Tokenization. The Future of Capital Raising?

A few years ago, I was involved in an interesting project where we attempted to “tokenize” the ownership interests of a company which owned as its only asset an apartment complex in Kansas City. We were trying to represent the rights of several owners of the company through a cryptographically secured digital token recorded on distributed ledger technology (DLT). DLT is a digital system that records details of transactions in multiple locations at the same time as opposed to on a centralized database.  

As a business transactions attorney who works with transferring ownership rights in assets for a living, I found the reasons for tokenization to be compelling. Tokenization seemed to promise more transparency and security since all transactions would be recorded (by consensus) on a decentralized, secure database; greater access to deals by lowering the minimum investment amounts; lower costs and fees by using self-executing agreements known as “smart contracts” on a blockchain; and increased liquidity by way of a secondary market to buy and sell the tokens.  

During the project, however, some negative financial implications of tokenizing real estate became increasingly apparent to the parties involved, and so motivation to complete the project began to wane. The real estate sponsor realized that its transaction fees (including carried interest) could become obsolete since only tokens would be traded (rather than the underlying real estate) in the future. The title insurance agent saw the elimination of its function altogether. The lender struggled to see how it could make a loan or otherwise participate in tokenized real estate deals. And I saw my role rapidly changing from a transaction attorney to a regulatory compliance attorney. Ultimately, the project died under its own weight.  

Over the last couple of weeks, though, I’ve been having encouraging conversations with our lawyers and a few potential clients about some new tokenization projects. One of those deals with tokenizing a private equity fund. Funds provide a way for multiple investors to pool their money together to be managed collectively by a fund manager in accordance with a certain investment strategy. Tokenization seems like it would make fund management more efficient as it gives these firms that are operating and making distributions from the fund the same records of information at the same time. I expect that entrepreneurs would be watching this development in the market closely given that all the benefits mentioned above would be useful in its capital raising and investor management activities. 

It’s too early to report anything else worthwhile about the project now, but I’m excited to learn about the progress of tokenization since my last project and will share, as appropriate, as things progress.  Please stay tuned.