Many investors believe that even the most bullish market has nowhere to go but up. For a lot of new entrants that started their investment careers at the bottom of the Q1 2020 crash, this has proven true. But for some, feasting on the fruits of flourishing indices is not enough.

Seasoned players know that there is more room to run on the private market. This is where the “accredited investor class” composed of high-net-worth individuals and institutional fund managers have placed their $10+ trillion in bets on alternative investments like hedge funds and private equity. In 2020, the SEC relaxed the qualifications for accredited investor status in the name of “democratizing access” to alternative assets, essentially removing barriers to entry without building the accompanying guardrails.

What got more coverage from the financial press however, was the concurrent rise of the retail investor on Robinhood, a mobile app offering fractionalized shares in otherwise prohibitively expensive assets. Buoyed by seemingly infinite liquidity pouring in from the Fed, it’s difficult to determine where exactly the threat of moral hazard may lie in this scenario. But as many a Robinhood nightmare story goes, the potential losses can be catastrophic for retail investors who are unfamiliar with the complex rules that maintain “efficient markets.”

This confluence of trends poses a question: are free markets sustainable without informed participants?

My case study for this discussion is Masterworks.io, an art market / fintech platform recently featured on Jim Cramer’s CNBC show, “Mad Money.” Masterworks promises to democratize access to the art market by offering fractionalized ownership shares of Post-War and contemporary paintings that command millions of dollars at auction for as little as $20.

Fine art is the ultimate “sophisticated asset class” and is at its core elitist. It’s an insider’s game. There are no real regulatory bodies governing the sale of artworks and primary market prices are notoriously opaque. Only when art reaches public auction are prices revealed, and even still such sales are predominately orchestrated behind the scenes with the auction floor serving merely as theatre. It is a simulation inside the simulation that is capitalism.

Masterworks claims to “outsmart the art market” with their proprietary data insights. However, Masterworks reveals in their SEC Offering Circular that they use Third Party data that they don’t independently verify. Masterworks goes on to explain the risks associated with the use of this data, their core value proposition:

The statistical data relating to the art market is difficult to obtain, may be incomplete, out-of-date, or inconsistent and you should not place undue reliance on any statistical or general information related to the art market included in this offering circular.

When it comes to picking winners, Masterworks showcases the outrageous returns of many famous paintings, including works by Monet that realized 40x multiples at auction. It’s true that art outperforms any other asset class as an intergenerational store of wealth, so the opportunity to displace the control of the rich patrons and share in the cultural value creation sounds decidedly democratic.

But there is a lot of fine print. Those 40x multiples are over a 40-year holding period. Art is extremely illiquid. Paintings flip only a handful of times in a lifetime and thus are not frequently exposed to market validation. Who is to say that this small team with no track record of art market success can predict which paintings will generate such outsized returns within the 3–10 year holding period Masterworks promises investors?

Not Masterworks, as they explicitly state:

The timing and potential price of a sale of the Painting are impossible to predict.

The primary market offerings of “securitized shares” in paintings are not actually approved by the SEC, nor is Masterworks a FINRA licensed broker-dealer. Masterworks profits with a 1.5 and 20 management fee model (same as hedge funds) and LPs in the primary fund are required to be accredited investors by traditional net assets and income rules, so this isn’t too democratizing.

Masterworks has gamified the secondary market with a trading platform, much like Robinhood, that allows anyone to buy and sell fractionalized shares of paintings providing investors with “art market exposure.” However, Masterworks explains that this marketplace is nothing more than a “bulletin board” to merely facilitate private exchanges between collectors. Masterworks states they have “no involvement” with this secondary market and cannot ensure monetization.

The truth of the matter is that there is no such thing as a fractional share of a painting or a stock — the concept is functionally valueless anywhere outside of these closed systems. Masterworks, like Robinhood, is exploiting asymmetric knowledge by means of deceit. They’re manipulating the rules of the game by weaponizing the complexities of our regulatory system and using them to manufacture consent.

We are witnessing the systemic failure of the institutions we built and fund with tax dollars to protect us from exactly these kinds of schemes. This is the infrastructure that we need our government to build and maintain. Instead, two of the four most powerful cabinet positions in our current administration are held by partners at the same private equity firm. Here is how they explain their value proposition:

Pine Island Capital Partners is a unique partnership model composed of experienced investment professionals and former senior government and military leaders formed to source attractive middle market investment opportunities with the potential to benefit and grow through the involvement of the Pine Island team.

This unique model pairs investment professionals with “D.C. partners,” a list of names that includes former senators, ambassadors, and generals, creating a virtuous circle by “capitalizing on their influential networks.” Pine Island’s sector focus includes Aerospace and Defense, Government Services, Space Systems, and Information-based technologies.

Pine Island’s investment vehicle of choice is the SPAC, another shadowy financial innovation that became increasingly popular over the course of the last year. SPACs are “blank check” shell corporations that enable investors to sell shares in an undisclosed, often unidentified private company on the public market with very little regulatory oversight. Anyone can buy shares in SPACs — they are traded on the New York Stock Exchange. You can even buy fractional shares of SPACs on Robinhood for $1.

This confluence of trends poses a second question: are free markets sustainable with informed participants?

We cannot blame this on the retail investors’ lack of “sophistication” — there is no amount of due diligence that can adequately prepare an individual to navigate these murky waters with constantly shifting tides. We can’t possibly blame this on the individual rendered powerless by the intracies of a system meticulously designed with exactly that intent. And yet, we will.

This is the deluge that triggers the cascade that ushers in the impending flood that drowns us all. We have seen these patterns before and we will see them again. We are destined to repeat history until we learn our lessons.

Surely some revelation is at hand; Surely the Second Coming is at hand.

And yet, here we are, waiting for our savior to arrive.

Many investors believe that even the most bullish market has nowhere to go but up. For a lot of new entrants that started their investment careers at the bottom of the Q1 2020 crash, this has proven true. But for some, feasting on the fruits of flourishing indices is not enough.

Seasoned players know that there is more room to run on the private market. This is where the “accredited investor class” composed of high-net-worth individuals and institutional fund managers have placed their $10+ trillion in bets on alternative investments like hedge funds and private equity. In 2020, the SEC relaxed the qualifications for accredited investor status in the name of “democratizing access” to alternative assets, essentially removing barriers to entry without building the accompanying guardrails.

What got more coverage from the financial press however, was the concurrent rise of the retail investor on Robinhood, a mobile app offering fractionalized shares in otherwise prohibitively expensive assets. Buoyed by seemingly infinite liquidity pouring in from the Fed, it’s difficult to determine where exactly the threat of moral hazard may lie in this scenario. But as many a Robinhood nightmare story goes, the potential losses can be catastrophic for retail investors who are unfamiliar with the complex rules that maintain “efficient markets.”

This confluence of trends poses a question: are free markets sustainable without informed participants?

My case study for this discussion is Masterworks.io, an art market / fintech platform recently featured on Jim Cramer’s CNBC show, “Mad Money.” Masterworks promises to democratize access to the art market by offering fractionalized ownership shares of Post-War and contemporary paintings that command millions of dollars at auction for as little as $20.

Fine art is the ultimate “sophisticated asset class” and is at its core elitist. It’s an insider’s game. There are no real regulatory bodies governing the sale of artworks and primary market prices are notoriously opaque. Only when art reaches public auction are prices revealed, and even still such sales are predominately orchestrated behind the scenes with the auction floor serving merely as theatre. It is a simulation inside the simulation that is capitalism.

Masterworks claims to “outsmart the art market” with their proprietary data insights. However, Masterworks reveals in their SEC Offering Circular that they use Third Party data that they don’t independently verify. Masterworks goes on to explain the risks associated with the use of this data, their core value proposition:

The statistical data relating to the art market is difficult to obtain, may be incomplete, out-of-date, or inconsistent and you should not place undue reliance on any statistical or general information related to the art market included in this offering circular.

When it comes to picking winners, Masterworks showcases the outrageous returns of many famous paintings, including works by Monet that realized 40x multiples at auction. It’s true that art outperforms any other asset class as an intergenerational store of wealth, so the opportunity to displace the control of the rich patrons and share in the cultural value creation sounds decidedly democratic.

But there is a lot of fine print. Those 40x multiples are over a 40-year holding period. Art is extremely illiquid. Paintings flip only a handful of times in a lifetime and thus are not frequently exposed to market validation. Who is to say that this small team with no track record of art market success can predict which paintings will generate such outsized returns within the 3–10 year holding period Masterworks promises investors?

Not Masterworks, as they explicitly state:

The timing and potential price of a sale of the Painting are impossible to predict.

The primary market offerings of “securitized shares” in paintings are not actually approved by the SEC, nor is Masterworks a FINRA licensed broker-dealer. Masterworks profits with a 1.5 and 20 management fee model (same as hedge funds) and LPs in the primary fund are required to be accredited investors by traditional net assets and income rules, so this isn’t too democratizing.

Masterworks has gamified the secondary market with a trading platform, much like Robinhood, that allows anyone to buy and sell fractionalized shares of paintings providing investors with “art market exposure.” However, Masterworks explains that this marketplace is nothing more than a “bulletin board” to merely facilitate private exchanges between collectors. Masterworks states they have “no involvement” with this secondary market and cannot ensure monetization.

The truth of the matter is that there is no such thing as a fractional share of a painting or a stock — the concept is functionally valueless anywhere outside of these closed systems. Masterworks, like Robinhood, is exploiting asymmetric knowledge by means of deceit. They’re manipulating the rules of the game by weaponizing the complexities of our regulatory system and using them to manufacture consent.

We are witnessing the systemic failure of the institutions we built and fund with tax dollars to protect us from exactly these kinds of schemes. This is the infrastructure that we need our government to build and maintain. Instead, two of the four most powerful cabinet positions in our current administration are held by partners at the same private equity firm. Here is how they explain their value proposition:

Pine Island Capital Partners is a unique partnership model composed of experienced investment professionals and former senior government and military leaders formed to source attractive middle market investment opportunities with the potential to benefit and grow through the involvement of the Pine Island team.

This unique model pairs investment professionals with “D.C. partners,” a list of names that includes former senators, ambassadors, and generals, creating a virtuous circle by “capitalizing on their influential networks.” Pine Island’s sector focus includes Aerospace and Defense, Government Services, Space Systems, and Information-based technologies.

Pine Island’s investment vehicle of choice is the SPAC, another shadowy financial innovation that became increasingly popular over the course of the last year. SPACs are “blank check” shell corporations that enable investors to sell shares in an undisclosed, often unidentified private company on the public market with very little regulatory oversight. Anyone can buy shares in SPACs — they are traded on the New York Stock Exchange. You can even buy fractional shares of SPACs on Robinhood for $1.

This confluence of trends poses a second question: are free markets sustainable with informed participants?

We cannot blame this on the retail investors’ lack of “sophistication” — there is no amount of due diligence that can adequately prepare an individual to navigate these murky waters with constantly shifting tides. We can’t possibly blame this on the individual rendered powerless by the intracies of a system meticulously designed with exactly that intent. And yet, we will.

This is the deluge that triggers the cascade that ushers in the impending flood that drowns us all. We have seen these patterns before and we will see them again. We are destined to repeat history until we learn our lessons.

Surely some revelation is at hand; Surely the Second Coming is at hand.

And yet, here we are, waiting for our savior to arrive.