Xiao Feng: Blockchain and Alternative Asset Allocation

Before talking about the topic of blockchain and alternative asset allocation, let’s look at a case. This case is the Yale University Foundation. In the past 20 to 30 years, the performance of the Yale University Foundation has been very good. It not only supports Yale University’s annual funding, but also increases the size of Yale University’s endowment fund from several billion US dollars to more than 20 billion US dollars.

The performance of the Yale University Foundation's entire fund portfolio can outperform inflation and performance benchmarks, and also outperform most of its peers, including the famous Harvard University Foundation. The reason why its performance can be outperformed is very important, or 90% of the reason is due to its innovation in asset allocation. This chart shows that in the past five years, the private equity allocation of the Yale University Foundation's asset allocation has not been less than 30%, and commodities including paint, timber, and minerals have not been less than 7%. The real estate allocation has never been less than 20% to 14. Adding the entire portfolio together, these three allocations exceed 50% of the entire asset portfolio. The proportion of non-liquid assets and non-traditional assets in the Yale University fund portfolio asset allocation accounts for more than half, so its allocation is very different from the traditional asset allocation theory, or it is very innovative. We can see that it is a 100% asset allocation ratio. If we add absolute returns and hedge funds, the proportion will be even higher.

So it is a traditional asset allocation model. The core assets should be highly liquid stocks, bonds or currencies. They should be allocated as core assets. Alternative assets with poor liquidity, such as commodities, PE, VC or real estate, should not account for a large proportion of the total assets, especially more than 50%. This is what our classic allocation tells us, but if everyone allocates their assets according to the most classic asset allocation model, then your return will be the same as others', and it is impossible to exceed your peers and far beat the performance return of your benchmark assets.

The reason why Yale University's asset returns over the past few decades have been able to beat its peers, beat the benchmark, and beat inflation is because it has made a very big innovation in its asset allocation model. It has incorporated a large number of alternative assets into the portfolio, which others are not yet aware of, and it has not yet discovered it when others have not yet discovered it. Therefore, the theoretical community finally called this summary the "Yale Model." 90% of the industry's returns come from this kind of asset allocation. We know that many American theories have repeatedly demonstrated that 90% of the performance returns of an asset portfolio come from asset allocation, not the selection of stocks and bonds. At least in the U.S. market, the selection of stocks and bonds contributes much less to an asset portfolio and its returns than asset allocation.

This brings us to a new topic. Now everyone is increasing the proportion of alternative assets in their portfolios. Originally, they may have been very careful to allocate only 15%. Yale allocated more than 15%, so some other asset portfolios, including the Harvard University Foundation portfolio, also increased their proportions in alternative assets. The final result will inevitably lead to the same proportion of alternative assets for everyone, because 90% of the performance can be explained as asset allocation. Then, perhaps in a few years, the performance of all of our peers will converge again. At that time, are there any new asset categories that can be included in the investment portfolio as alternative assets? I think there is an opportunity, and that is digital assets.

Digital Assets

The first attribute of digital assets is that they should be assets that are graded on the blockchain or registered on a distributed ledger. They should not be registered with the State Administration for Industry and Commerce, nor with the real estate department, nor with the vehicle ownership registered with the vehicle management department. Instead, they should be registered on the blockchain and distributed ledger and run on them.

The second is a virtual asset, a virtual asset that exists in the form of bits. Gold is a type of asset. Gold has a physical structure, an atomic structure. Real estate also has a physical structure, but digital assets have no physical structure at all.

The third point is that it exists in the form of computer code or computer programs, and is a programmable asset for trading. Bitcoin is a programmable asset. Paying Bitcoin is completely different from paying cash. Paying cash is a change in numbers, and one hundred decreases on the account and one hundred increases on the other party's account. Bitcoin is a payment to a computer program, a piece of code, not a simple line of numbers, but a program. It is an exchange between programs and a bridge between codes. This asset is programmable. There is no other reason why the central bank wants to explore the issuance of digital currency. The core reason is that the current legal currency is not programmable. It is impossible to program the RMB to define its use and flow, but digital currency can be programmed, and it can be controlled by computer programs.

The fourth characteristic is that it can operate intelligently, autonomously, and point-to-point without the need for human intervention.

The fifth characteristic is that most digital assets are in the form of coins. This is more from the perspective of the central bank and liquidity. Money is viewed from a commercial perspective. Banks are engaged in capital business and are more concerned with money. The word coin will become more and more important, because as blockchain digitization and blockchain digital assets increase, we call it coin more often, which is equivalent to a digital token. Therefore, the five characteristics of digital assets are that coins are converted into a certain digital token. Therefore, this digital asset is often monetized. This type of asset may become a new category of alternative assets, and may become a very important alternative asset configuration variety in the next ten years.

To explain it more clearly, let’s take the digital currency, which is the most mature and largest type of digital assets so far: Everyone will say that the central bank issues digital currency. In fact, there is no necessary relationship between digital currency and the central bank. The central bank can choose not to issue digital currency. Digital currency has existed for a long time.

Four categories of digital currencies

The first category is the central bank’s, which is called digital legal tender. No central bank has ever issued one, but all central banks claim that they want to study the issuance of digital currency.

The second type is called algorithmic currency. It is issued based on a certain mathematical algorithm. At least we believe in legal tender because it has national authorization and national credit. Algorithmic currency has no national endorsement or any centralized institution endorsement. So far, I think Bitcoin is one of them.

The third category is called protocol currency. Protocol currency is a common protocol on the Internet. In order to make this protocol run very well, we have designed a currency specifically for using this protocol. For this protocol to run successfully, it must be purchased with its currency. It must be paid. As mentioned earlier, smart contracts are a common protocol on the blockchain. Everyone signs contracts with each other through this protocol. For this protocol, we have specially issued a currency called Ethereum.

The fourth category is anchored assets, which are assets that are used as collateral to issue currency.

There are three categories of digital currency. One form of expression is the digitization of RMB. Algorithmic currency is Bitcoin. There is a new currency called Ethereum, which has risen by about 20 times since last year. There are many anchored assets, which may be anchored gold, land, or a house. Finally, it may be a certain device such as an airplane. It can also be registered on the blockchain. The legal airplane is the anchored coin. Algorithmic currency is based on a certain algorithm. Bitcoin now issues 25 new bitcoins every ten minutes. Why every ten minutes? The mathematical algorithm stipulates that the 25 new bitcoins issued every ten minutes are used to reward those who help others keep accounts in these ten minutes as their reward. This is issued according to a certain algorithm. Ethereum is based on a certain purpose, which is a smart contract. If you want to sign a smart contract, you must pay me to sign your smart contract with my technology. I only accept Ethereum, so it is issued for a certain purpose. Of course, the anchored asset currency can be collateralized by assets.

These four different digital currencies have different uses. Legal tender is the sovereign currency of a country. Even if it is digitized, it is still a sovereign currency and has all the functions of currency. So a few days ago, the director of the Statistics Department of the central bank said that only the digital currency issued by the central bank is currency. If he is right in this sense, only the digital currency issued by the central bank is legal tender. Anything issued by anyone else is definitely not legal tender, and does not represent national sovereignty or national credit. But is it not considered currency? Other forms of digital currency have their special uses. For example, the largest user of Bitcoin so far is a medium of exchange and a medium of payment. It does not have the functions of value storage and value standard. Legal tender does have these functions, but as a big function, the most core function is a medium of exchange and a medium of payment. Protocol currencies like Ethereum support technical protocols on the Internet to enable it to operate better.

The currency issued by anchored assets is for financing. I have gold and I don’t want to sell it, but I need some liquidity and cash now. Two companies have already done this, two blockchain startups have done this. The blockchain companies rent a large gold storage warehouse in the bank’s vault, and then store the gold there, and put the deposit certificate on the blockchain to issue coins. After you buy the coin on the blockchain, you can go to the vault in London, New York and Singapore to withdraw your gold. You can keep your coins or withdraw the gold.

In addition to digital currency being the largest type of asset at present, there are many other digital asset methods that are currently being developed, created, and tested, but of course there are no large-scale applications. For example, stocks, automatic trading, automatic settlement, do not require exchanges, settlement companies, or even economic companies. Six companies are already doing such transactions on this in the trial, but there are also smart debts. UBS Blockchain Lab has been trying to do smart issuance and trading on the blockchain, issuing $50 million in smart debts on the blockchain. Smart debts are completed point-to-point after the transaction, and the transaction is confirmed and settled on the distributed ledger. The transaction and settlement are completed in the same step. This is called smart debt. You don’t need the current huge market system to help you facilitate a transaction. Point-to-point can be completed by itself relying on computer programs and smart contracts.

What is device democracy?

Of course, a larger piece has not been well excavated yet. One piece is the Internet of Things white paper published by IBM in 2014. The title of the white paper is "Device Democracy". That is, if all these devices on the blockchain are registered on the blockchain, these devices will obtain autonomous rights and can be M2M, and machines can autonomously initiate financial transactions and make financial payments. Because these devices are autonomous, they are called smart devices. Any financial transactions on smart devices are called "smart assets". So we know that mobile phones have evolved from feature phones to smart phones because of mobile Internet. Mobile Internet makes mobile phones online 24 hours a day. Being online and surfing the Internet are two huge behavioral differences. To surf the Internet, you need to open a computer and enter a website to connect to the Internet, but smart phones enable you to be online and have a relationship with the Internet 24 hours a day. Because they are online 24 hours a day, mobile phones are called smart phones. Because they are online 24 hours a day, devices are called smart devices. Because the devices are intelligent, devices can be M2M, can borrow money from each other, can have financial transactions with each other, and can make financial payments with each other.

We call these assets intelligent assets, which is the prospect described in the IBM Internet of Things white paper. It can be noted that by 2050, there will be more than 100 billion connected smart devices in the world, and the intelligent assets it brings will be very large, possibly trillions of dollars, or hundreds of trillions of dollars.

This is a new development direction for some digital assets other than digital. Therefore, we can make such a prospect in the future. At present, the main form of digital assets is digital currency. Although the current market value of digital currency is only about 10 billion US dollars, we can conclude that digital assets will become a very large category of our alternative assets in ten years. Perhaps it will become the largest category. The most pessimistic estimate in 20 years is that the total market value of the entire digital asset will exceed one trillion US dollars, but when it exceeds one trillion US dollars, no asset portfolio can ignore it. Moreover, I don’t think it will take 20 years. Maybe in ten years, the total market value of digital assets will exceed one trillion. Therefore, in the next ten years, from the perspective of asset allocation of asset portfolios, digital assets, a new asset category, cannot be ignored. If anyone ignores it, the performance return of your asset portfolio will definitely be much worse than that of those who do not ignore it.