Dangers abound as private equity moves into the fintech age
Blockchain technology and non-fungible tokens (NFTs) are raising eyebrows as innovators seek to 'democratise' private equity through fintech apps, writes Selin Bucak.
Fintech groups have been exploring ways to make private equity investing more accessible, but some recent innovations using blockchain technology and taking advantage of the rise of non-fungible tokens (NFTs) are raising eyebrows.
One way to open up access to private equity has been through partnerships with fintechs like iCapital and Moonfare. These offer digital platforms for investment in alternative assets at lower-than-normal minimum investment levels.
A particular focus for several investment businesses, both new and established, have been tokenisation - the process of converting private equity holdings into tradable digital securities that can be issued and traded on a blockchain system.
Well-known companies like Partners Group or Hamilton Lane have in the last year listed tokenised shares of their private assets funds. Others, like German asset manager Patrizia, are working on creating tokenised versions of its institutional funds.
“Assets become much more accessible when they’re tokenised,” said Frederick Van Gysegem, partner at global consultancy Roland Berger's Brussels office.
“One of the major advantages we see is it allows for fractionalisation of assets. In that sense it’s similar to what you now see in stock exchanges with typical equity but done in a much cheaper and easier and more efficient way. We’ve been looking into it and working for multiple clients on this topic.”
However, it does raise some important questions, particularly when not all tokenisation efforts are tied to established firms that are registered with regulators.
“I am seeing a lot of unregulated projects in the marketplace. Projects that are using the DAO model to fundraise capital from investors and by doing that they are pretty much selling unregistered securities, which is illegal,” explained Max Dilendorf, founder of Dilendorf Law Firm, which focuses on digital assets.
DAOs – or decentralised autonomous organisations – are groups where each member has an equal say in decisions around how a pool of money is spent or managed.
Examples in Europe
One group making use of a DAO is Fukuro NFT. Founded by London-based Mike Vorozheykin, previously a research analyst at boutique firm IPS Capital, Fukuro’s goal is to create a decentralised organisation through the sale of NFTs to invest in private equity and real estate deals.
Vorozheykin told AltFi that the group will sell 10,000 NFTs, which will give holders the right to vote on projects, mainly buying and selling of real estate.
Vorozheykin said that very few authorities understand the crypto world currently. That’s why for this project they chose the Cayman Islands. The DAO is an entity that has beneficiaries and no directors. Therefore, Fukuro has registered in the Cayman Islands as a foundation company, which is a flexible structure.
“In terms of regulation, it’s not a fund. We are not investing money on behalf of anyone. That’s why every single NFT holder has a say. It’s like you and me meeting and saying let’s co-invest,” he said.
“To do that you don’t need a fund, you can do it in a joint venture. If you trust each other you can formalise it. Here everyone is taking a vote and deciding whether you should invest or not. We are acting as moderators,” he added.
There are others who have looked at the cryptocurrency world to innovate.
Idoru Capital was launched by Michael Beda, is headquartered in Estonia and is undergoing the virtual asset service provider (VASP) registration process.
According to his profile on the group’s website, Beda helped found P2P lender Huaxia Finance in Shanghai. The company was the subject of an illegal fundraising investigation in 2020, according to reports in the Shanghai Daily.
The group is rolling out the Idoru Token, which it says is in full compliance with European FIU requirements, to enable retail investors access to a pooled portfolio investing into venture capital and private equity companies, fund managers and startups. Investments include Israeli startup Autobrains and chipmaker Heilo according to posts on Idoru’s Telegram channel.
Another proposition has come from Backed, based in Switzerland, which has launched a token that gives ownership in a “decentralised private equity fund”, currently listed on Uniswap and PancakeSwap exchanges.
The group was set up by CEO Kevin Yunai – previously leading Danish tech company Mirsk Digital.
Both Idoru and Backed have been contacted but declined to comment.
Although popular in this new age of NFTs and cryptocurrencies, tokenisation of investments in this way can leave investors open to exploitation.
“I’m seeing this activity across different types of assets. Real estate companies, art and somehow the industry thinks the sponsors of these projects and crypto community investors by labelling projects as DAOs they are shielding themselves from all kinds of liability and the need to follow the law,” Dilendorf said.
“This is extremely misleading. Once you launch a DAO you become subject to regulations. If you’re selling an unregistered security, you are subject to existing law and you’re violating the law. The question is at which point the regulators will start going after these projects.”
For tokenisation to truly take off both traditional financial players and regulations will need to adapt, in Van Gysegem’s opinion.
Most regulations, even the more recent ones, have been built around traditional trading systems. These will need to be adapted to allow for tokenised trading. In addition, the technology needs to continue to evolve to shorten processing times, which can take a lot of time and energy in a decentralised system. This will impact the scalability of tokenisation.
Finally, there needs to be an ecosystem that helps investors make the right decisions.
“People have advisers to invest in stocks but if now you suddenly get access to all these opportunities like infrastructure, private equity, real estate, and it’s all very nice but how do you take the right decisions? There is a big role to play for the financial sector to help people make the right decisions. Their advisers need to be trained to help retail private investors into these new asset classes, taking into account the underlying risks,” he said.
If traditional organisations, like big asset managers, are the ones to roll out tokenised products, it is still easier for regulators to supervise the activity. However, Van Gysegem said, in the fragmented and decentralised tokenised world where individuals make their own decisions, the focus may need to shift to supervising individual investors, which would be completely new.
As people are drawn into investing via Facebook adverts, there is a lot of responsibility on regulators to find a balance between allowing innovation and not letting ‘digital’ private equity become the fintech Wild West.