Tokenization is the technical process of representing rights to an asset (such as financial securities) on a blockchain. In the context of private equity, this involves the creation of a token that represents ownership interests in a private equity fund – a so-called fund unit. These tokens can then easily be bought and sold digitally. There are further additional advantages which we will explore in this article.
Several private equity firms have already made the step to tokenized their funds. Early results are positive. In the US for example, Securitize, which is one of the pioneers in digital securities, has already orchestrated the tokenization of multiple private equity funds. In other jurisdictions such as Switzerland, other players like CompanyDAO use SPVs to tokenize this typically exclusive asset class. These funds have already experienced enhanced liquidity and broader investor participation.
Furthermore, investor sentiment towards tokenization is very positive. A survey conducted by Deloitte found that 75% of institutional investors believe that digital assets will become a common part of their investment portfolios within the next 5 years.
A tokenized private equity fund would operate pretty similarly to a traditional fund, but it comes with a more digital twist.
In the context of a tokenized private equity fund, each token generally represents a proportional ownership interest in the fund’s underlying portfolio. This includes rights to:
If you are a fund manager considering tokenizing your fund units, think about the underlying assets of the fund themselves. Are they tokenized as well, or are they so-called “traditional” assets? The question is relevant, since tokenizing the fund without tokenizing its underlying assets will limit potential benefits.
Tokenized Underlying Assets
When the underlying assets are tokenized, the benefits of transparency, efficiency, and liquidity extend beyond the fund level to the asset level. For example, if a private equity fund invests in tokenized real estate or private companies, each of these assets can be traded and managed with the same efficiency as the fund tokens. There are also the automation advantages brought by smart contracts. For example, proceeds from a successful exit of an underlying asset could be automatically distributed as cash waterfalls to holders of the fund units.
Non-Tokenized Underlying Assets
In the case that underlying assets are not tokenized, some of the benefits of tokenization are not available. The efficiency gains for example are limited, as the fund manager must handle two separate sets of processes: one for traditional assets, one for tokenized fund units. That said, tokenized fund units retain certain advantages. They can be easily transferred from investor to investor, especially if they are listed on an efficient secondary market. Fractionalization of the fund units remains technically possible, for lower investors barriers to entry.
Which of the above scenarios makes the most sense?
In the end, the decision to tokenize underlying assets or not really depends on the specific goals and perceived advantages of the fund. If the primary objective is to enhance liquidity and accessibility for investors, tokenizing the fund may be sufficient. However, for maximum efficiency and transparency, tokenizing the underlying assets makes the most sense, for the additional synergies that they bring.
