The Institutionalization of Crypto ft. Sam Bankman-Fried & Dave Olsen
Where do you put your money? “TINA” aka “There Is No Alternative” – that’s how the current environment is described by some investors as they continue to invest in traditional asset classes. Interest rates remain depressed, with the 10-year U.S. Treasury Note hovering near historic lows. Meanwhile, the S&P 500 is trading at 20x+ forward earnings and the spread of Bank of America’s high yield index compared to the S&P 500 dividend yield hovers around 3%, which is staggeringly low (20-year average is 6.4% spread). As investors search for yield, they are increasingly rejecting the TINA narrative, and seeking alternative assets to diversify their portfolios away from inflated asset prices into resilient, noncorrelated asset classes. More and more, investors are using fractionalization platforms to access assets that meet this need.
Institutional asset managers and endowments have historically diversified their portfolios by following the Yale model for asset allocation, which places a significant percentage of assets into illiquid, alternative investments. Rightfully so, Yale has achieved 11% IRR in the last 10 years. A recent survey found 40% of institutional investors are increasing allocations to alternatives, and 90% are doing so in search of diversification. These investments have historically performed exceptionally well and have remained uncorrelated to traditional equity markets. Access to this asset class has also been restricted to wealthy individuals and institutional managers, until recently.
With regulatory changes from Reg A+ and Reg CF, a number of platforms in the real estate and investment management sectors provided investors the opportunity to invest in fractional shares of equity, art, commercial real estate and startups, including Cadre, Fundrise and PeerStreet. Others, like Royalty Exchange and Rally, have opened new models to invest across music royalties and collectibles.
With 2020 legislation expanding the SEC definition for accredited investors, and private offering growth outpacing public offering growth, the customer funnel and variety of offerings continue to grow. And with a $70 trillion wealth transfer set to occur, as wealth is handed down from Boomers to their offspring, the stakes are high for these platforms to win customer investment assets. As we’ve observed the evolution of this market, we’ve found a number of business models and target assets stand out, including that of our recently announced portfolio company within the farmland sector, AcreTrader.
This customer demand for access has grown an ecosystem looking to satisfy. Below is a market map of companies offering fractional ownership of various alternative assets, as well as some of the infrastructure players that support these companies.
Attributes of an Attractive Asset Class
As we evaluate the qualities lending an asset to fractionalization, we first looked at what has made these assets attractive to institutional investors over time and then how technology can improve access or relative investment attractiveness. Reflecting on these key issues, we feel there are three primary categories of factors to consider: investment quality, barriers to investment, and market size. Within investment quality, we focus our attention on correlation with traditional equity markets, scarcity or trophy asset qualities, and real underlying value. Regarding barriers to investment, we consider limitations to access, opacity of valuation, and lack of liquidity.
Investment Quality Factors:
Investment Barrier Factors:
Affinity: Some potential investment assets have ties to a buyer’s passions or hobbies. This could include memorabilia from a favorite sports team, royalties from a childhood song, or a treasured rare book. The investors’ affinity to these assets provides a non-financial benefit by fulfilling expression or other passions.
Market Size: For an asset class to be attractive, the addressable market size must be large enough to support a business at scale. Niche businesses may be attractive to limited segments but may not be largely available to investors. An example of insufficient market size is litigation finance, where demand has historically outstripped supply, limiting growth.
Expected Growth Segments
Based on the criteria above, four asset classes we are particularly excited about are agriculture, fine art, collectibles, and music royalties.
U.S. land covers nearly 2.3bn acres and roughly 52% is used for agricultural purposes, including cropping, grazing and farmsteads. Agricultural-use land remains scarce, while population and food consumption continue to rise, driving increased demand for agricultural land. This elevated demand has driven agricultural land prices to rise steadily, even amidst broader economic recessions. As developments in climate change, trade, technology, and consumer preferences change food supply chain behaviors, the agriculture sector will be impacted, from growers and suppliers to traders and investors. We believe these trends will serve as tailwinds for agricultural assets and increase demand for savvy capital providers in the sector.
These capital providers will need to find, diligence, acquire and administer cash flowing properties across farmland, pastureland, timber, solar and wind farms. Tech-enabled investment platforms will provide expertise and access to these investment opportunities for accredited investors and smaller institutions would not otherwise be able to access them. Additionally, given the lack of a transparent marketplace for these transactions, technology in this space focuses on establishing valuations from proprietary data, streamlining deal diligence and documentation process, and connecting property owners with investors.
As firms tackle this space, local relationships will be key to building success. Many agricultural deals are done through local brokers based purely on relationships. In farmland, a government survey estimated that ~75% of sales occur in private, off-market deals. A typical transaction would be for adjacent property owner to purchase property from a retiring neighbor. Platforms who don’t actively search out these deals face the danger of becoming a lender of last resort when deals aren’t able to be executed at local level, instead of a preferred capital partner. We believe AcreTrader is the leading platform in this space, which drove us to lead their recent Series A fundraising.
Global fine art market sales were $64bn in 2019, of which the U.S. accounted for 44%. At the same time, only 9% of transactions occur online. However, high-net-worth millennial collectors are frequent users of online sales platforms, with 92% having purchased online, 36% of whom spent > $50k and 9% of whom spent > $1mm online. This points to a younger, digitally native collector base that should continue expanding the online global art market going forward.
As with other asset classes, we believe quality of supply is key to platform success and differentiation in the world of fine art. Since many artworks are singular in supply and difficult to source, demonstrated ability to list well-known artists and works will help drive high-net -worth customers to a platform (flywheel effects). Partnerships with existing players (e.g., galleries and auction houses) will be important for success as well, since this can drastically impact the supply available to a platform.
As the sector continues to innovate, we see firms like Masterworks and Artsy continuing to drive competition with traditional brick and mortar galleries and auction houses.
The U.S. collectibles market is estimated to be a $3.8bn annual revenue market. The primary components of this sector are antiques (defined as objects >100 years old), world currencies, sports collectibles, comics & animation art, jewelry, collectible cars, and wine. Antiques and collectibles are timeless yet discretionary items, which makes the collectibles market highly sensitive to changes in disposable income and the broader economy.
The primary existing players in the online antiques/collectibles market are eBay (11% share) and Heritage Auctions (32%). The remaining industry remains highly fragmented, representative of e-commerce and its effect on competition in the sector. The industry has considerable technological and upkeep requirements, which has historically made it difficult for new entrants to break through. Going forward, we expect to see more platforms using tech-forward approaches to push through to consumers and offer integrated marketplace, education, and portfolio management platforms. This includes firms like Rally, Otis, and Alt.
As competition intensifies from these growing alternative investment platforms, auction houses are expected to ramp up their online presence to compete for supply. We also anticipate competition intensifying and ultimately, players with reputation, reliability, and competitive pricing should win out. Scale and multiproduct offerings to spread costs across multiple categories of collectibles will also help to support healthy margins and ultimately define winners.
Music publishing in the U.S. is a $6.4bn annual revenues sector. Industry revenues have risen over the last 5 years an annualized 2.8% to $6.4 billion. In 2021 alone, the industry is growing at a 3.0% rate and is projected to grow an annualized 0.7% over the next five years to 2026, with a slight headwind as growth normalizes following COVID.
In the music royalties sector today, Sony, Universal and Warner have significant market share (8.7%, 7.5%, and 5.2% respectively), however the industry remains highly fragmented. The evolution of content creation and distribution platforms, from YouTube to Spotify and Soundcloud to Tik Tok, have reduced barriers to entry for new artists. As a result, many musicians are reluctant to sign with a major label and publishing company. This growing number of individual musicians has effectively offset concentrations from industry consolidation, creating a competitive market for creators.
Typically, to invest in royalties, investors acquire the copyrights or a share of the copyrights of musical compositions or enter into agreements to administer copyrights. Revenue is derived from these compositions by licensing them for inclusion in records, film, TV, and other media. Investors are entitled to a percentage of the royalty income, which varies among contracts. Royalty income is derived from four main types of royalties: Performance, Mechanical (Recordings), Synchronization (TV/Film), and Other. As album sales have declined, consumers have increasingly shifted from physical products toward a digital catalog of music. Publishers have benefited from increased music licensing via online streaming services, video games and features in advertising campaigns.
In the past few years, existing catalogs of major artists became increasingly valuable due to their scarcity and cultural value. Thus, publishers and other investors can build a strong capital base by acquiring the rights to legendary artists' catalogs and turning those catalogs into what are essentially money-making franchises. Investment funds, like Primary Wave and Hipgnosis Songs Fund Limited, have been created for this purpose and traditional private equity groups like KKR and Morgan Stanley have executed deals in the space as well.
From an investor perspective, portfolios can be passively or actively managed to focus on building the value of their portfolios by boosting revenue. Amplifying the value of a given portfolio can occur from inking synchronization deals, where songs are used in advertisements or films. Songs have also seen climbs in value from inclusion in video games or even biopics filmed about artists. This increasing interest from investors has left it ripe for disruption. Companies like AmplifyX and Indify are focusing on the long tail of new, digitally native musicians, while Royalty Exchange has focused their attention on blue chip royalty catalogues, such as those of Dire Straits and Eminem.
Jump Capital believes alternative investment fractionalization is the next wave of unbundling and increasing consumer choice in financial services. We find the application of marketplaces and digital solutions to these asset classes to be an exciting evolution increasing consumer access. Applying blockchain technologies also cannot be overlooked as enabling and disrupting approaches to the same solution. These are areas where we are interested to invest. We look forward to hearing from entrepreneurs innovating this space and those with a contrarian perspective on this.