Art tokenization has arrived

Investors can now fractionally own real world assets through tokenized funds

by Alex Broudy, Technical & Financial Writer
Oct 14, 2022

One of the biggest investment sensations over the past year has been digital art in the form of non-fungible tokens (more commonly known as NFTs), but interest and prices have collapsed under unease about the quality and value of NFTs and the unregulated, wild west space. Serious investors are looking for quality.

Waning interest in digital art comes as fractional ownership of real-world assets, and particularly fine art, is finally becoming easier. Fine art has outperformed the S&P 500 for the past 25 years, but most investors do not have the funds or expertise to assess or access desirable works of art which may be likely to outperform. That’s where a tokenized art fund can make the difference.

Tokenized art funds are a new kind of investment opportunity that combine the benefits of digital asset securities (DAS) with the uncorrelated returns of art as an alternative investment. In addition to being an asset class historically uncorrelated with the public markets, digital asset securities are also unrelated to cryptocurrencies. Although this type of investment may share a word in common with non-fungible tokens, tokenized art funds differ in several key ways.

Different by Design

Digital asset securities rely upon an SEC exemption, unlike NFTs and cryptocurrencies. In the United States, digital asset securities operate as exempt securities on the blockchain. They uphold the same regulatory requirements as traditional exempt securities but do so in a digitally native way. Unlike NFTs, digital asset securities are handled by FINRA-regulated broker-dealers and SEC-registered alternative trading systems. While the regulators have established rules for these trading venues to prevent bad-actors and mitigate risks to investors, private market investments come with market, liquidity, and regulatory risks, including digital asset securities risks.

A key difference between investing in alternative assets online and investing in digital asset securities is that you truly own the alternative asset when it is issued as a digital asset security.

When investors buy alternative assets such as art or private equity from some secondary markets online, they are effectively buying contracts that designate them as the owners of the investment purchased. But the investor does not typically get to control the ownership record. Their assets are managed somewhere else and can be lost or compromised outside of their control. When alternative assets are made into digital asset securities, investors get to be in control because their rights are recorded on public blockchains and only tradeable by them.

From Compliance to Appraisals

With tokenized art funds, compliance is achieved by following Reg D and Reg S to offer exempt digital asset securities. These digital asset securities record ownership rights on public blockchains so that provenance can be easily tracked and automatically maintained.

Appraisers inspect the original works of art comprising tokenized art funds and assign them independent values. Each work of art is then securitized and fractionalized so it becomes a lower-minimum investment that can be structured and traded digitally. Finally, smart contracts containing appraisal values are digitally signed by the appraisers, authenticating the pieces of art on the blockchain. These expert appraisals give works of art real-world value and are something that NFTs largely lack.

Opening the Door to Liquidity

With tokenized art funds, digital asset securities can be traded between KYC’d accredited investors in a way that guarantees the instant transfer of ownership rights upon the completion of a sale. Because this process is conducted on the blockchain, intermediaries are minimized and investing in art becomes more streamlined.

Securitizing artwork on the blockchain provides greater transparency into pricing and provenance, and increases trading efficiencies as well. Through tokenization accredited investors are now able to efficiently buy and sell digital asset securities on blockchain-connected secondary markets and bring potential liquidity to the art world.

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