The potential of private equity blockchain adoption

Blockchain’s expanding impact

Blockchain-based technologies are becoming more established as a solution to the complex data sourcing, management, and distribution problems today’s financial service businesses are facing. While many associate blockchain with cryptocurrency, the use cases for blockchain technology go well beyond payments and currency trading. A wide range of organizations are already adopting blockchain-powered solutions to add efficiency and security across all areas of data management, including client onboarding, identity management, and transaction processing.

Early proofs of concept have demonstrated that blockchain technology can deliver results. But what is the reality? Is it possible for a private equity firm to use blockchain to “tokenize its ecosystem”?

Cautious early steps

Today, several private equity firms have experimented with blockchain beachheads on a small scale. But the industry standard is what it has been for generations: paper agreements that represent ownership in companies, often out of date, with multiple amendments that are near impossible to track, or side-letter agreements that often don’t make their way to finance and accounting systems. Replacing it with anything else, no matter how promising, represents a big step. That’s why, and understandably so, some of the industry’s first steps to embrace blockchain have been measured and tentative. The caution that surrounds blockchain may have less to do with doubt in the technology itself and more to do with recognizing the lack—so far—of industrywide standards. Most private equity blockchain adoptions and implementations are working in parallel with, rather than as a replacement to, traditional processes. But as regulators and practitioners increase their comfort with blockchain technology, this “belt and suspenders” approach is likely to give way to fully blockchain-driven solutions.

From possibility to implementation

The promise of widely available, secure, always up-to-date information—using digital credentials that reside on interoperable blockchains and can be used across the ecosystem—can solve fundamental problems that have been part of the industry’s day-to-day operations for years: someone’s always missing something. There isn’t a complete ownership detail for one of the portfolio companies. An investor’s tax status is not known. A distribution check bounced due to inaccurate account detail. None of those problems are insurmountable—but taken together, they represent sand in the gears.

Blockchain can speed the sharing of information, boost accuracy and timeliness, or enhance security and verifiability—or all three. It can provide:

• A more efficient transaction flow, on both the deal and investor side.
• Deal document operationalization and maintenance.
• Carried interest calculations that reduce complexity and the need for interpretation.
• Investor identity verification that can confirm their eligibility to invest in alternative investment (AI) or qualified purchaser (QP) vehicles.
  

New frontiers for clients

Beyond the operational benefits of blockchain for private equity that can simplify and streamline data management for general partners, blockchain-driven recordkeeping solutions and tokenized fund interests also offer significant benefits for investors in private equity funds. There are a number of benefits of blockchain that private equity investors in tokenized funds can expect to realize: (1) deeper and more liquid secondary markets, allowing the use of private investments as collateral, and (2) customization of investments.

Recognizing the potential challenges

The potential benefits of blockchain for private equity technology require foundational steps before they can take their place in everyday operations. At the most basic level, more participants need to buy into the idea of blockchain before it achieves the critical mass that will make people confident “turning off the lights” on older systems.

Adopting blockchain also carries some basic questions: 

• Who will own it?
  
• Should firms develop private blockchains to exercise full control over who reads and edits their data, or develop their solutions within public blockchains to enable broader verification of their data and participation in transactions?
• If there are transaction fees associated with its use, who will earn them?
• What means of digital payments—a stablecoin or comparable fiat equivalent—will the system adopt?
• How can it be made interoperable for all parties in all situations?

Of course, privacy and data confidentiality are also step-one concerns to address. The fact that security is part of blockchain’s architectural reason for existing doesn’t mean it happens all by itself.

These questions aren’t insurmountable, but it’s important to recognize and address them so that private equity blockchain adoption can continue past its first steps and move toward meaningfully serving the entire industry.

How Deloitte can help

With more than 10 years’ experience helping large organizations understand and implement blockchain and digital assets, Deloitte has established itself as a trusted adviser in helping companies throughout the financial sector put these new tools to productive and reliable use. If you’d like to talk more about strategy and adoption of blockchain for private equity, let’s connect.

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