Private markets prove a good testing place for tokenisation

2024 has seen a number of tokenisation projects targeting private markets. Nicholas Pratt examines if progress is really being made

The suitability of private markets as a home, or at least a testing place for tokenisation has long been recognised. The logic is as follows: the level of automation and technology efficiency within private markets and private asset classes is generally so poor that it has much more to gain from new technology than more efficient fund types.

It may be a $10 trillion asset class but its infrastructure is still heavily manual and paper-based, affecting both distribution and back-office processing. So why not go straight to tokenisation rather than the various stages of automation that have featured in other asset classes over the last 20 years or more?

Furthermore, the benefits of tokenisation such as greater liquidity and accessibility are especially suitable for wider access and improved processing rates would have a greater impact on the private markets and real world assets like real estate and infrastructure. For example, by enabling funds to be issued natively on a blockchain, the minimum required investment can be lowered, making these assets more accessible to a wider range of investors.

However, private markets are technologically inefficient for a reason – they are complex, unstandardised and difficult to scale. When this magazine last looked at the use of tokenisation in private markets (October 2023), we highlighted the challenges that are impeding progress – a lack of technical standards and regulatory complexity.

While progress has generally been slow to date and these barriers still remain, there has at least been a flurry of activity in the opening quarter of 2024.

Flurry of activity

In January there was the launch of Libre, an institutional Web3 protocol developed in partnership with Laser Digital, the digital assets arm of Japanese bank Nomura, and fintech WebN, based on technology provided by Polygon Technology.

Libre had even lined up hedge funds and private markets investors Brevan Howard and Hamilton Lane for its launch.

"We believe that tokenisation has the potential to revolutionise the way investments are managed and traded and are focused on strategically partnering with other leading firms to improve compliance and streamline access to the private markets through initiatives like Libre,” says Victor Jung, head of digital assets at Hamilton Lane.

Hamilton Lane has been involved with similar projects before, such as the 2022 venture with Figure Technologies that aimed to issue shares in its private assets fund on the Provenance blockchain but was eventually abandoned a year later

Two years later, however, the Libre platform has gone live and is open to eligible investors. Built on Polygon’s Chain Development Kit, Libre is focused primarily on alternative investments but is also looking to include money market funds.

Furthermore, the parties behind Libre are looking to integrate with other Layer 1 and Layer 2 networks, via the Libre Gateway to enable institutional investors to access a range of funds via Libre.

“As the foundation and infrastructure become established for the tokenisation of institutional financial instruments, innovative use cases will become the next phase of development,” Polygon Labs’ Global Head of Institutional Capital Colin Butler, says. “We are thrilled to be able to foster this entry point for tier-1 funds on Libre, and see the Gateway as the foundation for a radically improved global financial system.”

Blockchain projects

Hamilton Lane was also involved with another blockchain-based project. In April, investor services firm Apex claimed to have become the first transfer agent and fund service provider to administer regulated securities using the blockchain as the investment book of record.

The transaction involved Hamilton Lane and Swiss digital assets specialist Sygnum Bank. Together, the three entities created a new digital asset share class of the Hamilton Lane GPA fund and a DLT registry to automate the various fund administration tasks as well as the distribution.

Apex stated that it intends to “increasingly utilise this operating model for all of its asset management clientele” adding that it will enable them to sell more of their product.

Another proof of concept was completed in February when Citi partnered with Wellington Management and Wisdom Tree for the tokenisation of private funds.

The pilot involved a private equity fund issued by Wellington with ABN Amro as the investor. The underlying fund distribution rules were encoded into a smart contract and embedded in the token transferred to hypothetical clients of WisdomTree.

As the asset servicer, Citi also tested multiple scenarios of transfers using smart contracts relying on simulated identity credentials issued by WisdomTree and a private fund token as collateral in an automated lending contract with DTCC Digital Assets (formerly Securrency).

“Smart contracts and blockchain technology can enable enhanced rule enforcement at an infrastructure level, allowing data and workflows to travel with the asset. By testing the tokenisation of private assets, we are exploring the feasibility to open up new operating models and create efficiencies for the broader market,” says Nisha Surendran, emerging solutions lead for Citi Digital Assets.

“Blockchain-enabled finance is the future of the industry, and this proof of concept showcases the ability to explore the transferability of tokenised funds and related compliance in different markets,” said Maredith Hannon Sapp, head of business development, digital assets, at WisdomTree.

“This will inform future in-production use cases of how blockchain technology and smart contracts can be used in on-chain transactions.”

There are also a number of regulatory initiatives taking shape. In March, the Financial Stability Board announced that tokenisation would be one of its three priorities for 2024. While the FSB is generally concerned with limiting potential systemic risks, other regulators are looking to be more constructive.

In November 2023, the Technology Working Group of the UK government’s Asset Management Taskforce issued a roadmap for implementing fund tokenisation, albeit one that had conditions. According to the working group, its inaugural report provides a baseline model for the implementation of tokenisation, that can be used within the existing legal and regulatory framework, and which investment management firms can implement immediately.

Conditions for eligibility

However, the funds must meet certain conditions to be eligible for tokenisation. For example, they must comprise mainstream assets and continue to provide valuations and settlements through the same processes and timeframes as conventional funds.

This would rule out most private markets funds. It also suggests why widespread adoption of tokenisation in private markets may still take some time.

As Wisdom Tree’s Sapp has stated, legal considerations, identity standards, data flow, privacy concerns and compatibility with existing standards need to be further evaluated in collaboration with regulators.

“The financial services industry should work collaboratively to build an identity infrastructure to facilitate wider tokenisation adoption, addressing jurisdictional complexities and ensuring data security in digital networks,” stated Sapp in a blog post from February.

“While smart contracts are only as efficient and accurate based on the code written, they can be prone to security breaches if not coded correctly or subject to operational risk if not interacted with securely.”

Myles Milston is co-founder and CEO of Globacap, which describes itself as a private capital markets ecosystem. As he says, tokenisation only relates to the final part of the transaction lifecycle. And for it to work on a mass market scale, the underlying infrastructure still needs to be digitised and automated, as do all the other parts of the transaction lifecycle, from onboarding and identity to trading on the secondary markets and using the tokenised assets for collateral management.

While the usage of blockchain technology in financial services is still nascent, states Sapp, there are many real-life use cases today that demonstrate how this technology could improve the ways end-investors buy, sell, receive and interact overall with their investments over time.

“Streamlined workflows, increased accessibility and increased reliability showcase the transformative potential power of blockchain technology and specifically smart contracts,” says Sapp. “Collaborative efforts among market participants, especially with standardisation of identity credentials, could improve the efficiency and transparency of the entire financial services ecosystem.”

The phrase ‘over time’ is key. All of these developments will require patience and collaboration – two words not necessarily associated with the fintech sector.

The use of tokenisation and blockchain technology in private markets as well as the need for more collaboration and utilities are subjects that will be discussed at the inaugural FundsTech Forum, held in London on April 25. More details can be found here.