Traditional channels for project finance often leverage special purpose vehicles (SPVs) to securitize debt, giving investors peace of mind through a higher assurance of repayment. Project finance is often used to fund long-term infrastructure and other major industrial projects through a limited or non-recourse financial structure, allowing the cash flow from the project to pay back the debt or equity to investors.
Because of its isolated structure, financing via an SPV realizes most risk during the construction phase, as no revenue is being generated by the project at that time. While some of the risks are mitigated with offtake agreements and other similar contracts, the limited recourse structure of the project places it in a higher risk classification than traditional debt or equity financing.
Project Tokenization
Tokenization opens the door for debt or equity ownership of the project by utilizing blockchain technology. The process involves “minting” digital security tokens, which can represent either an ownership stake within the project or the rights to interest payments on loans used to finance the project. Because each token represents one unit of ownership, the process enables fractional ownership of the project through multiple investors, allowing them to take on as many shares of the project that fit their risk appetite.
Compared with traditional securitization, tokenization via the blockchain can significantly reduce overhead costs and drastically improve the liquidity of the underlying assets of the project. Because of the “transparency by default” structure of the blockchain, both investors and token issuers can specify rights and limitations through smart contracts, freely trade tokens between stakeholders, and maintain stringent transactional records for audit purposes.
Solving An Old Problem
The gap between financing and infrastructure has created long-standing problems for economic development. The high costs and relatively low efficiency of traditional financing methods have created a rift between the economic need for new infrastructure projects and the capital needed to fund them.
Tokenization solves many of the underlying issues present within project finance, mainly through the increased liquidity offered to investors within an asset that has historically been locked in. Compared with conventional finance, tokenization can lower transactional costs and decrease counter-party risks.
Another long-standing barrier comes from the sources of capital financing, as traditional options rely on wealthy benefactors and large institutions to finance such projects. The fractional ownership offered through tokenization brings down many financial barriers to investment, as a new pool of smaller-scale investors can now enter the market, greatly enhancing the project’s access to alternative sources of capital.
Future Challenges
While tokenization offers robust solutions to the access and liquidity problems that arise with conventional financing methods, it can only be fully utilized if the underlying regulatory issues are adequately addressed. While security tokens and the tokenization process are still relatively new developments in the realms of project finance, the regulatory obstacles are slowly catching up.
While just a few years ago, the fall of the ICO was a significant deterrent for investors interested in crowdsourcing through digital securities, recent developments on the regulatory front have enabled the STO and tokenization process to become fully compliant with financial regulations. While some countries move faster than others, the seemingly exponential rise in the global regulation of STOs plays a significant role in assuaging the skepticism of traditional investors who may not be too familiar with blockchain technology and tokenization.
The Grand Re-opening of Secondary Markets
While we have already covered the liquidity benefits offered to investors through tokenization, perhaps one of the more underrated benefits of the process lies in the increased transaction speed when transferring ownership units.
Traditionally, secondary equities markets could take several weeks to complete the transfer of ownership from one investor to the next. This delay was a significant physical and psychological barrier for investors. The underlying assumption held that once they had acquired the assets, selling them on the secondary market would be next to impossible.
Since most crypto exchanges operate on a 24-hour cycle, the decentralized peer-to-peer nature of the verification process ensures that transactions can be completed within minutes or seconds. Such efficiencies within the secondary transfer market ensure delays are practically non-existent, and investors can freely transfer ownership of their tokens whenever they see fit.
The Evolution of Project Finance
While it is unlikely that conventional financing methods will disappear overnight, as more project sponsors leverage the STO for new projects, the benefits of tokenization will become more apparent.
Access to low-cost financing has always been a major obstacle, particularly with the financing of small-scale infrastructure projects. By tokenizing such projects, we can accelerate economic development on a global scale, giving power back to the very people who would benefit.
