A Novel Approach to Democratize Alternative Investment

How blockchain could transform retail money into a new pool of capital

Photo by Stanislaw Zarychta on Unsplash

In a world where a low-interest rate is so prevalent, everyone is hungry for a higher yield. Recent data released by Chartered Alternative Investment Analyst Association has revealed around 12% of worldwide investments were allocated to alternative asset classes in the last two decades. This number is expected to go up even higher to 24% by 2023.

An asset class is considered an alternative investment if it falls in the realm of investment outside the publicly traded securities. It could be hedge funds, private equities, private commercial real estate, or even natural resources partnerships. An investment strategy that put high allocation to this type of asset class was popularized by David Swensen, an investment manager who ran Yale University endowment fund.

Despite its captivating nature and promise of low correlation with the public asset class, alternative investment remains elusive to this day. It is still characterized by illiquid nature, less accessible, and less transparent. Limiting the potential investor base and prohibiting retail investors to participate.

The landscape, though, could change in the near future, as a tech-enabled mechanism to promote the democratization of alternative investment has gained traction in some parts of the world.

A recent paper co-authored by BNP Paribas, CAIA, and Liquefy, has explored the possibility of creating a digital representation of non-digital assets on a blockchain, a process famously called tokenization. It’s a game-changing approach that can bring benefits to both investors and fund managers of alternative assets.

Photo by ZSun Fu on Unsplash

In the blockchain world, tokenization is a common term. It refers to a mechanism where some form of physical (and non-physical assets) be converted into “tokens” that can be moved, stored, and recorded on a blockchain. Tokenization of alternative investment is a great leap as the burdensome characteristics associated with an alternative investment such as difficult to transfer and daunting to track can be eliminated.

From the four benefits of tokenization highlighted by the paper, there are two most standout advantages that the author thinks will give the utmost impact. Firstly, tokenization could address the inherent challenges of illiquidity, provided the fact that the secondary markets for trading are established already. Secondly, tokenization could make alternative asset classes more divisible, which will reduce the price per unit and making those asset classes more affordable to less sophisticated investors.

Despite these benefits, some challenges remain looming as some alternative assets are not easily scalable to be tokenized. For instance, in the area of hedge funds, where a sizeable number of assets are needed to create a portfolio of diversification. Otherwise, the trap of under-diversification could prove to be a hurdle.

Furthermore, greater liquidity enabled by tokenization may not directly translate into a higher return. As some types of alternative investments, such as private equities, are traditionally generating value via market inefficiencies captured in the illiquidity premium.

Nevertheless, the path of tokenization is worth trying with some strings attached. First, a strongly regulated secondary market must be established, to ensure clear exit strategies especially for retail investors. Second, investor education must be emphasized, again, this is to ensure retail investors who are usually less sophisticated can understand and quantify the risk.

To conclude, tokenization could transform retail capital into a new essential pool of capital that suffice to power the financing necessity of private markets. After all, with global debt kept rising and the world is faced with the potential of a weaker economy, traditional sources of capital may no longer be enough to keep pace with growing demand.


A Novel Approach to Democratize Alternative Investment was originally published in DataDrivenInvestor on Medium, where people are continuing the conversation by highlighting and responding to this story.