Fund Tokenization: Should You be Excited or Should You Scared


Fund tokenization is gaining quite the media mileage, and just as much money. This article will try to explain what is going on, how you are going to benefit from it as a potential investor, and why you should still act with utmost caution. With all the problems that remain to be solved, it will dive into the nitty-gritty details that all professionals should be wary of. You will learn to design funds of such as these or to directly invest in them. And to cap it off, the top players will be identified and recognized.

The Potential of Tokenized Funds

Fund tokenization is essentially the equalizer of the venture capital world. VC is known as an industry for a select few who are are so rich that their net worth can be compared to an entire countries GDP. With fund tokenization however, this, once unreachable realm, is now made available to an expansive global market.

To understand what tokenized funds are, we need to understand what funds are. Funds in this regard pertains to the VC funds or Venture Capital funds. These funds are ruled by two kinds of partners. The limited partners, often abbreviated as LP, and the General Partner or the GP. The funds mainly come from the limited partners who are considered large investors who will be part of the VC for the next ten years. The limited partners’ main purpose is to generate a certain amount of capital to be injected into the venture. The first few years of a VC’s existence is dedicated to scouting for limited partners to potentially strike deals with and should they find a worthy business to invest in. When the VC finds a need to acquire funds, they make a capital calls for the limited partners to respond to. After it is all said and done and the investment has had been sold, the money will be returned to investors. If there are gains after the exit, fair portions of the profit will also be given to the limited partners. There is only a handful of people all over the world capable of dishing out huge sums and afford to wait 10 years before the any returns from investment is realized. This is often the frustration of VCs because they had to pitch over and over to the same group of people to have the funds that they need. And because no average person can compete with the big boys, they are stuck with the usual suspects.

Dissimilar to the funds gathered by a traditional capital call, the tokenized fund can actually be sold after only a year which is 9 years earlier than usual. These tokenized funds are delivered to the investors as securities. This is good news given how no normal person can actually wait for 10 years to see his/her money grow. With this new setup, more people will be able to entertain capital calls from VCs if they can sell their stake in as early as a year later. And using the blockchain to further expand into the huge pool of global investors. Having all of the transactions in the blockchain as a digital asset also means allowing for programmable securities. This means that the fund can be tied with specifically designed rules to the liking of both the investors and the VC management. These hard coded rules can further attract investors who might prefer not to engage directly to those people seeking investment.

The main goal of fund tokenization is to rival the traditional structure to garner more investment. This can only be done if the tokenized fund can outperform the old LP in racking up profits. If it is deemed that the blockchain based VC can compete with the orthodox VC then the way tokenized funds are packaged can be the stone that will tip the scale to its favor.

Why You Should be Worried Still

As promising and fancy as they seems, the next generation VC fund is not yet on par with the old dogs of the VC world. Primarily, the tokenized fund just fails to compete in terms of internal rate of return or IRR when compared to the old LP structure. Another issue is the question of how exactly the VC fund is going to be regulated. By its nature, all of blockchain enabled assets are hardly traceable to a single entity. And given the strict guidelines that financial regulating bodies have over these behemoth funds, asset trading of assets hidden in layers of encryption would spell any confidence to authorities. In the US, for instance, private VCs need to present enough information or the US rules has the responsibility of blocking any form of unreasonably shady trading.

The old LP structure had stood its ground since the early 1970s. That’s a 50 year head start in terms of fine tuning all the necessary kinks to better suit all investor and financial manager need. This experience cannot easily be pushed aside despite the technology backing of the tokenized funds. To put it in the simplest sense, the traditional VC is friendly to investors. The main selling point is that investors know exactly when they will be getting their money back even if that time is the 10 years that was already previously mentioned. These funds are said to be self liquidating which means that all the money gained from the investments will be given back to the limited partners. With the massive experience that these VC oldies brings, they are able to circumvent most of the effect of taxes imposed by the states. These VCs are able to offer their investors packages with very well defined tax reporting capabilities, tax impact management, and prevention of double taxations. The GPs and the LPs are also able to design contracts that they can both be comfortable with as they share the gains and all the expenses. The LPs are further ensured to get their money back by giving incentives to financial managers who prioritize returning cash before taking fees.