Fine arts, held as prized possessions, are also an attractive asset class due to their immunity to political change and less volatility compared with financial assets, and potential for high investment returns. In 2017, the market value grew by 12% and is valued at $63.7 billion. Despite its historical upside, the market is plagued by opacity, illiquidity, tax evasion, risk of fakes, misattributions and remains confined to the ultra-rich. The market is also controlled by a few well entrenched middlemen who operate on the strength of their reputation. Five countries hold 92% share of the fine arts market; China and U.S. segments are the largest (see Figure 1).
The rise of blockchain technology-led platforms, or marketplaces in the fine arts space, is set to herald significant shifts in the trading of fine arts. Several new-age tech-wielding players have recently surfaced such as Maecenas, Deloitte’s ArtTracltive, Verisart, Ascribe, Monegraph, Artlery, and asset registry Codex and a host of its ecosystem partners — Heffel Fine Art Auction House, Feral Horses, etc. Traditional players such as Dadiani Fine Art gallery and Whitestone Gallery are also gearing up to join the blockchain bandwagon.
Unshackled by Blockchain
Blockchain’s distributed database records immutability, consensus algorithms, tokenization, transparency, traceability, etc., provides an opportunity for everyone from artists through dealers and auction houses to radically transform the fine arts market.
First and foremost is the move to transparency from what is an opaque market, reforming transactional activities on the basis of shared operating protocols. An important aspect of investment in art is ensuring that the artwork is indeed original and its vendor is indeed the rightful owner. This is currently handled by middle agencies such as auction houses, and despite their virtuous reputations, the risk for fraud remains as an issue.
Blockchain-driven authenticity and provenance is seen as a way to shift trust from reputation to technology. Blockchain brings the operationally critical ingredient of traceability across the stages of asset lifecycle — from asset ownership certification creation to subsequent transactions, a far cry from the traditional market, where individuals each hold paperwork that conveys their version of truth. Initiatives are underway to develop industry standards for identifying fakes, forged and stolen arts.
Blockchain could enable a variety of business outcomes.
Significant Cost Reduction
A blockchain-based business model for the fine arts market can lead to several cost advantages besides augmenting overall revenue through growth of the market.
A major source of cost reduction is in transaction fees. In the traditional market such fees can add up to 25% of the total cost of a transaction. Transaction fees tagged on by emerging blockchain platforms are typically around 6%.
Blockchain’s peer-to-peer nature would eliminate middlemen and further reduce costs.
Moreover, shipping and storage costs reductions are possible since the blockchain platform, in most cases, assumes the responsibility of safe-keeping the assets while investors trade the tokenized versions of the works.
The problem of reneged bids, which can undermine the profitability of transactional activity, is likely to decline with the use of blockchain-based platforms (i.e., by requiring bidders to deposit cryptocurrency in smart escrow contracts, such as the approach taken by Codex’s Biddable application).
Reduced shipping frequencies implies reduced risk of damage. Reduced in-transit damage risk and overall improvement in process are expected to result in rationalization of insurance costs benefitting both insurers and customers.
Increased Revenue to Artists
Artists would receive greater compensation via blockchain on the initial sale and on resale via royalty payments (due to lower transaction fees). The latter are often overlooked by the incumbent system. Blockchain could also represent a boon in the digital arts space since blockchain would establish unique identities for limited edition artworks, which hitherto remained impossible.
Fractional Investment Spurs Market Expansion
Blockchain is enabling tokenization, which is motivating innovators to offer smaller denominated financial assets (created on the back of a high-priced piece of art for sale) of a single piece of art to a group of individuals. Think exchange traded funds (ETFs), which are backed by underlying securities or commodities such as gold. Known as fractional investment, this innovation makes available smaller denominated, art-backed non-fungible, non-replaceable assets, and could open up ownership of an asset class that has traditionally remained closed to all except the ultra-rich. Owners of high-value artworks can use fractional mechanism to sell shares and raise money while retaining ownership control. This can be done by issuing tokenized units of assets to the extent of 49% of the asset value. Galleries, too, are expected to make use of this mechanism to finance their new purchases.
Implications to Banks, Wealth Managers and Insurers
A Deloitte Art and Finance report notes that 88% of private offices and 75% of high net worth and ultra-high net worth clients are seeking artworks as assets in their investment portfolios. The demand from wealth management clients for fine arts investments is growing and the emergence of blockchain-based markets has the potential to enlarge the investor base and expand the opportunity for all participants. Banks, wealth management entities and insurance players would do well to evaluate this emerging digital ecosystem and engage their customers on the resultant opportunities.
For art-oriented investment funds, the lack of liquidity and longer lock-in periods may be eliminated.
Capital market firms can leverage the transformed fine arts market to boost the demand for such funds as a way to help clients diversify their portfolios. They can also make fine arts a top-ranking asset class by improving market data feeds, order books, indices and derivatives.
Portfolio managers can exploit improved information flows to more accurately price their positions, leading to efficient markets.
Banks that offer art asset-backed loans can improve their fund-based services and better serve their clients.
Insurers can avail themselves to blockchain’s reduced infrastructure costs to streamline inspection (i.e., authenticating and validation ownership), administration and underwriting. Codex, for instance, lets insurers track possession of artworks during transit, verify insurance valuations and administer claims.
While there are many upsides, organizations in the lending, investment and insurance markets will need to dramatically overhaul their business processes to keep pace with the transformative changes happening across the blockchain-enabled fine arts market.
The Road Ahead
The fine arts market is unregulated and is known to suffer incidents of money laundering. Banking, wealth management and insurance players have to factor this in before plunging into the blockchain-powered fine arts marketplace. Blockchain, despite its tremendous potential, needs to be embraced with adequate security measures. Read “Toward Building Secure Blockchains” and “Ingredients to Secure Blockchain Data & Transactional Jewels” to learn more.
This fledgling market will be a test case for the interplay of two opposing forces — affordability-driven demand and exclusivity-based market value shaping. The resulting culture clash between new investors who are expected to participate via fractional investments, and the class of collectors who are known to take pride in possessing art pieces in exclusivity will be interesting. The market should evolve, as blockchain-based platforms accommodate both categories of participants, resulting in significant market expansion and opportunities for all.