Towards a tokenised future

As companies remain private for extended periods, retail investors hold a greater opportunity to benefit from early access. Tokenisation has the potential to expand private market access, offering more flexibility than currently available. Following a series of record-breaking IPOs, retail investors have been eager to capitalize on their investments.

June marked a notable example, with SpaceX allocating 20% of shares to these investors, totaling an estimated $15 billion. Since the company's initial public offering (IPO), SpaceX's shares have risen approximately 10% from their original $135 offering price. However, those with access to the company prior to the IPO reaped substantial gains.

For instance, Peter Thiel's Founders Fund invested $20 million in 2008, followed by $600 million in subsequent investments, valued at $67 billion based on the opening trading price of $150 per share—a 108-fold return on invested capital. A recent backer, Sequoia Capital, reported a 14.5x gain after investing in 2019. While significant gains can be achieved on public markets, the majority of growth occurs during the private stage.

This is particularly true as companies now tend to remain private for longer durations. To capitalize on this growth, retail investors need earlier involvement. Open-ended funds have partially facilitated this, but they typically cater to wealthier investors and impose strict eligibility requirements and large minimum investments.

Tokenisation presents an alternative to this issue. Fund interests are represented digitally as tokens recorded on a blockchain, automating the investor registry and distribution process to minimize logistical challenges associated with smaller commitments. Dr. Steffen Pauls, CEO of private equity investing platform Moonfare, explains that tokenisation allows fund interests to be divided into smaller units, enabling fractionalization of substantial commitments.

This fractional ownership could significantly decrease minimum investment sizes. Moreover, tokenisation could extend to private asset ownership, representing shares as tokens, which would enable private companies to have a more widespread investor base akin to public markets. Examples of such tokenization technology already exist.

Citi began offering private wealth clients access to tokenized depositary receipts representing shares in blockchain platform Kaleido in June. While this doesn't equate to full tokenization of shares, it marks a significant step in that direction. These receipts operate as separate securities issued by the bank, distinct from direct share ownership and do not grant the holder traditional shareholder rights.

Hamilton Lane launched a tokenized share class in May, providing access to its evergreen Global Private Assets Fund through the digital marketplace Allfunds. BBVA Asset Management was the first investor, with exclusive distribution to institutional portfolios and subsequent access through a feeder fund managed by fintech company Securitize.

However, fund tokens still represent the same security and are subject to the same regulations. Depending on the jurisdiction, they may limit access to wealth investors. Michael Sholem, a financial services regulation partner at Macfarlanes, states that "The FCA has been consistent in stating that a significant amount of fund tokenization can already be achieved within the existing regulatory framework, provided the token represents an interest in a fund that is itself operated in accordance with existing UK regulated funds regulation."

This implies that tokenization could operate within fund structures such as LTAFs, which do not impose minimum investment sizes and provide access for ordinary retail investors under the category of "restricted investors." Nevertheless, retail access to tokenized stakes in private assets would face regulatory hurdles, and the highly fractionalized ownership created by tokenization could present its own challenges.

For instance, private companies are not generally designed for thousands of small investors exercising individual voting and information rights. As a result, many tokenized models may rely on aggregation mechanisms, such as investors holding tokenized interests through a nominee, special purpose vehicle, or other intermediate structures, with voting rights exercised collectively.

Despite these hurdles, mass tokenized ownership could potentially reduce incentives to list, as private companies would have access to the same transparency and reporting requirements as public companies.