The fund managers at Wave Financial Group considered different options when they were looking for an investment they could turn into a digital asset. Fine art, wine, and racehorses all lost out to America’s humble native spirit: Kentucky whiskey—$2.5 million worth of it.
The group’s Kentucky Whiskey 2020 Digital Fund purchased 2,500 barrels of new whiskey in 2020, betting that the barrels will increase in value by three to five times in the course of the five years they spend stored in a warehouse in Kentucky. The group initially had a higher target of 25,000 barrels.
It isn’t a traditional investment and Wave Financial is considering a 2021 version of the fund for this year. The fund is really an experiment in the burgeoning digital asset space: the group will issue digital “tokens,” representing shares in the fund, which investors will be able to trade on a crypto exchange while the barrels are being held in storage, creating a new market and adding a second tier of complexity to the investment.
How does the fund work?
Once the 2020 fund closed for investment, California-based Wave Financial completed purchasing barrels of new Kentucky whiskey from its partner, Wilderness Trail Distillery, and moved them to a warehouse for storage.
The aging of the whiskey is critical. Bourbon, by U.S. law, must be aged in new oak barrels. The maturation is also how whiskey increases in value. Wave Financial estimates that a single barrel of new Kentucky whiskey will increase in value from around $1,000 to between $3,000 and $5,000, or more, after five years.
Even if the selling costs include high commissions to retailers or distributors, the group projects returns of at least three times the initial investment.
After a one-year lockup period, Wave Financial will issue investors with digital tokens representing shares in the fund. The tokens can then be traded on one of the regulated crypto asset exchanges the group is currently in talks with.
“The tokenization is about putting the fractional ownership of the fund onto the blockchain in tokens,” said Benjamin Tsai, Wave Financial’s president and managing partner, in an interview with Barron’s. “When one barrel gets sold, everybody is fractionally enjoying that capture of value.” Blockchain is an essential technology for cryptocurrencies. In short, it’s a novel, decentralized ledger system that verifies and records transactions.
In the physical world, Wave Financial will likely sell the barrels over a period, potentially across a few years, depending on Kentucky market conditions. When the barrels are sold, investors will exchange their tokens to Wave for their share of the return on the fund, though the fund may return some capital before all barrels are sold.
Why Kentucky whiskey?
Tsai and his partners at Wave Financial settled on Kentucky whiskey after considering a range of other assets. They needed something that was alternative enough to warrant its own token market, but dynamic enough to make a strong investment over time. Hard assets were an obvious choice.
Some of the assets that didn’t make the cut include collectibles, like fine art or wine. They also considered real estate, Indonesian carbon credit, and Japanese racehorses.
“I don’t want to sound too dry about it,” Tsai said. “Our model is purely about it being a good investment.”
Wave Financial’s market research projects that demand for Kentucky bourbon will increase year-over-year through 2027. Their data also show it to be a somewhat “recession-proof” investment: during the global financial crisis, U.S. whiskey sales mostly held firm, growing in both 2007 and 2008, but slipping by 1.4% in 2009 before returning to growth in 2010.
Another key reason Wave Financial selected Kentucky whiskey is that, as an asset, it is more like a commodity than a collectible. There is a regulated process for distilling and aging it, only marginal differences between the value of most whiskeys at scale, and a liquid market of distillers, bottlers, and distributors that regularly buy and sell mature whiskey domestically and internationally.
“We are in a commodity space, this is a commodity, and I would like people to think of this as a commodity,” Tsai said.
In other words, it’s a more stable market than Japanese racehorses.
Tsai is confident that Wave Financial will be able to find a buyer at a good price when the whiskey has matured. They have a few options, including selling the whiskey back to Wilderness Trail if the distiller has immediate supply needs for mature whiskey. They could also sell to other distillers, non-distiller producers like bottlers, and international buyers.
The tokenization aspect itself is a little more uncertain. There seems to be little incentive for investors to sell their shares in the fund prematurely, and it’s unclear how liquid the market for the tokens themselves will be. Tsai seems to think most investors will hold on.
“Our fund is basically a private-equity fund,” Tsai said. “If we don’t have the token component then they’re basically along for the ride.”
The view from Barron’s
Wave Financial’s whiskey fund is a big bet on a very alternative market. The fundamentals seem solid, the liquids are insured, and Tsai, who used to run Bank of America Merrill Lynch’s commodities business in Asia, has more of a traditional finance background than many in the crypto asset space.
However, it remains that this is an unknown play that looks really good on paper. The past decade has been kind to American whiskey: the drink has become more popular over the past 10 years, but five years in a barrel is a long time for tastes to change, and this investment isn’t without that risk. The projections of future demand for Kentucky whiskey are encouraging, but far from rock-solid financial modeling.
But more meaningful to markets than the investment itself is the token structure. Digital assets are a burgeoning field, and this is a genuine attempt to break new ground on a technical front while also pitching a robust investment case.
Even if the token market isn’t as popular as pitched, it will be an innovation. The fund closing comes as
is ripping to record highs on what seems like a daily basis, and digital assets are being taken seriously in a way not seen since before the crypto market crash in 2017.