##Why Wave Financial’s Kentucky Bourbon Blockchain Bonds May Be A Sober Investment

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While many tokenization projects have proved to be little more than publicity stunts, digital asset manager Wave Financial’s tokenization of a whole year’s supply of Kentucky Bourbon (roughly four million bottles by Wave’s estimate) appears to be a well thought out project that is likely to add credibility to the emergent digital asset space.



Asset backed cryptocurrencies, where tokens are redeemable for an underlying asset, such as real estate or commodities, have become increasingly popular as they have filled the void that the demise of Initial Coin Offerings left.



Tokenization can offer benefits over today’s analog approach to debt and equity raising. Protocols, such as Ethereum and Tezos have provided the glue to connect together issuance platforms (such as Vertalo, Securitize and Securrency) with trading venues (such as TZero and Openfinance), creating a powerful and low cost infrastructure for issuers to manage their cap tables, seek, secure and vet investors, and access liquidity pools.


Tokenization Isn’t A Panacea



However, tokenization is not a panacea and unless a tokenization project is built on solid foundations, it will have problems in getting traction; and that’s what has been playing out in the nascent digital asset markets to date.




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Just as we saw in the ICO boom, a good deal of the new tokenization projects seem to be more intent on using the novelty of tokenization to create a buzz and interest around a fundraise as opposed to using the technology to raise money more efficiently.



That buzz may be short-lived and tokenization comes at a price; while the technology can reduce issuance costs and improve distribution, it is at the cost of additional complexity — not to mention unwanted regulatory attention. This can ultimately lead to a project’s failure.





In many cases, a bank loan collateralized on the asset or its future revenue offers an easier path to raising cash against assets than tokenization. Where the number of investors is low and there is little turnover of ownership, cheap cap table management software — or even excel — is likely to be much more efficient than issuing on the blockchain.

Those that go down the tokenization path face the challenge of thin liquidity for digital assets on secondary markets. That lack of liquidity means that initial investors may not be able to exit their investment easily, or at a fair price.



It is with this in mind that Forbes recently sat down with Matteo Dante Perruccio, President International & Partner at Wave Financial and Tom Bombardi, Director at Wave Financial to discuss the digital asset manager’s recent announcement.



Wave Financial has inked a deal with the Danville, Kentucky-based Wilderness Trail Distillery to tokenize 25,000 barrels of 2020-vintage Kentucky Bourbon, initially worth approximately $25 million. Wave Financial plans to make the whisky investment publicly available through their specialized digital asset closed-end fund — “Wave Kentucky Whiskey 2020 Digital Fund (WKW20)”. The fund intends to realize returns through the strategic sale of barrels during the fund's lifetime, aiming to generate a 20% IRR over a six-year investment horizon.


Why Whisky?



The Wave Financial team are veterans from the financial world, with deep experience in private banking and real estate investment. So it is no surprise that the team have taken a rigorous approach to scanning the market to find an asset class that both makes sense to the investor as well as the issuer and where blockchain can play a unique role in adding value to the process.



According to Perruccio, that was an extensive search. Before settling on Whisky, the team had looked at, and cast aside, investment theses in areas as diverse as Japanese racehorses, renewable energy and real estate.




The Wave Financial team decided on whisky for a number of reasons. Firstly, it is an asset that has a track record of appreciating in price. Demand is booming and the investment has historically been resilient in adverse market conditions. Secondly tokenization uniquely solves a uniquely challenging problem with the way that distilleries finance growth, offering a better solution than the aforementioned collateralized bank loan. And thirdly, it’s a commodity that improves with age, rather than deteriorates.



Examining the price appreciation aspects first. The demand for quality whisky is booming. Sales in the U.S. were up 5.3% in 2019, increasing by $1.5 billion, to a new record of $29 billion. Tennessee or Kentucky Whisky aged four years or more is particularly in demand and it’s hard to find it available in wholesale today. That’s why a barrel of whisky purchased for $1,000 can be worth $4,000 five-to-six years later after it has matured and is ready for bottling.


An investment in whisky may also be recession-proof; during the 2007–2009 recession, whisky by volume and dollar sales only fell YoY once, by 0.7% and 1.4% respectively. That’s something to consider in these current economic turbulent times.



Tokenization appears, in this case, to uniquely solve an issue that whisky distilleries are challenged with as they look to expand to service insatiable global demand. The demand for whisky has taken all the capacity out of the market which makes it hard for a successful whisky operation to expand. While land in Tennessee and Kentucky is relatively cheap, the cost of acquiring new equipment and managing the expanded operations can be expensive.




Traditionally, this would be solved by levering up the balance sheet with debt to expand operations. However, that’s not a great option for the distillery as bank loans are expensive — over 10%, excluding closing costs according to the Wave Financial team. Whatsmore, that loan is likely to remain unpaid until that whisky has aged at least five years and can then be sold to the public. That eats into profits.


That's where Wave Financial’s closed end whisky fund, powered by tokenization plays a critical role by replacing the need to borrow to fund expansion with pre-selling the product, enabling the distillers to have cash-flow upfront.




Investors buy fund units in the fund, and the distillery then uses the proceeds to invest in producing a new batch of whisky which is then laid down to age for five-to-six years. Investors are provided with tokens that represent their shares in the fund which can be freely traded by the investors once their one-year lockup period ends.



It’s a valid criticism to point out that this can all be achieved without the use of tokenization or blockchain technology, after all, pre-selling inventory and closed-end funds are concepts that pre-date the blockchain. That said, the infrastructure and tools provided by blockchain will make it easier and cheaper to manage the fund according to Perruccio.




Challenges Ahead




Like all initiatives using new technology, the are still some early challenges that will be faced. For one, the market downturn has made it more challenging to source investors. While the fund had initially planned to have closed its first round by March, this timeline appears to have slipped as the company adjusts its strategy to adapt to the changing economic circumstances — investors are less forthcoming in this depressed market.



However, there’s an argument to be made that as investors search for places to park their money to weather the storm, whisky represents a good place to generate outsized returns.




Finding initial investors may be one hurdle, another will be to build a “liquidity ladder” of interested buyers on the secondary market once the token comes out of lock-up and becomes traded. Whereas national exchanges such the NYSE, CME and NASDAQ NDAQ has plenty of liquidity, the digital asset exchanges (Alternative Trading Systems) still suffer from acutely thin liquidity.



A recent study identified that in one month this year, there was only $193k a month of traction across all digital securities secondary trading venues (albeit these do not cover OTC transactions). Digital asset exchanges are feeling the heat from the slower-than-expected uptake in demand; Openfinance recently demanded that existing security tokens on their platform to re-list and pay additional fees, and while TZero’s has been able to raise money recently, its raise of $5m was small in comparison to the $134m that it was able to raise two years ago.




That said, an digital exchange platform isn’t the only option available for traders. The Wave Financial team has extensive relationships with the financial community and so it is likely that even if there is not liquidity in the ATS space, they will have a network of global intermediaries who are able to make markets in the fund through Over The Counter (OTC) mechanisms.



Time will tell as to how successful the WKW20 fund will be. It is certainly a commendable attempt to advance the nascent digital asset space and everyone in the digital token industry will be rooting for its success.