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Decentralised, Fractionalised and Tokenised: Digital Assets Represent the Future in Private Markets

Amsterdam / Guernsey / Ireland / Jersey / London / Luxembourg / Netherlands 17th May 2024
Private market managers looking for new and innovative ways to attract investors are turning to tokenisation as an answer.

Cryptocurrencies are decentralised, unregulated digital currencies trading on a blockchain. Tokenisation, also using a blockchain, is the issuance of digital tokens that represent ownership in an underlying asset (examples include equities, bonds, funds, and illiquid assets like private equity and real estate).

In the battle of new financial technologies, it is tokenisation that looks to an increasingly significant future in private markets. Bill Prew, Group Director – ICS Strategic Execution, and Kobus Cronje, Managing Director – Guernsey, look at the implications for the sector:

 

Digital assets are democratising private markets

One of the main selling points of tokenisation is that it allows for assets to be fractionalised, or split up, into much smaller units, making them more accessible to a broader group of investors.

In the world of private markets, this could unlock a number of distribution benefits by breaking down some of the entry barriers investors typically face when allocating into the asset class.

Today, most private market funds will have a high minimum investment threshold well into the millions, putting them out of bounds for all but the wealthiest investors. In contrast, a tokenised private market fund would be much cheaper for investors to subscribe to.

Given that many private market managers are currently trying to diversify their client base including the targeting of retail investors, tokenisation could provide them with an opening.

Equally, tokenisation might also enable smaller or mid-sized institutions such as public pension funds to access private market funds directly, instead of going through intermediaries such as consultants or via a funds of funds.

Liquidity is another value add enabled by tokenisation. Previously, investors in private market funds were subject to strict lock up periods and only had limited exit opportunities, but a tokenised private market fund can be traded on the secondary market.

Investors and asset services should, in time, also obtain cost savings through tokenisation as it allows for complex processes to be automated while mutualised workflows reduce the need for manual reconciliation.[1]

Additionally, investors and other parties may benefit from better transparency as information can be shared seamlessly on a blockchain between all of the different parties involved in the transaction.

In addition to the tokenisation of funds, underlying assets held by funds can also be tokenised. Whilst any traditional asset can be tokenised, the best use cases are expected to be private market assets such as private equity, real estate, infrastructure and the like. In particular tokenisation will open up liquidity for these otherwise less liquid asset classes.

 

What do investors really think?

The early signs suggest that investors are quite open to the idea of tokenisation.

BlackRock, for example, saw its newly launched tokenised, digitally native treasury fund accumulate $375 million in just six weeks[2] and many in the industry regard this as being a ‘game changer’ that will result in the acceleration of tokenised funds across the industry.

Similarly, consultants are also bullish that tokenisation will reshape private markets. According to the Boston Consulting Group, the size of the tokenised illiquid asset market could reach $16 trillion by 2030[3], while Bain & Co estimates tokenisation could help the alternatives industry generate an additional $400 billion in revenues.[4]

These numbers have certainly caught the attention of private market managers.

 

Getting the market going, and growing….

Although tokenisation has a lot to offer private markets, it is still in the embryonic stages of development. If tokenisation is to become more embedded in private markets, then it will need to be underpinned by intelligent regulations, strong counterparties, and robust corporate governance standards:

  • Regulation

Regulators across Europe appear to be taking a measured stance on tokenisation and digital assets.

In the EU, regulators have confirmed that cryptoassets not covered by the Markets in Crypto Assets Regulation (MICA) – such as security tokens – will be subject to pre-existing rules, such as the Markets in Financial Instruments Directive II (MiFID II).

A similar position has been adopted in the Channel Islands. For instance, Jersey has said that virtual assets will be treated as just another asset class[5],  whereas Guernsey’s Lending Credit and Finance Law states that tokens are not virtual assets and should therefore be regulated as ordinary securities.[6]

Meanwhile, the UK Financial Conduct Authority (FCA) is engaging with the industry and its peers (i.e. regulators in Singapore, Japan, and Switzerland) about possible use cases for fund tokenisation, and recently published a report on the topic.

Earlier this year, the FCA, together with the Bank of England, announced they would establish a Digital Securities Sandbox, a move designed to spur wider adoption of digital assets in the UK.

Sensible regulations will be a critical enabler in supporting the development of tokenisation in private markets.

 

  • Strong counterparties and robust governance are musts

 Although cryptocurrencies and tokens are not the same thing, the recent history of digital assets has been punctuated by a series of service provider failures.

FTX, once considered to be the poster child for cryptoexchanges, collapsed amid a liquidity crunch after it was revealed that the exchange had misused customer funds.

A number of other cryptoexchanges have also folded in recent years following frauds or cyber-attacks.  These incidents raise serious questions about the risk management practices and corporate governance standards in the crypto world.

If tokenised private market funds are to attract flows, the industry firstly needs to disassociate itself from cryptocurrencies. Next, the private market funds industry has to demonstrate that it uses high calibre service providers and adopts best in class corporate governance standards.

Service providers themselves, in particular transfer agents and administrators, also need to be forward thinking and adapt existing systems and processes to support digital fund and underlying asset ownership.

As interest in tokenised funds gathers momentum, this is creating opportunities for forward-thinking and experienced fund managers, some of whom are already exploring how they can adapt their existing offerings.

 

Tokenised funds – the future is coming

There is clearly appetite for tokenisation, and private market funds are likely to be among the main beneficiaries. However, tokenised private market funds will only win mandates if the industry is backed up by world class regulations and forward thinking, reputable service providers.

 

 

[1] Bain & Co – December 21, 2023 – $400 billion opportunity  in distributing alternative investments to individuals

[2] CoinDesk – April 30, 2024 – BlackRock’s BUIDL becomes largest tokenised treasury fund  hitting $375 m , toppling Frankin Templeton’s

[3] Coin Telegraph – September 13, 2022 – Tokenisation of illiquid assets to reach $16 T by 2030 – report

[4] Bain & Co – December 21, 2023 – $400 billion opportunity  in distributing alternative investments to individuals

[5] IFI Global – The evolution of Virtual Assets and Jersey’s Growing Role

[6] Carey Olsen – October 30, 2023 – Tokenisation: The Blockchain revolution for funds

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