Collectibles Tokenization & Optimal Security Design
Blair Vorsatz – The University of Chicago Booth School of Business
-- Collectibles like art, wine, and classic cars have long interested investors, both for their attractive return profiles and for their low correlations with other major asset classes. Yet collectibles investment has remained elusive to most. This is because collectibles are expensive and indivisible, creating an obstacle to diversification, and round-trip transaction costs are enormous, often 20-30% of the sales price.
While financial innovation has struggled to overcome these challenges, blockchain technology has given rise to a fundamentally different solution – tokenization. Tokenization transfers ownership rights from a single physical asset to many digital security tokens, facilitating infinite divisibility and low-cost trading on exchanges. While tokenization addresses the issues of divisibility and transaction costs, the obvious obstacles to collectibles investment, early movers in this space (like Maecenas and TheArtToken) have been met with limited interest.
In my recent paper “Collectibles Tokenization & Optimal Security Design,” I try to explain the puzzle of why collectibles tokenization, which seems promising at first glance, has had very limited success in practice. I address this puzzle by comparing the costs and benefits of tokenization. In theory, tokenization has two primary benefits. First, there are diversification benefits because investors can own diversified portfolios of tokens (instead of just one or several expensive works). Second, trading through an exchange instead of auction houses & dealers dramatically lowers transaction costs. However, there is also an important cost that is often overlooked – when fractionalizing a painting, since nobody is a majority owner, the painting is stored in a vault, which destroys the value normally received from viewing and possessing the painting.
Collectibles, in principle, derive their value from the “emotional dividends” that their owners expect to enjoy through possession. This is much like how stocks derive their value from financial dividends – it’s just that collectibles’ dividends are non-financial. Since collectibles have negligible intrinsic value, most people believe the value of the emotional dividends is large.
Meager interest in collectibles tokenization makes sense if the benefits of lower transaction costs and divisibility are outweighed by the cost of the forgone emotional dividends. In other words, current collectibles tokenization destroys value because it squanders potential emotional dividends. However, just because there is no majority owner, there is no reason that the collectible can’t be rented. This framework implies that collectibles tokenization can create value if the underlying collectible is rented and the rental yield is large enough.
Turning to the data, I use a portfolio choice model to estimate the minimum rental yield needed for collectibles tokenization to be value-creating. Intuitively, the rental yield is a dividend yield paid by the collectible security token – with a large enough rental yield, investors will demand more collectibles than there are in existence, pushing up the price and creating value. Across a variety of specifications and for a number of collectibles asset classes, the upper bounds for the rental yield estimates are 5 – 8%. This means that, being conservative, earning an annual rental yield of 5 – 8% would be enough to make collectibles tokenization attractive to investors. While this sounds large, annual yields earned in existing art rental markets are no less than 6% and often at least 15%.
The key conclusion of my study is that investor interest in collectibles tokenization will increase dramatically if the collectibles security tokens pay annual financial dividends of 5 – 8%. These dividends would be financed by renting the underlying collectibles. This would give the token “stock”-like features, stemming from “real estate”-like characteristics. As I estimate the value of global collectibles at $23.9 trillion, collectibles tokenization has the potential to create a fundamentally new and highly demanded asset class.