I think all Private Equity Funds will be Tokenized in 5 years

By Sean Emery

Embracing Liquidity in Private Equity: How Tokenization Can Transform Investment Dynamics

The tokenization of private equity is set to transform the investment landscape, creating new opportunities for asset management and trading on a global scale. As this innovative approach gains traction, key industry insights highlight its potential impact and growing acceptance:

- Market Potential: Forecasts predict tokenized assets will reach an impressive $24 trillion by 2027, signalling a major shift in investment opportunities (Source: Kaleido).

- Investor Interest: Many fund managers consider private equity prime for tokenisation, given its limitations in liquidity, transparency, and accessibility (Source: Bain & Company).

- Early Adoption: Private Equity and Hedge Funds are anticipated to be the most likely asset classes to undergo significant tokenisation soon (Source: Bain & Company).

- Big Players Testing the Waters: Institutions like Citibank are already exploring tokenisation through successful simulations, indicating potential for broader adoption (Source: Citigroup).

- Overall Growth: The global private equity market is expected to grow at a CAGR of 10.2% from 2022 to 2028, with tokenisation likely playing a crucial role (Source: Antier Solutions).

Addressing Liquidity Challenges in Private Equity with Tokenization

One of the largest drawbacks in private equity investments is the lack of liquidity for Limited Partners (LPs).

This issue has been a significant barrier to entry for many potential investors and a point of frustration for existing ones. The traditional private equity model locks in investments for extended periods, often spanning several years, with limited opportunities for early exit. This illiquidity has been a persistent challenge, making it difficult for investors to rebalance their portfolios or access their capital when needed.

The Liquidity Imperative in Private Equity

According to a recent report by Bain & Company, the liquidity challenge in private equity has become increasingly pronounced, especially in the face of rising interest rates and economic uncertainty. The report highlights that the traditional exit routes such as mergers and acquisitions (M&A), buyouts, and initial public offerings (IPOs) have become more difficult, exacerbating liquidity constraints for LPs. As a result, fund managers are now exploring alternative liquidity solutions, such as secondary markets and net asset value (NAV) loans, to provide some relief to investors.

MSCI's analysis further underscores the liquidity issues faced by private equity investors. The unpredictable timing and size of cash flows from private equity investments demand careful liquidity management. Poor liquidity management can force investors to liquidate public assets or sell their private equity stakes at a discount in the secondary market, leading to significant transaction costs. The NBER's research also reveals substantial transaction costs associated with the illiquidity of private equity investments, often resulting in unfavourable outcomes for sellers in the secondary market.

The illiquidity of private equity investments is a significant drawback for Limited Partners (LPs). This challenge is multi-faceted and affects various aspects of the investment landscape:

1. Extended Lock-In Periods: Private equity funds typically have long investment horizons, often spanning 7 to 10 years or more. During this time, LPs have limited opportunities to exit their investments early, making it difficult for them to access their capital or rebalance their portfolios in response to changing market conditions or personal financial needs.
2. Limited Secondary Market: While there is a secondary market for private equity interests, it is relatively small and can be illiquid. Selling a private equity interest in the secondary market often involves a significant discount to the net asset value, which can be unappealing to LPs seeking liquidity.
3. Capital Call Structure: Private equity funds operate on a capital call basis, where LPs commit a certain amount of capital upfront, but the actual investment occurs over time through periodic capital calls. This structure can create uncertainty for LPs, as they need to maintain liquidity to meet these calls, even if the timing and amount are unpredictable.
4. Valuation Transparency: The valuation of private equity investments can be opaque, with less frequent and less standardised reporting compared to public markets. This lack of transparency can make it challenging for LPs to assess the current value of their investments and make informed decisions about potential sales or rebalancing.
5. Exit Strategies: Traditional exit strategies for private equity investments, such as initial public offerings (IPOs) or strategic sales, can take years to materialize. During this time, market conditions can change, potentially impacting the expected returns.

Tokenisation is the only viable Solution

Tokenisation offers a transformative solution to address the liquidity challenges in private equity. By converting equity interests in funds or companies into digital tokens that can be traded on a blockchain platform, tokenisation enhances liquidity and provides investors with more flexibility. These tokens represent Limited Partner Certificates (LPCs), distinct from traditional equity instruments and do not constitute securities, thus avoiding the regulatory complexities associated with securities.

Key benefits of tokenising private equity include:

1. Enhanced Liquidity: Tokenization allows equity shares to be traded on secondary markets, similar to stocks. This means investors can buy and sell their tokens more freely, providing a much-needed liquidity option previously unavailable in traditional private equity settings.

2. Fractional Ownership: Tokenization lowers the barriers to entry by allowing for fractional ownership. This enables smaller investors to participate in private equity investments, broadening the investor base and increasing potential capital for funds.

3. Transparency and Efficiency: Blockchain technology enhances transparency by providing a tamper-proof, real-time ledger of all transactions. Smart contracts automate many of the operational aspects of private equity management, reducing administrative costs and the risk of errors.

4. Access to a Broader Investor Base: By making private equity investments more accessible and liquid, tokenization attracts a wider range of investors, including those who were previously excluded due to high minimum investment requirements.

How RainFin Tokenizes Assets

At RainFin, we utilise a sophisticated tokenisation process to convert private equity assets into digital tokens. Here’s an overview of how we achieve this:

1. Asset Identification: We start by identifying suitable assets for tokenisation, ensuring they meet our rigorous standards for investment quality and potential.

2. Legal Structuring: We structure the assets as En-Commandite Partnerships - and issue Limited Partner Certificates (LPCs), which comply with regulatory standards while avoiding the complexities associated with securities.

3. Digital Representation: The LPCs are then digitally represented on the XCAP blockchain, a secure and decentralised ledger that ensures the integrity and traceability of transactions.

4. Smart Contracts: We develop smart contracts to automate token issuance, transfer, and management. These contracts handle profit distribution, compliance enforcement, and other key operational aspects.

5. Secondary Market Integration: Tokens can be traded on secondary markets, providing liquidity and enabling investors to buy and sell their tokens as needed. This integration ensures that investors have access to liquidity throughout the lifecycle of their investment.

Creating a Secondary Market

RainFin is committed to creating a robust secondary market for tokenized assets. By integrating our tokens with secondary trading platforms, we ensure that investors can easily buy and sell their tokens. This market integration not only enhances liquidity but also provides a transparent and efficient trading environment.

Accessing On-Chain Capital

The amount of capital already on-chain looking for investment opportunities in real-world assets (RWA) is substantial. Private equity managers should look to access this capital instead of the crowded traditional marketplace. On-chain capital offers a new and growing pool of investment funds, driven by the increasing acceptance and adoption of blockchain technology. By tapping into this capital, private equity managers can diversify their investor base and enhance their fundraising potential.

The RainFin Advantage with XCAP Blockchain

RainFin is at the forefront of leveraging tokenisation to address liquidity issues in private equity. By utilising the innovative XCAP blockchain technology, RainFin provides a robust and secure platform for issuing and trading LPCs. This integration ensures that the entire lifecycle of tokenised assets, from issuance to trading, is automated and compliant with regulatory standards.

For private equity fund managers looking to navigate the complexities of tokenisation and enhance liquidity for their investors, partnering with RainFin offers a strategic advantage. RainFin's end-to-end solutions and expert guidance ensure a smooth and successful implementation of tokenisation projects, paving the way for a more dynamic and accessible private equity landscape.

To explore how RainFin can transform your asset management strategy through tokenisation, contact us today to book a demo or discuss your specific needs. Join us in shaping the future of investment and unlocking the full potential of your assets in the digital age.