What we learned from Bitcoin and altcoins is that the there is pent up demand for liquid digital assets. Digital tokens shares can be cashed out much faster and more easily than conventional paper shares because there are significantly fewer layers between buyers and sellers.”
Other players in this space include Blockchain Capital, SPiCE VC, and Science Blockchain, who have all successfully issued digital shares in their venture funds and those shares are preparing to trade on regulated exchanges. In the very near future more funds will provide liquidity as a competitive advantage. Ultimately, we may look back at the days where our financial portfolios were tied up in illiquid investments and consider this as old school as the Blackberry.
Article first appeared August 16, 2018 on Forbes.com.
