Derek Edward Schloss (TDW): Ben, it’s great to sit down with you on Security Token Academy’s The Digital Wrapper. I’m looking forward to learning more about your products and work over at Wave Financial. I always enjoy hearing about pre-blockchain backgrounds — I noticed you’ve spent quite a bit of your career working in Asia.
Benjamin Tsai (Wave Financial): Thanks Derek — yes, I was originally trained as an engineer, and I spent some time in Asia as an engineer. I ended up going back to business school, and after the program, I spent about fifteen years in Asia working in finance, in Tokyo, Hong Kong, Singapore, and Taipei. My first twelve years were with Merrill Lynch working on structured products¹, both equity and fixed income, packaging derivatives for high net worth clients — it’s quite a popular business in Asia.
Derek Edward Schloss: Great — and the last few years you were over there?
Benjamin Tsai: Eventually I was tasked to rebuild the commodities business for Bank of America across Asia. I worked on that for two years. In my last three years, I moved to AllianceBernstein where I switched to somewhat of a buy-side role focused on alternative investments. I was in charge of the strategy. We handled products around hedge funds, and fund of hedge funds, infrastructure, real estate and all sorts of exotic asset classes. That’s my background in finance, and about three years ago, I came back to the U.S.
Derek Edward Schloss: Thanks for the helpful intro. What’s been your general area of focus since you came back to the United States?
Benjamin Tsai: Real estate and fintech — in fact, my work in fintech led me into the blockchain and crypto space, which I became actively involved in a few years back. Two years ago, I co-founded a nonprofit called the LA Blockchain Lab and we work with UCLA, USC, UC Irvine, and Cal Tech — along with the city government of Los Angeles — to promote blockchain development and usage, and its proliferation across Southern California. About one and a half years ago, I met with David Siemer and we started Wave Financial.
Derek Edward Schloss: Wave Financial is a blockchain-based asset management firm in Los Angeles. I’d love to unpack Wave’s thesis a bit — who are the customers that Wave serves, and what problems are you solving for them?
Benjamin Tsai: Sure — I’ll take it from a macro perspective. I’ve done equities, I’ve done fixed income, I’ve done commodities — and I really see cryptoassets as the next asset class. That’s the first area we find very interesting. The second area we’re focused on is the application of blockchain technology as it relates to the tokenization of different assets and different products. Wave Financial is an asset manager that serves high net worth and institutional investors around these two themes.
Derek Edward Schloss: I can imagine your background in regulated markets is probably helpful in navigating some of the unexplored territory around both of these two areas.
Benjamin Tsai: Definitely. You know, one of the things we realized early is the increasing regulation of the space — which ties back to my past work. I was licensed in Japan, Hong Kong, Singapore, Taiwan, and in the U.S. as well with various securities and marketing licenses. I’m quite familiar and comfortable with being in a regulated space, and when we set up the firm, we bought an RIA² and rolled that into Wave Financial so that we could become a regulated entity for managing client assets. As an RIA, we have a fiduciary duty to our clients to do the best that we can as an asset manager.
Derek Edward Schloss: Let’s jump into Wave’s latest security token product — the “crypto derivative” fund you’ve called Wave BTC Fund. This is a type of tokenized product I haven’t spent time thinking about in the past, so I’m interested to learn more about this.
Benjamin Tsai: The original idea behind the product came from the fact that people in the wealth management business — typically high net worth clients — they are first interested in getting as much yield³ as they can. Once the yield is understood, they’ll ask what risks they have to take in order to get that yield. So we decided to approach this from a yield perspective — we asked ourselves, “what can we do in the space that would generate good yield for clients, while having reasonable risk exposure.”
Derek Edward Schloss: Understood — that makes sense.
Benjamin Tsai: And in looking at risk, one of the things we noticed is the high volatility that comes with many cryptocurrencies, which can be a problem for many people. So we decided to take that volatility and essentially convert it to yield using BTC derivatives, and package that yield together into a monthly dividend-paying fund product. We’re selling off the volatility of BTC to generate a stream of yield that we’re paying out on a monthly basis — our target rate is about 1.5% a month or roughly 18% a year which we think is quite an attractive number today.
Derek Edward Schloss: I might need a bit more help unpacking this structure. So the idea is that the Wave BTC Fund, which is tokenized, holds the rights to the underlying BTC assets. Now, anyone can purchase call options⁴ from the Wave BTC Fund — these call options are contracts that provide those buyers the right, but not the obligation, to purchase BTC from the Wave BTC Fund at a later time and price. And in exchange, these call option payments are aggregated and paid to the Wave BTC Fund token holders through a monthly dividend.
Benjamin Tsai: Yes, that’s right. We’re typically selling roughly “one month, 20% out of the money” options — so options 20% higher than the current spot price. And this resets monthly. So with the Wave BTC Fund, we’re letting clients get exposure to Bitcoin’s upside up to 20% per month, and anything greater than that they’re giving up for the yield. I want to highlight the fact that we’re leaving the client quite a bit of headroom — it’s 20% of rise every single month. If you were a Bitcoin holder and the market’s up over 20%, it would make sense to take some money off the table.
Derek Edward Schloss: So for your clients — these high net worth individuals — there’s first and foremost the target yield associated with the product. But in addition, there could be other benefits for having this alternative exposure to BTC. From a portfolio management perspective, the tokenized Wave BTC Fund is simply a tool in the toolkit to help them achieve greater diversification in their portfolios. Do I have this right?
Benjamin Tsai: That’s correct — actually, that’s one of the ways that we talk to people about this. Some people hold Bitcoin on their hardware wallets, in their sock drawer or something. That’s certainly one way to do it.
Derek Edward Schloss: [Laughs] Right.
Benjamin Tsai: But when you think about it, that might not be the best way to hold your Bitcoin. It’s certainly not the easiest way of handling assets, and most investment assets in the world, that’s definitely not how you take care of it. You don’t print out your stock certificate and stick it in your safe — we don’t do that anymore. So we think the Wave BTC Fund is a good way to have alternative exposure to Bitcoin, with a slightly more actively managed component as opposed to just buy and hold. And fundamentally, buying and holding doesn’t pay a return of any sort — here, we’re able to provide a high level of return.
Derek Edward Schloss: Understood — that makes sense. That brings up the question, who custodies⁵ the actual BTC owned by the fund? And where is the fund incorporated?
Benjamin Tsai: Fidelity Digital Assets handles custody of the BTC, and the fund is a British Virgin Island entity — BVI — set up as a closed-end fund. When someone new invests in the fund — we create units, we buy Bitcoin, and we custody the BTC with Fidelity. We’re one of the early clients of Fidelity’s Custodial Services. We went through their full review process, and we also work with other counter-parties on the options side.
Derek Edward Schloss: I think I understand the product a bit better. I’d love to dive more into the tokenization part of the fund’s construction — why was the act of tokenizing the Wave BTC Fund so attractive from your perspective?
Benjamin Tsai: I think the tokenized fund structure here makes a lot of sense because it opens new channels for liquidity⁶. Not only are we providing buybacks on a regular basis, but clients can put fund tokens onto the market to buy or sell as they wish. The value of the fund is relatively easy to determine — the fund holds Bitcoin and the sale of options — which lends itself well to determining value for trading. And in this case, it’s probably easier to price and trade compared to a tokenized VC fund, which may not have as clear of a NAV⁷, and which typically does NAV on an annual basis.
Derek Edward Schloss: Vertalo is your tokenization and technology partner for constructing the product. I had a chance to sit down with Vertalo’s Dave Hendricks earlier this year. Why did you decide to work with Vertalo on the tokenization piece, and what does that relationship unlock for your team?
Benjamin Tsai: We first started this firm roughly a year and a half ago. At that point, the infrastructure wasn’t quite there for building everything out and being able to support the whole ecosystem. To me, it was relatively clear that we needed to get to a place where the client experience was similar to an E*TRADE or a Schwab — an online brokerage. Crypto was nowhere near there. And the security token space? That was even further behind. We decided to search out the best partners we could work with to create the type of products that we wanted to create. We’ve been speaking with a number of platforms and Vertalo’s platform was very flexible with what we wanted to accomplish. We decided to work closely with them in terms of development and integration work. In addition, Vertalo works closely with Prime Trust — a qualified custodian⁸. We decided to go down this path of working with both of these counterparties — Vertalo for tokenization development and integrations, and Prime Trust as a custodian for the security token that represents the Wave BTC Fund.
Derek Edward Schloss: And the downstream trading piece? Once the lockups end, are there security token trading platforms you think are well suited for the tokenized fund product?
Benjamin Tsai: Right — probably the most important component, which is also the most behind at this stage, is the trading component. In the U.S. we’re starting to see a number of players come out and support security token trading. OpenFinance Network is probably the most advanced — they have a listing board with buy and sell orders. tZERO and SharesPost have both signaled their interest in working on this as well. And internationally, we’re really starting to see this environment move forward. Hong Kong recently announced regulations with regards to tokenized securities and the exchanges that manage that process. So we’re still early days in the security token exchange space, but we are starting to see some progress — and the progress that I typically focus on are the major markets like Hong Kong and the U.S., as opposed to some of the smaller, offshore, esoteric locations.
Derek Edward Schloss: Listening to you speak — it sounds like Wave is thinking about building products that can be easily priced, with the investment potential to trade across global markets. I think creating products in this way is authentic to some of the core values that make digitization and blockchains interesting for securities in the first place — in other words, engineering for transparency and global trade.
Benjamin Tsai: Thank you. I feel that what we’re doing is being extremely client focused in terms of what clients want, what clients need, and how we can provide the best experience for them. I think that’s the right way to look at it — because in the end, if the clients aren’t interested, then it’s a non-starter.
Derek Edward Schloss: Another reason I find the tokenized fund model so interesting is that the fund model can be extrapolated to all kinds of assets — with a tokenized fund, you can start bringing all sorts of interesting products into blockchain-based environments. Do you see Wave engineering new products with this same structure in the future?
Benjamin Tsai: Definitely — the fund structure is great for tokenizing various things. On the collectibles side, we’re exploring the tokenization of Picasso art pieces. We’re looking at tokenizing whiskey barrels. We’re looking at tokenizing Japanese race horses — packaging their cashflows. We’re really looking at all sorts of different ways to provide investment exposure using tokenization technology, which can help us create different investment profiles for our clients. In general, I think the whole idea of tokenization opens up the possibility of liquidity. And I’m very careful in what I say, because true liquidity comes from having buyers and sellers that actually want to trade something back and forth — not the fact that there is a place for someone to go trade. All three of the products I mentioned — Picasso art pieces, whiskey barrels, race horses — typically, these don’t have a liquid market today.
Derek Edward Schloss: How do you see tokenization creating more liquid markets for those three assets in particular — horses, art, whiskey?
Benjamin Tsai: So, Japanese race horses are regulated — only Japanese corporates or individuals can buy them. We think non-Japanese investors would like some kind of exposure here. Tokenization will make it easier to access products not currently accessible due to regulatory barriers. And for Picasso pieces, the barrier is the high cost of entry.
Derek Edward Schloss: Right — the high unit costs associated with purchasing a single Picasso.
Benjamin Tsai: Yes. Right now we’re looking at ten Picassos — a combination of roughly $600 million dollars, so each Picasso is somewhere between $50 — $100 million dollars. That’s definitely a price tag barrier. And we see similar discussions in the real estate space, right? The price tag for each unit is too high for average investors, and tokenization and fractionalization aims to help with this.
Derek Edward Schloss: And whiskey?
Benjamin Tsai: With regards to whiskey barrels, it’s an investment product that isn’t popularly available — it’s something people don’t really have great access to. Tokenization is a tool that helps open up that access. The investment thesis behind this asset class is very good — not a big drinker myself, but I’ve done research in this space and my understanding is that a barrel of whiskey increases significantly in price throughout its aging life. This increase in value is very interesting — something that has great return profile that we can package and offer as an investment product. Here, we’ll create a tokenized whiskey fund where people can invest at day zero, and as the barrel ages, interested buyers and sellers can create a market for these tokens. Now that you have a liquid market trading these tokens throughout the whiskey’s life — other producers, or bottlers, or wholesalers are able to buy tokens to hedge their exposure. It can help create a commodities market for actual producers who, maybe three, four years ago, should’ve put away a barrel of rye whiskey as opposed to bourbon — and they didn’t do it, and now they need it. With commodities, there’s always a speculator side and a producer’s side. One side wants to hedge, and the other side wants to punt. Tokenization allows us to recreate this for various assets that historically have not been able to easily do that.
Derek Edward Schloss: I’ve really enjoyed this conversation — can you close us out Ben? What are some of the things folks can expect from Wave Financial over the next year?
Benjamin Tsai: We’re continuing our work on the asset tokenization side — we’re aiming to launch a whiskey product early next year. We’re also expanding our firm to be able to service more clients in more countries — we really like the fact that this technology is global in nature, and we’re actively building for this.
Derek Edward Schloss: Ben, on behalf of Security Token Academy, thanks for joining me on The Digital Wrapper.
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¹ Structured products are those pre-packaged structured finance investment strategies based on a single security, a basket of securities, options, indices, commodities, debt issuance, or foreign currencies. From the issuer’s point of view, structuring means that a number of existing financial products have to be combined to achieve the client’s desired return function.
² RIA, or a Registered Investment Advisor, is a person or firm who advises high-net-worth individuals on investments and manages their portfolios. RIAs have a fiduciary duty to their clients, which means they have a fundamental obligation to provide investment advice that always acts in their clients’ best interests.
³ Yield refers to the earnings generated and realized on an investment over a particular period of time, and is expressed in terms of percentage based on the invested amount or on the current market value or on the face value of the security. It includes the interest earned or dividends received from holding a particular security.
⁴ Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.
⁵ Custody refers to third party ownership of one’s assets. In blockchain, holding custody of a wallet and its assets also means holding the private keys and the responsibility of keeping funds and digital assets safe.
⁶ Liquidity is the ability to find someone on the other side of the market, at a reasonable price, for the size that you’re looking for. It’s both the size of the “bid-ask” spread, which is the difference between what people are willing to sell and buy for, and also how deep those markets are.
⁷ NAV is net asset value, which represents the net value of an entity and is calculated as the total value of the entity’s assets minus the total value of its liabilities. When used in the context of a fund or ETC, the NAV represents the per share/unit price of the fund on a specific date or time.
⁸ Qualified custodians are those financial institutions that clients and advisers customarily turn to for custodial services. These include banks, savings associations, and registered broker-dealers. Custody of client assets occur when the custodian holds, directly or indirectly, client funds or securities or has any authority to obtain possession of them.
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