Investing in Deep Value: Tokenisation

Traditional accounting and the Wall Street financial analysis that derives from it is not fit for purpose in the modern world.

This problem is particularly acute in equity markets, where intangibles increasingly dominate and proxy indicators (like research and development spend) are poorly correlated with value creation and stock price. The bond markets are better at picking up intangible value because it tends to correlate with quality of income and this implicit relationship underpins many default-risk algorithms. Credit swap spreads pick up differential value in credit rating bands (not all BBB companies trade at the same spread) and these differential values do map against certain patent value algorithms: but the underlying management activities that drive sustainable outperformance are not commonly understood.

The arcane world of accounting has produced masterpieces such as FASB's 2014 700 page revenue recognition standard or the 2016 lease recognition rule that was 10 years in discussion. Baruch Lev, Professor of Accounting and Finance at New York Stern School of Business highlighted the self-referential and largely useless nature of backward looking financial statements in his recent book "The End of Accounting". Together with his co-author Feng Gu he recommends that public markets adopt many non-financial measures of company performance and in effect start to act more like private equity funds or venture capitalists in how they measure value.

This is not a high bar.

Whilst there is undoubtedly significant merit in understanding and valuing the core intellectual property of a business (the monetary value of its patents, trademarks, trade secrets etc.) this is a limited and backward looking exercise in that the value being recognised is something that has already happened. Such valuations are an exercise in "running off" the future earnings expectations in a discounted cashflow model - and subject to huge amounts of subjectivity when the IP is not fully monetised. Predictably there are many debates amongst intellectual property and accounting professionals about the right way to accomplish this task and whether it should be a statutory requirement or not. But these arguments miss the real point of value.

Where the real value lies (for investors) is in forward looking analysis. This means doing more than scratching the surface of what creates enduring value in a company and finding a way to benefit from the insight. This latter point is critical since if markets do not value the insights you derive then what is the point of having them?

Currently financial markets do at least play lip service to valuing registered IP. The value ascribed to them depends on the sector, materiality and level of obviousness. Typically patents drive most value in Tech and Pharma, copyrights in Media and trademarks in Consumer. What is largely ignored however is that these "hard" IP assets are the output (or product) of a process, that takes place on a platform and is mediated by people.

It is these three pillars of "soft" intangible value: process, platform and people, that actually drive innovation, sustainable competitive advantage and outperformance over time. The management actions that optimise and integrate these three drivers also generate transactional flows within the organisation or the ecosystem within which the business operates. This is increasingly mappable using AI/Network analysis and represents the Organisational IP of the business.

In the last few years an economic model has emerged that recognises, unitises and measures the value of these transactional flows. Based on the notion that the intrinsic value of an enterprise is built on Organisational IP, investing in these transactional flows should allow a pure-play exposure to the value of the business model in a way that no other part of the capital structure does. This model is tokenisation.

A token or cryptocurrency is the purest expression of the Organisational IP of a company. It allows investors to side-step the systemic risks of equity investing and in early stage companies (where the relative contribution of intangibles versus current cashflow is heavily skewed) tokens provide a better risk management option - because their liquidity is likely to be greater (and not subject to pre-emption rights or discounting).

A thoughtful and quantitative comparison between investing in equity and investing in tokens was published recently by Jamie Goldstein at Pillar VC. In his well articulated Medium article Jamie arrived at the following conclusions:

• Buying equity has advantages in terms of alignment and flexibility (depending on the shareholder structure and preferences)
• Buying tokens provides early liquidity for investors
• Buying tokens is often a better economic deal for investors

The opportunities are widespread for this type of analysis.

In my consulting practice I am currently evaluating tokenised ecosystems in financial services (monetising customer value), motion pictures (monetising content that has multiple channels and uses) and organisational change (monetising human potential within complex organisations). In each of these situations the engagement of people with the platform and process drives transaction volume creating currency appreciation and utility.

To conclude this necessarily high level article, I believe that it is becoming evident that the relationship between token economics and the intrinsic value of the organisational IP of a business is highly correlated and that properly managed cryptocurrencies offer investors a unique way to invest in the deep value of a company. As cryptocurrencies proliferate a universe of pure-IP investing will emerge that will accelerate the Death of Accounting and explain the failure of IP exchanges.

It is an exciting time to be working as this new financial system evolves.