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Asset-Backed Tokens: The New Dawn In CryptoCurrency

Asset-backed tokens are beginning to emerge in crypto markets and have the potential to eventually overshadow first generation cryptocurrencies like Bitcoin and Etherium. This new class of token is markedly different from its predecessors, as it is characterised by its security, stability and liquidity.  Asset-backed tokens mark a natural evolution of the blockchain, as it evolves from its roots with Bitcoin to find broader market applications.  The weaknesses of Bitcoin and other cryptocurrencies have become apparent: the lack of intrinsic value gives rise to vastly differing perceptions of its value, with naysayers saying its worth zero and supporters arguing for a million-dollar price tag, resulting in huge price swings.  This stomach-churning volatility makes most cryptocurrencies highly unpredictable, and thus poor stores of wealth for investors, and risky media of exchange for merchants.

The crypto markets are evolving away from early adopters who have low historical entry prices and, as a result, high risk tolerance: if you bought Bitcoin at $500, you may not mind the price falling from $19,000 to $7,000; you’re still sitting on a massive gain.  But the crypto markets are attracting increasing numbers of new players who are more traditional investors and market participants. They are buying in at current prices, and would not welcome a 50% fall in value.  This New Money will look more deeply into the investment merits of individual tokens, and thus have a greater appreciation for more traditional norms of value that asset-backed tokens can provide.

Hogi Hyun
D1's Hogi Hyun

The blockchain is at its heart a secure ledger, a form of accounting and reporting that offers clear visibility of historical ownership and transactions. As such, it is ideally suited for the asset management industry, which in its element consists to two ledgers: a record of investors and a record of investments. In addition, a key characteristic of the blockchain is divisibility, and this is the core concept of asset management vehicles such as funds and ETFs: an individual investor can own a small slice of a much larger portfolio that would otherwise not be obtainable.  As a result, it is only natural that the blockchain should seek an application for asset management and thus asset-back tokens. The main difference is that asset-backed tokens require a real-world back-end to acquire, manage, safe-keep and divest real world assets, while cryptocurrencies that lack intrinsic value, utility tokens and security tokens do not require the same degree of accuracy, care and diligence.

To date, the big success story in asset-backed tokens is Tether, which is a token backed $1 for $1 by U.S. Dollars. From its launch in May 2015 the market cap has grown from USD 250,000 to USD 2.5 billion. More importantly, its daily trading liquidity as of 21 May is USD 2.5 billion, a whopping 100% of its market capitalization.  Bitcoin, in contrast, has a much larger market capitalization of USD 145 billion, but its daily trading volume is only USD 5.3 billion, 3.6% of its market capitalization.  The same is true for Etherium and Ripple, which have trading volume/market capitalisation ratios of 3.1% and 1.0% respectively. And Tether remains wildly popular with investors as a stable token despite the fact that the token is surrounded in controversy, as it is supported and possibly controlled by Bitfinex, the largest Bitcoin exchange in the world by volume, and lacks transparency and audits on the amount and location of the underlying U.S. Dollars it is supposed to be holding.

In addition to the primary trading liquidity provided by asset-backed tokens like Tether, there is also a second form of liquidity that these types of tokens carry – physical liquidity derived from cashing out.  Let’s take the example of D1 Coin, a diamond-backed token that we are working on launching shortly.  An investor in D1 can select diamonds from the asset pool and exchange D1 Coins for physical diamonds. While the primary purpose of D1 Coin is to offer exposure to diamonds as an asset class, the fact that token holders can exchange for physical diamonds gives the token an underlying price support: if the price of D1 falls below the value of the diamonds, token holders will take advantage of the arbitrage and exchange their tokens for diamonds.  The same would hold true for other tokens backed by other assets.

Key success factors for asset-backed tokens will reside primarily on the back-end operations, as token holders will gravitate towards tokens with proven assets, transparent valuations, regular audits, experienced managers and reliable custodians.

We are seeing green shoots in the asset-backed token market, as players test the waters with a variety of assets, from commodities to securities, and a sprinkling of real assets like property. Expect more to come, as demand picks up from New Money entering the crypto market, and from early Bitcoin buyers who start to seek a little bit of hedging and healthy diversification.

Hogi Hyun is a Director at D1 Mint