At the beginning of the year, I participated in Wharton's course on the Economics of Blockchain and Digital Assets. 

The capstone project entailed brainstorming up an idea for a digital asset.

In the spirit of building in public, I thought I'd share where my head was back in February. 

If this sounds interesting to you and you'd like to build it — or if you (or someone you know) is building an equity vehicle like this already — then please send me an e-mail here.

This tokenized investment vehicle does not exist. These materials do not constitute a solicitation or any offer to buy or sell any security or financial instrument, or to participate in any investment strategy.

Dhow is a blockchain-based pooled investment vehicle. It provides individuals and institutions with a diversified portfolio of private-market assets in Africa, Asia, and Latin America.

Dhow aggregates capital commitments from global investors through the issuance of its own token (DHOW) and deploys the proceeds (in USDC) into small and mid-size businesses that are excluded from traditional sources of capital (e.g., banks, capital markets).

The value of Dhow is two-fold: it is an innovative financing vehicle for financially excluded businesses, and it expands the universe of investable opportunities for individuals and institutions.

According to the International Finance Corporation, 30 million small and mid-size business in developing countries face a finance gap surpassing $4 trillion.

These potential users of capital face a variety of challenges. For instance, legacy banks in these markets typically engage in plain-vanilla, collateralized lending. Non-bank lenders, such as private credit funds, have more sophisticated approaches to credit risk assessment and can engage in cash flow-based lending, however there are few of them.

Private equity (PE) funds constitute an alternative for larger, more professionalized businesses, however the returns of PE funds targeting the developing countries most in need of private capital have essentially been 300 basis points above the 10-year U.S. Treasury. Institutional and accredited investors justifiably ask why they should leave the United States for lower returns. As a result, fewer PE funds in these markets are able to raise capital, depriving SMEs of another source of risk capital.

From the sources of capital perspective, institutions are tired of fee drag eating into returns, the lack of transparency in PE funds, and misalignment between companies’ long-term growth initiatives and fund managers’ pecuniary benefits. In addition, non-accredited individual investors are deprived from accessing investments in private companies altogether.

A blockchain-based approached to private-markets investments addresses most of the problems outlined above. For example:

• Addresses the finance gap — Dhow aggregates new capital commitments across individuals and institutions, helping to close the finance gap besetting SMEs.

• Unlocks new capital — Through the security token, non-accredited investors may participate in private-markets investments through fractionalized ownership, unlocking a new source of investment capital.

• Lowers fees — Tokenholders participate and benefit directly from the underlying investee companies’ performance; management fees are reduced significantly, while the investment team’s long-term incentive is through DHOW token ownership. The fee drag of carried interest is removed.

• Brings transparency — Ownership of Dhow tokens would grant access to a portal where investee companies’ financial statements and operational metrics are viewable.

• Creates alignment — Dhow ameliorates the principal-agent problem and creates tighter alignment between entrepreneurs’ long-term growth initiatives and investors’ desire for long-term capital appreciation. The tokens could also be granted to companies’ employees as part of an incentive plan.

• Provides liquidity — Dhow tokens would be tradable on a decentralized exchange from day one, enabling liquidity for token owners, while liberating them from traditional PE funds wherein returns are dependent on an exit or liquidity event.

Given that Dhow would utilize a security token (DHOW), holders would receive numerous rights, including:

• Economic rights — DHOW holders would be entitled to receive a pro rata share of dividends from the underlying businesses. Over time, the token’s value should appreciate as the investee companies attain / exceed their growth plans.

• Information rights — DHOW holders would have access to companies’ financial statements and other material disclosures. They would also receive the same from the investment team managing the assets.

• Governance rights — DHOW holders would be able to vote on delegates to serve as Governance Council members (akin to a Board of Directors). The Governance Council would include independent remuneration and audit committees, and would provide approvals for operating expenses. The Governing Council could also seek community feedback on key decisions (i.e., minting tokens to raise a follow-on pool of capital).

• Community benefits — DHOW holders would be able to participate in a gated community. This could extend beyond the typical Discord server to include members-only content and discounts on merchandise / services produced by investee companies.

The supply of DHOW tokens would initially be fixed at 100 million tokens in an initial token offering. Given that this would be a security token, we are less concerned with tokenomics / distribution schedules than protocols and dApps. The DHOW offering is akin to a private placement.

At the initial token offering, each DHOW token would be exchanged for 1 USDC. This implies a $100 million raise (gross of fees), the proceeds of which would be broken out as follows:

• ~ 80% of capital to be used for primary investments in 10 to 15 companies (~ $5M to $8M per investment)

• ~ 15% reserved for follow-on investments in high-performing companies

• Balance to cover startup / operating expenses (TBD)

Should no companies merit a follow-on investment, the ~ 15 million DHOW tokens could be burned to replicate the economics of a buyback.

Over time, the community could vote on a follow-on capital raise / token issuance to expand the number of investee companies. Conceivably, DHOW could become a global index fund for private SMEs.

Dhow would launch on the Polygon network for two reasons:

• Ecosystem — Polygon is an Ethereum Virtual Machine-compatible sidechain of Ethereum, which means it can leverage the existing Ethereum developer network. In addition, Polygon has 7,000+ dApps, including decentralized exchanges. Moreover, Polygon bridges easily to the Ethereum Mainnet.

• Fees — Dhow seeks to drive financial inclusion, and that includes by enabling individual investors all around the world access to private-markets opportunities. Polygon’s relatively low transaction fees not only enable more people to participate, but also allow for a greater portion of each investment to go toward underbanked businesses.

Dhow would utilize smart contracts, primarily for dividend payments. The mechanics would be as follows: upon receipt of a dividend payment from a portfolio company, the Dhow vehicle would leverage a smart contract to convert the proceeds into USDC (if necessary). Upon conversion, the USDC would be transferred to the wallets of DHOW holders as of the date of record.

There are two key stakeholder groups that will need to adopt the asset: investors and the Dhow team.

Beyond the financial cost of investing, investors would face the opportunity cost of allocating capital to DHOW tokens over other assets. In addition, there would be a mismatch between the liquidity of the DHOW token (virtually day one on a DEX) and the long-term nature of business-building in developing countries.

The benefits to investors would be dividend payments and long-term capital appreciation through a geographically and sector-diversified portfolio of non-listed assets. This breadth of diversification could reduce macroeconomic, jurisdiction, and idiosyncratic risks.

The Dhow team would need to accumulate DHOW tokens to tighten alignment between the performance of the token and the underlying portfolio companies. Conceivably, members of the Dhow team would be encouraged to purchase a certain percentage of the tokens at launch — akin to a general partner’s commitment to a private equity fund — to ensure the team has skin in the game. As with investors, the Dhow team benefits from dividend payments and long-term capital appreciation.

In a non-pecuniary sense, both investors and Dhow team members could derive benefits from the operational and financial data available to DHOW holders. To wit, enterprising individuals might identify the key value drivers of SME growth in specific markets or sectors. Over time, if the project gains traction and demonstrates value, follow-on capital raises could create a portfolio of sufficient scale to create a (commercial) database that benchmarks key performance indicators (such as SAP), or indeed, become an investable index in its own right.

Separately, one could foresee DHOW tokens being used to pay for third-party services that enhance the operations of portfolio companies, thereby creating tighter alignment between advice and outcomes.

The Dhow concept could be susceptible to a few systemic risks.

The first would be a hack or failure of the Polygon (or Ethereum) network, which would undermine trust in Dhow (and the DHOW tokens), leading to a meaningful deviation in token value relative to investee company fundamentals.

The second element of systemic risk would be tied to Dhow’s reliance on USDC as the currency for investments and dividend flows. USDC is a multichain currency (e.g., Avalanche, Ethereum, Solana, etc.). If the collateral backing USDC turns out not to be at parity with the U.S. dollar, then a liquidity crisis on, say Solana, could hit the Ethereum chain and thus impact Dhow.

The third systemic risk pertains to regulation. Given that the Dhow concept is a security token, and the vision is to raise capital globally for investments in multiple jurisdictions, regulators could kill the concept swiftly. In practical terms, Dhow would need to start with a small pilot program to prove the concept in one or two jurisdictions, particularly those with forward-leaning regulators that offer a sandbox for crypto innovation.

*This was cross-published at caseyjr.org. *