Tokenizing Private Funds 1/3
Traditionally, private market investments have been structured as illiquid limited partnerships, with investors committing their capital for extended periods, commonly ranging from 5 to 10 years. The exclusive and opaque nature of these limited partnership (LP) models has been defended as necessary for the industry, as it restricts the number of investors able to participate. Proponents argue that this approach enables the fund to operate with greater strategic freedom and to take risks that may appear contrarian or counterintuitive in the short-term. However, at DwellFi, we challenge the notion that tokenizing a fund is detrimental to the industry. Instead, we believe that the instrumental benefits of tokenization, including enhanced liquidity and increased accessibility, make it a more favorable structure for attracting new capital inflows and investors. In this three-part series, we will demonstrate the advantages of tokenized funds and address common misconceptions, ultimately illustrating why the purported benefits of undemocratic LP models are dubious at best.
Laying out the foundation, it is important to clarify what the tokenization of a fund actually entails. Importantly, the tokenization of a fund involves the creation of digital securities representing ownership in the fund. A tokenized fund still retains its investment thesis and operational model, even with increased investment inflows. The primary advantage of tokenization is improved liquidity, as digital securities can be easily traded on secondary markets. Such liquidity advantages are largely absent in the industry at present; in the case where secondary markets do exist, equity ownership suffers from undervaluation due to the need to find suitable buyers. Tokenization ameliorates this issue: while some argue that this liquidity may disrupt a fund’s investment strategy, we contend that it allows for a longer-term investment outlook and reduces pressure on LPs to prematurely exit their positions. Tokenization enables easier buy-in and buy-out via secondary markets, reducing the impact on a fund’s investment strategy in the event of early exits under traditional LP models.
The tokenization of private investment is an important development in the industry, providing a solution to the challenges of traditional private financial investments by creating a new level of liquidity and new opportunities for investors. The liquidity provided by tokenization enables investors to take a longer-term view and make more targeted investments, reducing the pressure for liquidity that exists in traditional LP models today. As the industry matures and continues to adopt tokenization, it is likely that we will see further adoption of tokenization, both improving the ability of funds to meet the investor needs and address long-standing liquidity challenges that exist in private markets at large.