Asset Classes Aren’t Born, They’re Wrapped

This newsletter is part of The Assetizer, GenTwo's thought leadership platform.

When does a new asset class really become a new asset class?

This question has been a subject of conversation around the office lately, in the context of digital assets. But the question is more fundamental, and goes to the heart of what assetization really is.  

The obvious answer, one that you might get from an investment committee, is that an asset becomes a class when it is big enough (has a lot of value) to garner institutional interest, regulators get involved and sign off, and there is a long enough track record.

But the conversations we have been having made me suspect that this answer has it backwards. I did some digging with my trusty LLM into the history of finance, and we found that when new asset classes come into being, very often something else comes first.

Here are some examples.

Brady Bonds

Firstly, it's not always intrinsic value that makes an asset class.  

Take Brady bonds. In the 1980s, a number of Latin American countries defaulted on their debt, leaving US banks stuck with piles of bad loans. (Bond markets had been as good as closed to risky sovereigns since the defaults of the 1930s, which is why so much lending sat on bank balance sheets to begin with.)  

The defaults threatened a US banking crisis. So Treasury Secretary Nicholas Brady proposed that banks accept a haircut in exchange for new, standardised bonds they could actually sell, with principal secured by long‑dated US Treasury zero‑coupon bonds, financed with IMF/World Bank money.  

The plan worked, and then something unexpected happened. Seventeen countries eventually issued these bonds, creating for the first time in decades a pool of tradable risky‑sovereign debt. Indices were then built to track it, funds were launched to buy it, and banks set up desks to trade it.  

Once that machinery existed, any risky country could sell ordinary bonds into it, no rescue needed. A market that had been practically dormant for fifty years reopened. The point is that the underlying didn’t change; it was the same promises from the same governments. What changed was the container.

Commodities

Second, if something does have intrinsic value, that doesn't necessarily make it an asset class either.

Consider commodities. Commodity futures have existed since at least the 1850s. But to invest in them you had to buy the actual futures and then keep rolling them over before they came due, or risk taking delivery of actual wheat or soybeans. That's a full-time job. Most investors interested in commodities, not to mention institutions like pension funds, are not interested in that kind of work just to hold an exposure.

Enter Goldman Sachs. In 1991 it released the Goldman Sachs Commodity Index (GSCI), the first investable index of its kind. The index did the rolling; banks could now offer simple products tracking it, and an investor could hold "commodities" as a single line in a portfolio. It took a while, but the money came: investment in products tracking these indices went from under 5 billion dollars in the late 1990s to over 100 billion by 2007, with pension funds allocating to commodities for the first time.

A century of futures attracted almost no investor money. One good wrapper attracted a hundred billion in fifteen years. Same commodities, different container. It was the quality of the wrapper that decided how much money would come.

Currencies

Finally, even easy access and obvious value get you nowhere if the asset pays nothing. Consider currencies.  

Currencies have always been easy to access. Just go into a bank and you can exchange dollars for euros or anything else. But for a long time they were not an investment. Companies traded currencies as hedges to protect their businesses, and professional traders could bet on them. But there was no yield. A pile of yen is just a pile of yen.

That changed with the invention of dual currency bonds, where you invest in one currency and the principal is repaid in another, at an exchange rate fixed on day one. The classic buyers were Japanese insurers in the 1990s, starving for yield with domestic rates near zero.  

These bonds paid them noticeably more than any yen bond could. This was partly because dollar interest rates were higher, and partly because the investor was being paid to accept a risk: if the dollar fell, the principal came back worth less. But at least the risk was clearly defined. You knew from day one exactly what you were paid and exactly where it could hurt. And that is what turned a yield-less exposure into something an ordinary bond portfolio could hold.

Conclusion

So the point I am trying to make is this: an asset can't become an asset class until it has a financial wrapper. The quality of that wrapper decides how much investor money will come. And the best wrappers do something more: they define the risk, which is what makes an exposure something ordinary portfolios can hold.

What does this have to do with crypto? Well, digital assets are still waiting for their best wrappers. Tokens are wrappers too, but they only represent the raw asset, and most of the world doesn't have a wallet and probably never will. ETFs opened the door by making the raw asset broadly accessible. But access is only chapter one. Every mature asset class offers more than access: income versions, protected versions, managed versions. That menu barely exists for digital assets yet.

We think it's coming. Stay tuned, we'll have a lot more to say about that soon. 

Tom Lyons, GenTwo