Real Assets & Financial Assets | Understanding Asset Types (Part 1)

in DTube2 years ago

Welcome to Savage Corner; where finance and crypto meet. Today’s newsletter is the full transcript of our second YouTube video. If you haven’t seen it, please watch and like. If you prefer video to written content, subscribe on Youtube and let me know. I plan to ‘pick up the pace’ and publish videos more frequently in the months ahead.

Today I'd like to talk about finance and babies. Don't try to explain finance to babies, they are not ready for the concepts!

Okay, actually, today I want to talk about asset types. Asset types are a pretty basic finance concept, but it's material that can be new to many people from the crypto world. We're getting moved pretty quickly. Pause the video, go back, take notes if you need to. Or look below the video for the link to where the transcript of this video is published.

When we think about asset types in the traditional finance world, there are basically two categories. There are real assets and financial assets.

#Real Assets
Real Assets are something tangible, like this cup of coffee or this shirt. We don't think of a cup of coffee or a shirt as being assets. What if it's this piece of land, or this railroad car full of coffee beans? Specific physical things, real assets have non fungible characteristics. This piece of land is different from the adjacent piece of land, this railroad car full of coffee beans came from a different farm than the next railroad car full of coffee beans.

Trading in real assets requires a completely different mental framework because of this non fungible characteristic. You’re not only thinking about the individual characteristics of this particular one. You're also thinking about the general characteristics of the asset class. Wine for example, was it a good year? Is it a good vintner? Is champagne coming in or out of style? I don't like bubbles in my wine!

#Financial Assets
Financial assets are distinctly different from real assets. Instead of being physical, tangible things, they are actually bundled legal rights. We're getting into subcategories here, but there are basically three subcategories of financial assets. There are bonds or fixed income, there are equities, which you might hear referred to as stock. And there are synthetic assets or derivatives.

A derivative is any financial asset that derives its value from some other financial asset or real asset. This is where it starts to get really interesting.

One of the most commonly traded types of derivatives is called a future. And a future is actually trading future delivery of real assets. Instead of buying a railroad car full of coffee beans, you're buying a scheduled delivery of a railroad car of coffee beans. If you hold that scheduled delivery until it matures, and that date arrives, you need to find a place to put a railroad car full of coffee beats. If you don't want to receive a railroad car full of coffee beans, you need to sell that financial asset before the scheduled delivery date; on to someone else who is either covering a short position (they don't want to deliver a railroad car full of coffee beans), or someone who actually does want to receive a railroad car with coffee beans. That's a classic example of futures.

Okay, equity would be like ownership in something. So, stock is typically ownership in an underlying enterprise. I own shares of Apple, which means I actually have a legal claim, a bundled legal right to a portion of Apple's earnings. Now, Apple's Board of Directors might choose to retain their earnings instead of paying a dividend. But I still own a legal right to some theoretical ownership of Apple; that legal right has value and it trades.

##Fixed Income
My fixed income asset is somebody else's contracted liability. I may have a signed legal note where I lend somebody $100,000; they are required to repay $100,000 in five years, Every year between now and the repayment date, they're paying me $8,000 a year. We could think of that as being an 8% coupon on a $100,000 note. That would be an example of fixed income in the traditional financial markets.

#Financial Assets -> Very Large Numbers!!
The numbers get very big very fast. When we look at futures, we're not talking about a railroad car of coffee beans, we're talking about a train of coffee beans. When we look at the fixed income markets, we're not talking about $100,000 note, we're talking about billions of dollars of bonds, or maybe hundreds of millions of dollars of bonds. When we're talking about equity, it can actually be shares in a very small company this is a $15 million company, there's a million shares outstanding, and so each share is valued at $15. Or it could be, this is a trillion dollar company, there's 100 billion shares outstanding, so each share trades it $10. Very big numbers.

#Bundled Legal Rights - Financial Assets
Now that we've covered the three basic subcategories of financial assets, which are derivatives, fixed income, and equities, I really want to lean into the fact that all of these financial assets are actually bundled legal rights.

Rather than it being a tangible item sitting in Apple's lobby, taking money out of their pockets every time they receive a check, it's an intangible. I have a right to money, but it's kind of wishy-washy. Maybe they'll pay me some of it, or maybe in order to capture it I have to actually sell that right to someone. Either way, the value of that is actually backed by the theoretical legal right that's enforceable in court.

Similarly, with derivatives there are legal rights, and those rights are enforceable against some counterparty, which is the other side of the trade. With fixed income, there are enforceable legal rights that are enforceable against the lender. Being able to take the lender to court to request repayment, or have some legal rights around that repayment, is part of what gives it value.

#Individual Legal Rights - Real Assets
Circling back to real assets, real assets value is also backed by legal rights. Because real assets have non fungible characteristics, their legal rights are individual rather than bundled. This title to this piece of land, this title to this adjacent piece of land, that title may include legal rights to that land and it may specifically exclude certain rights. Does this title give me water rights? If it doesn't give me water rights, who owns the water rights? The value of that land can be influenced by which rights are actually included in the title, even though I'm standing on the land, either way.

For some real assets the legal rights are much more abstract. I own this coffee cup. If somebody breaks into my house and steals this coffee cup, I don't know why they would. But if they did, I may decide that the legal right to recover that coffee cup is kind of irrelevant to me, and let it go. I may decide this is a priceless coffee cup. It was my grandmother's (it wasn't). But if it was, and I cared that much, I could file a police report and the police would just say, "meh", and again, that legal right doesn't have a lot of value. I could hire a private investigator and go find them. And then what? File an injunction in civil court to have the coffee cup recovered? Technically, I have the legal right to do that. Is it worth it? I don't know. It depends on the value of the coffee cup.

In a sense, all of the value of traditional finance, all of the value of assets in traditional finance, traces to some degree back to the fact that they carry legal rights. If a Mona Lisa is stolen off of my wall, (this isn't a Mona Lisa); if this “not Mona Lisa” is stolen off of my wall, I have the right to recovery. It could pop up in a museum in 50 years and if I have a police report showing that it was stolen off of my wall in 2021, the museum is required to return it to me. Charges could actually be brought against the museum for receiving stolen goods. So when we're looking at real assets, provenance matters, right?

I don't want to get too deeply into valuation framework for real assets. And I definitely don't want to get too deeply into valuation framework for financial assets because there is a lot to unpack there and that could be hundreds of future videos.

The key takeaway as we transition from traditional finance assets, real assets and financial assets, into blockchain assets, is that all real assets and all financial assets are accompanied by either individual legal rights or bundled legal rights.

Thank you for coming to Savage Corner. Again, my name is Joseph Savage. I'm your host. Next time on the Savage Corner YouTube Channel, we're going to talk about blockchain assets, the way that I break down and categorize blockchain assets, and how that relates to financial assets.

There's been a lot to unpack in today's session; this post was originally published at where you can find the link to a downloadable worksheet!

Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.

Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Savage Corner writers hold crypto assets and actively trade in certain markets.

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