Tokenization of Private Equity Funds in Germany. Direct and Indirect Participation and Feasibility

Master's Thesis, 2023

86 Pages, Grade: 1,0


Table of contents

List of figures

List of tables

1 Introduction
1.1 Motivation and objective of the thesis
1.2 Research questions
1.3 Structure of the thesis

2 Core concepts of tokenization in Germany
2.1 Digital ownership
2.2 Distributed Ledger Technology and Blockchain Technology
2.3 Crypto tokens and security tokens
2.4 Legal matters of security tokens

3 Core concepts of Private Equity in Germany
3.1 Characteristics of Private Equity
3.2 Development of the German Private Equity market
3.3 Legal matters in Private Equity

4 Approach for tokenization of Private Equity Funds
4.1 Indirect participation in Private Equity with tokenized products
4.1.1 Legal structure
4.1.2 Involved parties and mechanisms
4.2 Direct participation in Private Equity with tokenized products
4.2.1 Legal structure
4.2.2 Involved parties and mechanisms
4.3 Considerations for tokenization of equity products
4.4 Secondary market
4.5 Further considerations

5 Feasibility of tokenization in Germany
5.1 Added value through tokenizing Private Equity
5.2 Challenges of tokenization of Private Equity
5.3 Effects of tokenization to the Modern Portfolio Theory

6 Conclusion
6.1 Essential findings
6.2 Critical evaluation and limitations of the thesis
6.3 Recommendations and areas for further research


Statutory Declaration


Tokenization refers to the creation of a digitized representation of an asset on the blockchain and has the potential to play a critical role in the digital transformation of the financial sector. The asset class private equity refers to a form of financing of private companies through fund structures which raise money from investors. The aim of the master thesis is to examine whether private equity is suitable for tokeni- zation. After analyzing different characteristics of private equity, such as the illiquid­ity or mechanisms like capital calls, the master thesis concluded that the asset class is suitable. Private equity shares in the form of security tokens can help to reduce illiquidity and cashflows like the capital calls can be automated by the use of smart contracts. For the tokenization, the master thesis recommends to use existing stand­ards, such as the Ethereum blockchain or the ERC-1400 token. Furthermore differ­ent structures for issuing private equity tokens were elaborated. These include a structure for an indirect participation via a special purpose vehicle which issues to­kens and simultaneously invests into a fund, but also a direct participation where the fund itself can issue tokens. During the description of possible structures, all relevant laws were included. These include the German Electronic Securities Act (eWpG), German Banking Act (KWG), Security Prospectus Act (WpPG), Capital In­vestment Act (VermAnlG), Securities Trading Act (WpHG) and the German Invest­ment Code (KAGB). All structures were evaluated from the perspective of private equity funds, institutional investors, private investors or other relevant intermediar­ies. Also benefits and challenges for the different structures and participants were discussed. The benefits include an increase in efficiency of several processes, po­tential cost savings, the possibility for funds to reach more investors or the possibility for investors to diversify their portfolio more. Still these benefits could only be made use of, if major challenges are mastered by the market participants. These include an insufficient legal framework, different hurdles when implementing a secondary market or the problem that theoretical approaches might work differently in reality. Still, the master thesis concluded that the tokenization will add value, which is why it is likely that tokenized private equity will be found in more and more portfolios in the future. Thus the master thesis also examined the influence of tokenized private equity funds on a portfolio according to the modern portfolio theory of Harry M. Mar­kowitz.

List of figures

Figure 1: Decentralized network (left) vs. centralized network (right)

Figure 2: Example transaction on the Ethereum Blockchain

Figure 3: Use cases for different types of tokens

Figure 4: Overview of laws possibly applicable when offering tokens

Figure 5: Applicable laws and regulations for classification of tokens

Figure 6: Return of private equity vs. public equity

Figure 7: Overview of different portfolio sizes and chances of success

Figure 8: Cashflows during the fund period (“J Curve”)

Figure 9: Fundraising of private equity firms in Germany

Figure 10: Private Equity investment volume by type

Figure 11: Different types of investment funds under the KAGB

Figure 12: Typical German Private Equity Structure

Figure 13: Tokenization structure for indirect participation 1

Figure 14: Tokenization structure for indirect participation 2

Figure 15: Special assets structure

Figure 16: Systematic and unsystematic risk

Figure 17: Risk-return profiles and efficient frontier

Figure 18: Risk-return profiles of different asset classes

Figure 19: Shifted efficient frontier

List of tables

Table 1: Different token standards on the Ethereum blockchain

1 Introduction

Digital transformation continues to be one of the most relevant topics in the modern society. It is taking place in people's private lives, but also in business, which leads to a fundamentally change of these areas (BMWK, 2022). All industries are affected, including the financial sector. According to several studies, the blockchain technol­ogy plays a critical role in the digital transformation of the financial sector (Paulsen, 2022). While the introduction of the blockchain technology in 2008 had the basic idea to establish a digital and decentralized currency, more research and new ideas about the technology quickly revealed that the use cases go far beyond just sending money from one party to another. The potential of the different use cases of the blockchain technology, to transform the financial industry, is supported by a rapid growth of the development of the technology. While investments in companies deal­ing with the blockchain technology came to several hundreds of millions of dollars ($361.53 million) in 2014, investment volumes reached $33 billion in 2021 (Pagidyala, 2022).

One of the use cases with a huge potential is the tokenization of assets. Tokeniza- tion describes the creation of a digitized representation of an asset on the block­chain, including the rights and obligations of it (BaFin, 2019a). This could also be applied to the asset class private equity. The Boston Consulting Group (BCG) esti­mates the tokenization of illiquid assets a $16,000,000,000,000 ($16 trillion) busi­ness opportunity by 2030, with $3.7 trillion of that being not listed equity or invest­ment funds (Kumar et al., 2022). There are several reasons why the tokenization is of great interest especially for the asset class private equity. These include the il­liquidity of the asset class, the complex structures and manual processes, as well as restrictions for several investors to invest into the asset class. Especially in pri­vate equity, the tokenization can help to increase efficiencies, safe costs, loosen complex structures or increase investment volumes. Besides these advantages the tokenization in general can be seen as a step towards digitalization in that sector, which closes the circle to the first mentioned necessity to digitize the financial sector.

Due to the described relevance of the topic, this master thesis deals with the topic of tokenization of private equity funds in Germany. Particularly due to the legal situ­ation, clear boundaries are drawn to other markets and other asset classes.

1.1 Motivation and objective of the thesis

This master thesis deals with the concrete implementation of tokenization of private equity funds. The topic is examined in its entirety, so that the master thesis will pro­vide a comprehensive view of various topics related to the tokenization of private equity funds. In order to achieve this, various structures for realizing the tokenization will be developed and discussed. These structures allow for different ways, including direct and indirect ways, to participate in private equity funds. In addition, the devel­oped structures will be analyzed from the perspective of different market partici­pants. The current German legal framework is taken into account for all considera­tions. In addition to the structures, which are possible under the current German law, an outlook is given with further structures, which are not possible under the current law, but which could still be conceivable in the future. The participants on which the master thesis mainly focuses are private equity funds, institutional inves­tors, private investors and other intermediaries. In addition, the benefits and poten­tial mentioned above are related to individual structures and participants and are further examined.

Still, the benefits and the described large potential of tokenization of private equity, are currently offset by a relatively small market volume. While a handful of market participants are establishing structures through which investors can indirectly par­ticipate in private equity via a token, these have not achieved a major breakthrough. An example is the German FinTech Finexity, which in 2022 raised €1,000,000 from issuing tokens. The raised capital was afterwards invested in a private equity fund and the tokens allows for a participation of the cashflows from the fund (Gr0nlund, 2022). While this confirms a certain demand, a volume of €1,000,000 is only a frac­tion compared to the described potential and not of relevance for most private equity funds. Reasons for an outstanding breakthrough in private equity tokenization are various significant challenges connected to the asset class itself and the German regulations. These challenges are also elaborated and evaluated within the frame­work of this thesis.

Due to the high actuality of the topic and related laws, the tokenization of private equity has not yet arrives in a mature form in reality. Thus this thesis will add value by creating and evaluating different structures for tokenization of private equity, so that they can possibly be implemented in reality in the future. Also, this thesis shows for different market participants which advantages a tokenization can bring, but also which challenges have to be overcome for a successful implementation. After read­ing the thesis, the reader should have a full overview of how tokenization of private equity works, know and be able to evaluate different structures, as well as be aware of benefits and challenges to be able to deal with them successfully.

1.2 Research questions

In order to fulfill the aforementioned objective of this thesis and to provide a holistic overview of the topic, three research questions will be explored. These questions will be answered within the framework of this thesis and will thus provide new an­swers for the undeveloped market for tokenized private equity funds. The research questions are the following:

1. Is private equity as an asset class suitable for tokenization, and if so what challenges must be overcome?

To answer this question, different characteristics of the asset class need to be con­sidered. These include investment structures, cashflows of private equity invest­ments and other characteristics. Furthermore it must be analyzed whether these characteristics can technically be represented via tokens. Also a weighting of poten­tial benefits and challenges will be analyzed, as well as approaches to solve the challenges are developed. Also it will be evaluated whether the tokenization of pri­vate equity funds is in general a desirable step for the whole industry.

2. What structures are possible for the tokenization of private equity and how do they relate to the current German law?

Within the scope of the thesis, different legal structures will be developed and eval­uated. All structures that are possible under the current law are presented. These use the possibility of tokenization of debt products or fund shares, which means that these structures comply with the German Electronic Securities Act (“Gesetz über elektronische Wertpapiere”, “eWpG”) and all other relevant laws. Currently the Ger­man law does not permit the tokenization of equity, which is why tokenization struc­tures of tokenizing equity will only be described briefly as an outlook for what could be possible in the future. Furthermore the relevant laws will be described before the structures are developed.

3. Which market participants can benefit from tokenization and are to- kenized private equity funds a useful complement to the portfolio in the sense of the modern portfolio theory according to Markowitz?

The thesis examines the impact of the potential of tokenization for all participants. These include the private equity fund itself, institutional investors and private inves­tors. Since one of the main aspects of tokenization is the fractionation of ownership, which at least technically creates the possibility for private investors to invest in the asset class, the impact of tokenized private equity funds on their portfolio is particu­larly examined. The modern portfolio theory according to Harry M. Markowitz is used for this purpose.

The methodical approach to structure the thesis and answer the questions is based on theoretical methods. The first step was a traditional literature review, using sci­entific sources such as journals and specialized books. In addition to these sources, reports and studies by authorities and companies, as well as podcasts in the form of interviews, were also consulted, particularly due to the topicality of the subject. Attention was always paid to the reputability of the source. By researching the sources and combining various findings, completely new structures were then de­veloped, which had not previously existed on the market or in literature.

1.3 Structure of the thesis

Goal of the thesis is to answer the three questions mentioned before and with the results to add value and create new findings for the tokenized private equity market, which still needs to be developed. In addition, this thesis should provide a compre­hensive overview of all aspects that need to be considered when approaching to tokenize private equity funds. To achieve this, chapter two and three describe the topics of tokenization and private equity separately from a theoretical point of view and thus create the foundation for the further research. The two chapters are of high importance, as basic concepts are explained and later chapters do refer to these. Both chapters also contain the current legal framework for the respective topics. After the theoretical introduction to the topics, chapter four combines the two topics. Here different structures for approaching a tokenization of private equity funds are explained. These include ways for an indirect participation, as well as direct partici­pation in private equity funds. Both structures include the description of the legal structure, as well as the involved parties and other characteristics of the implemen­tation. Furthermore structures which do not comply with the current German law are described briefly, to give an outlook for potential tokenization structures in the future. Chapter four does also discuss further considerations, such as a secondary market for security tokens of private equity, the mechanism of capital calls and a discussion about the target group of private equity investments. While chapter four does bring the topics of tokenization and private equity together, it describes the approaches from a neutral perspective, without any evaluation. Chapter five follows on from chapter four and begins by describing the benefits that the various structures can bring for different involved parties. Afterwards challenges for all participating parties and for the regulator are discussed. As some structures allow private investors to participate indirectly in private equity and also benefits and challenges concern pri­vate investors, chapter five also examines the impact of tokenized private equity products on the overall portfolio according to the modern portfolio theory of Harry M. Markowitz. The following conclusion is the last chapter of the thesis and will pre­sent essential findings, provide a critical evaluation of the thesis and outline recom­mendations as well as further areas for research.

2 Core concepts of tokenization in Germany

The tokenization of an asset describes the creation of a digitized representation of an asset including the value and the rights and obligations contained in this asset, as well as it enables the transferability of that asset (BaFin, 2019a). Digitizing assets becomes more popular currently, as the underlying technology for tokenization and prove of ownership - the distributed ledger technology and the blockchain technol­ogy - are compared to the internet itself also relatively new inventions. The use of these technologies on the internet is also referred to as “web 3.0” (Geroni, 2021). To understand the possibility of proving ownership digitally in the web 3.0 also re­quires to understand the development of the internet and why digital ownership was a problem with web 1.0 and web 2.0. With the new approaches for tokenization of assets, different studies show how enormous the potential of that technology is. The Boston Consulting Group (BCG) for example estimates the potential of tokenization globally to exceed $16 trillion by 2030, of which $3.7 trillion may fall on non-listed equity and investment funds (Kumar et al., 2022). Although this is a study for global assets and this master thesis only refers to the German market, it can be assumed that a considerable share of the amounts will fall on Germany. The reasons for this assumption are the first approaches of tokenization of assets in Germany, the topi­cality that the German federal financial supervisory authority (BaFin) ascribes to the subject and the Electronic Securities Act (eWpG) that was passed in 2021.

This chapter is divided into four subchapters. While the first subchapter describes the development of the internet in its different stages with regards to the prove of ownership and underlying technologies, the second subchapter goes more into de­tail on the blockchain technology, as the main technology for tokenization. The third subchapter will take a closer look on different tokens which can exist on a block­chain, with a special regard to security tokens, as these are the important ones when dealing with tokenization. As a result of creating security tokens to represent assets digitally, one has to check for the legal compliance, as these kind of tokens can quickly be classified as financial instruments or securities, which are highly regu­lated in Germany. Therefore the fourth and last subchapter is devoted to the legal framework that must be observed when tokenizing assets in Germany. During all of the four subchapters the focus will be on the concepts and opportunities behind the technology rather than the pure technical background.

2.1 Digital ownership

Digitalization is the process of changing data into a digital form that can be easily read and processed by a computer and among the most discussed topics in the past decades (Oxford Dictionaries, 2020). Digitalization happens in the private lives of people, in businesses among all sectors and in public matters. The world is more connected than ever before and, in most matters, future growth is dependent on digitalization. While digitalization can be seen as a superordinated term, new tech­nologies are the drivers for digital change. According to the German Federal Ministry for Economy and Climate Protection, the main technologies which drive digitaliza­tion nowadays include fields like big data, cloud computing or artificial intelligence and machine learning (BMWI, 2021). Still the basis and most important invention for digitalization and the before mentioned technologies is the internet itself. The inter­net, as a global computer network which is providing a variety of information and communication facilities, is the most common requirement for most technologies of digitalization developed nowadays. Although the internet keeps on developing every day, tracing digital ownership is still a problem which needs to be solved on a tech­nical basis and afterwards needs to be established as a standard. To see the first approaches to digital ownership in web 3.0, it is important to take a look at the de­velopment of the internet.

The internet has developed in different stages since it was invented in 1983. While web 1.0 only allowed users to access static webpages from almost any corner of the world, no interaction in the internet was possible. Web 2.0 describes the next generation of the internet and can be seen as the internet as we know it since 2004. Web 2.0 focuses on enabling users to interact with content on the web. Also users were able to upload content by themselves. Web 2.0 allowed for changing designs of web pages, it encouraged collaboration and interaction of users in transactions and thereby set the stage for e-commerce and social media platforms (Geroni, 2021). Although the internet as we know it today - web 2.0 - seems like a space with endless opportunities, there are some drawbacks of how the internet works. While there are nearly no limits to sharing information and interacting with each other, this also brings a problem with it. The problem is that there is no digital ap­proach for the verification of ownership. The example of a musician can illustrate this problem better. If a musician creates a new song and decides to share and distribute it via the internet, from a technical point of view he shares it and everyone can download it. Although there can be some technical barriers or also not-technical rules such as laws or even common understanding that dictate that the musician is the owner of his or her art, copyright breaches are still possible because there is the lack to represent the ownership of the musician digitally. This example can be trans­ferred to banks as well. If someone wants to deposit money digitally, the money is transferred and managed by a bank. Although laws and regulations rule that the money still belongs to the person who deposited it, the bank has the ultimate power over it. Also when doing transactions, there are banks which - as a trusted interme­diary - execute the transaction for you. To summarize the problem, the current web 2.0 does not allow to have unique identifiers for ownership which allow someone to prove ownership of something. The current solution is that trusted institutions take control over data, may that be files, money or other data. This is where the most current generation of the internet - web 3.0 - plays a role. Web 3.0 brings the change which could make these trust based models and the use of intermediaries unnecessary, as one of the features of web 3.0 is to use a decentralized network for passing data to the control of the owners. With that feature a user gets the oppor­tunity of exerting ownership of his or her data and also has the power to decide in which ways the data should be shared (Geroni, 2021). The first presentation of this approach and the technology behind it - the distributed ledger technology -is ex­plained in the next section.

2.2 Distributed Ledger Technology and Blockchain Technology

The first approach for the solution to the trust-based model which we know from web 2.0 and which financial services in the internet require today, was published in the Bitcoin Whitepaper in 2008 by a person or group under the pseudonym Satoshi Nakamoto. The published paper introduced the concept of a peer-to-peer network for electronic cash. A new technology - the Distributed Ledger Technology (DLT) - was described and the foundation for a new chapter of digitalization was laid (Naka­moto, 2008). The blockchain is only one, but by far the most used, application example of the DLT. As most financial applications in the DLT area use the block­chain system (Kurt & Kurt, 2022), the both terms are often used with the same meaning. In the following, this thesis will use the term blockchain with the meaning of the blockchain system and the distributed ledger technology as well. The block­chain is a decentralized database which is operated by different parties, which are located at different places and thus make the system decentral. One main charac­teristic of the blockchain is that there is no need for a central institution which has the ultimate power of the system. The data in the database is stored in the form of blocks which are chained to each other. This allows the database to grow continu­ously. The blocks are chained to each other by the use of a cryptographic method and hash-values. Thus, the system can record and store information (e.g. financial transactions) without the need of a financial institution as an intermediary, while at the same time it addresses security issues which were otherwise ruled by interme­diaries (Nakamoto, 2008). The blockchain allows transactions between different parties, without an intermediary, because the blockchain is (a) decentralized, (b) immutable and (c) built on a consensus-based process (OECD, 2019). These three characteristics are further described in the following paragraphs.


The blockchain is a decentralized database. This means that it is maintained by several parties, who communicate with each other in a peer-to-peer form. All parties in the system have the same access to the information stored in the database. There are no central authorities and no one holds a master file (Tata, 2022). Also parties act independently of each other. Decentralized databases are very different from centralized databases, as decentralized databases have the advantage that they are difficult to attack. Central databases have a central point which can be attacked and manipulated. With decentralized databases there is no such unique point of attack, which makes the system much more robust (OECD, 2019). The following illustrations shows how parties communicate in a decentralized structure (left side) and in a centralized structure (right side).

Figure 1: Decentralized network (left) vs. centralized network (right)

Editor's note: the figure was removed due to copyright issues.

Source: A. Kumar, 2022


The use of a cryptographic signature ensures that the data, which is added to the blockchain grouped into blocks, cannotbe changed after the data was confirmed by the participating parties of the network.A change would only be possible if a group of participants have control ofmore than 50% ofthe necessary resources to confirm transactions. Still the decentralized aspect of the blockchain minimizes this risk (OECD, 2019). If a group still decides that they want to change something on the blockchain -may it be a transaction or even the software code of the blockchain- they can do that, but in that case a new and parallel working blockchain is created. This event is called a fork of the blockchain and in that event the original blockchain is not changed, but the blockchain diverges into two potential paths forward. Thus the original blockchain and the data of it is not changed (Coinbase, n.d.).

Consensus based process:

The reason that the de-centrality and the immutability work, is a consensus-based mechanism. The mechanism is crucial to ensures that every block is valid and that all participants agree and maintain the same version of the ledger. As this mecha­nism is accepted and maintained by the participants, it is important to understand that it is based on the honesty of the participants. Malicious actions are possible but do not lead to a reward for the participants. By distributing rewards to the parties which act in favor of the consensus-based mechanism, the only rational way is to act in accordance with it. Following the mechanism in order to be able to get rewards is called mining. Among different consensus mechanisms there are Proof-of-work, where the participants provide computing power to the network, or Proof-of-stake, where participants provide tokens of the network to the network itself (Tata, 2022). Due to the three mentioned characteristics (decentralized, immutable, consensus­based) and the interaction of them, the ownership of digital assets which are based on the blockchain are unique identifiable. Each transaction on a blockchain is carved in stone and immutable. The transaction will forever be mathematically hashed and cryptographically connected to the other transactions on the blockchain. Also, for public blockchains, all transactions happening are publicly accessible to beviewed by anyone and thus anyone can comprehend which assets belong to whom. The data is accessible publicly byso called native block explorers, which provideall rel­evant information about transactions. Each blockchain has an own block explorer, where anyone can search for any wallet address, token address or transaction. Thus, anyone can check the public available digital ownership for a particular asset (Liljeqvist, 2022).

The following screenshot shows a transaction of the website, where all transactions which happen on the public Ethereum-Blockchain can be viewed. The picture shows a transaction between the wallet “0x30c167d2896f7c20a50beaa66b2dc7b380bd268e” (as the sender) and the wallet “0x73e99cbdcabbe2fd5f37c6e665e9551b3a3f975a” (as the receiver). The com­puted transaction hash is

“0xb0b666f1b187ee35e8e1be670cf19fb1150342bc08f92762a9e5e6c4e29c562f” and the amount of 0.05 ETH was transferred between the wallets. At the time of the transaction (Oct-31-2022) the amount equaled $78.35. The transaction fee was 0.000429697476327 ETH, which equaledabout $0.67. Furthermore, the transaction is storedin block number 15868963 and got 15 confirmationsby other participants of the decentralized network.

Figure 2: Example transaction on the Ethereum Blockchain

illustration not visible in this excerpt

Source: Etherscan, 2022

Ethereum was used as an example, as it is, in terms of market capitalization, the biggest blockchain besides the Bitcoin. While the Bitcoin-Blockchain was the first blockchain, the sole focus was on financial transactions. Following blockchains cop­ied that idea and more and more blockchains for financial transactions were devel­oped. The first approach to use the blockchain technology for other data than finan­cial transactions was Ethereum, which was first presented in 2015. The focus of Ethereum was to build a platform as the basis for further blockchain applications of different natures. Different use cases could be decentralized finance applications, voting procedures, decentralized storage or the tokenization of assets (Buterin, 2014b). For all of these applications the Ethereum-own token “Ether” is used. Ethereum does not solely focus on financial transactions, but a much broader variety of possible applications. One reason for the broad range of applications is the use of smart contracts, which are used on the Ethereum blockchain. The concept of smart contracts was already introduced in 1994 by Nick Szabo. In his concept paper he wrote about the vision of a digital marketplace built on automatic, cryptograph­ically secure processes. He defines a smart contract as “a computerized transaction protocol that executes the terms of a contract.” Further Szabo explains that, “the general objectives of smart contract design are to satisfy common contractual conditions (such as payment terms, liens, confidentially and even enforcement), minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries.” (Szabo, 1994, p.1). The Ethereum blockchain is the first blockchain which adapted the idea of smart contracts. The official Ethereum website even describes smart contracts as the fundamental feature of Ethereum applica­tions. On the Ethereum blockchain the smart contracts follow a strict if-then logic, meaning they are executed exactly as they are programmed and cannot be changed. An example would be that a transaction is triggered by another transaction (IF transaction A is complete, THEN start transaction B) (Buterin, 2014a). In addition to the use of smart contracts, the Ethereum blockchain offers another attractive fea­ture for tokenization, which is the possibility to set up a private blockchain on the Ethereum blockchain. The difference between public and private blockchains is de­scribed in the following paragraph. Chapter four will later return to the reasons why this could be important for certain tokenization structures (Buterin, 2014b).

Public vs. Private Blockchains:

Besides public blockchains - like Bitcoin and the Ethereum Mainnet- there are also private blockchains. While the two work in the same way, the difference is about the parties who have access to the blockchain. In a public blockchain everyone can be part of the network and take part in the peer-to-peer network. With private block­chains only selected parties can take part in the peer-to-peer network, meaning only these selected parties can trigger transactions and view data contents.

2.3 Crypto tokens and security tokens

A crypto asset or a crypto currency, as well as denominations of both are also re­ferred to as crypto tokens. Crypto tokens represent a programmable and tradeable asset or utility which allows the holder to use it for investment or other economic purposes (Frankenfield, 2022). Holding that token, as well as trading it or accessing related rights and claims is managed by the underlying blockchain as well as smart contracts. As many applications of tokens and their characteristics are similar to securities or financial instruments the German regulator and federal financial super­visory authority (BaFin) is monitoring the development of different tokens very close. In 2019 the BaFin released their first article about their view on Crypto tokens. The BaFin describes that from the regulatory perspective they see the emerge of three different types of tokens with a rough assessment of the property, a security or fi­nancial instrument has (BaFin, 2019b). The BaFin classifies different tokens as fol­lows:

- Utility Token: A Crypto token that allows access to services or products, such as admission of tickets or vouchers or admission for digital memory space. Ac­cording to the BaFin, the majority of domestic crypto tokens offered in an initial coin offering (ICO) fell into this category. In principle, utility tokens are not seen as a security under the Securities Prospectus Act (“Wertpapierprospektgesetz”, “WpPG”) nor as an investment under the Capital Investment Act (“Vermögen­sanlagegesetz”, “VermAnlG”) and also not as a financial instrument under the German Banking Act (“Kreditwesengesetz”, “KWG”) (BaFin, 2019b).
- Payment Token: A Crypto token which can also be called virtual currency or cryptocurrency and which has similar characteristics to the Bitcoin. The provider intends to use the tokens as an alternative means of payment. Stable coins can also be viewed as a payment token. In principle, payment tokens are not seen as a security under the Securities Prospectus Act (WpPG) nor as an investment under the Capital Investment Act (VermAnlG), but can often be financial instru­ments according to the German Banking Act (KWG) (BaFin, 2019b).
- Security Token: A Crypto token which can also be called asset token or invest­ment token. Holders of such tokens are entitled to membership rights and claims. These rights and claims can be similar to those of an owner of a stock or other investment securities. These include claims to dividend-like payments, voting rights, repayment of payments, interests or other cashflows. Security tokens can be seen as securities under the Securities Prospectus Act (WpPG) and also as a financial instrument under the German Banking Act (KWG). In the case that the security token would represent an investment under the Capital Investment Act (VermAnlG), the token will not be seen as an investment under that law, but as a security instead (BaFin, 2019b). While the term “Security Token” can be used for tokens with the before mentioned characteristics, from a German legal point of view a crypto token is a security, as soon as it is listed in an appropriate register for digital securities. This will be further examined in chapter 2.4.

In addition to the description of the BaFin, the following illustration gives an addi­tional overview of different use cases. While utility tokens show the least possible concrete use cases, it is worth mentioning that there is no limit for creativity in the use of utility token and more use cases could be found. Payment token include cryptocurrencies like Bitcoin but also Central Bank Digital Currency (CBDC), which is being developed by several central banks across the whole world, including the European Central Bank (ECB) with a digital Euro (Kurt & Kurt, 2022). Lastly the security tokens show the most use cases. It is interesting to see that most of the use cases are at a first glance not an innovation, but only already existing concepts, brought to a digital audience with the blockchain technology.

Figure 3: Use cases for different types of tokens

illustration not visible in this excerpt

Source: Own illustration based on Kurt & Kurt, 2022

Due to the fact that private equity is an already existing asset class and the funds which are tokenized are also an already existing asset which is just brought digitally to the blockchain, the description of the BaFin and also the illustration show that for the use case of tokenization of private equity funds, security token are the right choice. Furthermore instead of using the tokens for payments or other functions, the tokens should represent typical right and claims a private equity investor should have. Thus from now on the thesis will only focus on security tokens. The following three paragraphs will describe security tokens, different token standards and which of them could be used for security tokens, as well as security token offerings.

Security token

Security tokens are a digital representation of assets stored in a decentralized man­ner on a blockchain. They are assigned a specific value, which may be inherent in the security token itself or the security token may be assigned a value by parties involved to the token. Holders of such tokens are entitled to membership rights and claims. These rights and claims can be similar to those of an owner of a stock or other investment security (BaFin, 2019b). These can include ownership, voting rights, profit- or dividend-like payments, repayment of payments, interests or other cashflows. Typically, these rights correspond to the rights that the physical owner of the asset has. A security token can also represent partial ownership of the named asset and is issued against a certain amount of money. Thus they can also repre­sent an already existing real-world asset (Deloitte, 2019). Due to their characteristic as an investment, the focus of security tokens is often on cashflows and perfor­mance profiles. An advantage over traditional investments is the fractionation of larger assets. Larger assets tend to be illiquid, as it is difficult to convert them into cash when needed. With the help of security token, such assets can be fractionated and issued in an arbitrary amount of token. As a result of fractionizing and resulting lower values per token, as well as by using the blockchain as the underlying tech­nology, transferring these token to another party is easier than transferring huge volumes of illiquid assets, which makes the tokenized asset potentially more liquid. In addition, the issuance of security token (security token offering, STO) on a block­chain is much easier and requires lower issuance fees compared to the issuance of traditional equity or debt securities (Cashlink, 2022). Furthermore through the gen­eral visibility of transactions on a blockchain, the use of security tokens for tokeni- zation of assets enable a greater market transparency and thus more market visi­bility on capital markets which could prevent fraud attempts. Another difference to traditional securities is that due to the decentralized blockchain technology and the missing intermediary, security tokens can be traded around the clock and through­out the whole year. Also any specific conditions connected to the token (e.g. cash­flows) can be stored in a smart contract. This makes the management and control of the tokens less susceptible to manipulation, as the information of the smart con­tract are stored on the blockchain system and cannot be changed retroactively. Sim­ultaneous this leads to more automatization and less need for manual actions (Tata, 2022).

Details on the legal classification under German law, as well as relevant BaFin com­ments to the topic of security token are further explored in chapter 2.4.

Different token standards

From a technical point of view, different standards for the creation of digital assets have already been established. These standards define the concrete design of dig­ital tokens, including different attributes and smart contracts, the token can store. The nine basic attributes that all tokens can store include: name, symbol, decimals, possible balance, total supply, possibilities of transferability, different events, differ­ent approval and rejecting patterns (Kurt & Kurt, 2022). Besides these nine attrib­utes, there can be much more attributes for each different token standard. Also de­pending on the token standard, these attributes can be pronounced to different de­grees. A non-fungible token (NFT) for example needs certain attributes to be pro­grammed differently (because of the non-fungibility) than a token which is fungible. In the case of creating and issuing security tokens, anyone can theoretically estab­lish an own token standard. However, it makes more sense to fall back on already established token standards. This is because sticking to a standard ensures com­parability of tokens and thus more transparency for the users of the tokens. In addi­tion, sticking to a standard offers much better technical options, as the token can be transferred and stored in third party services (e.g. wallets). Lastly, choosing an ex­isting token standard for a security token is much less effort than programming a new token standard (Kurt & Kurt, 2022).

On the Ethereum blockchain there are different existing token standards. These re­sult from suggestions for improvement of tokens, which are numbered in sequence. A new suggestion is presented as a “Ethereum Request for Comment” (ERC). Among the most popular token suggestions which have prevailed are the “ERC-20”, “ERC-721” and “ERC-1400” tokens (Hays et al., 2021). An overview is given in the following table.

Table 1: Different token standards on the Ethereum blockchain

illustration not visible in this excerpt

Source: Based on Hays et al., 2021

The ERC-20 token standard was suggested by the founder of the Ethereum block­chain Vitalik Buterin in the same year as the launch of the Ethereum blockchain. With more than 600.000 different tokens created, it is by far the most used standard until today (Kurt & Kurt, 2022). The ERC-20 token consists of exactly the nine dif­ferent attributes mentioned before. If a token consists of these nine attributes, it can be called an ERC-20 token and be automatically processed by every infrastructure which is made for ERC-20 tokens. The ERC-721 token standard is the main stand­ard for tokens which are not fungible. The mentioned attributes are similar to the ones of an ERC-20 token but with some minor changes, including the uniqueness of every token. For security tokens, the ERC-1400 emerged as a standard. This standard is ERC-20 compatibly, which means it can be transferred and stored on ERC-20 infrastructure but has additional attributes which can be necessary for a security. One major difference is that the ERC-1400 token includes attributes to in­clude know-your customer (KYC) and anti-money laundering (AML) regulations in the token. Furthermore the tokens include the possibility to save the identity of the parties taking part in a transaction.


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Tokenization of Private Equity Funds in Germany. Direct and Indirect Participation and Feasibility
International School Of Management, Campus Frankfurt
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ISBN (Book)
tokenization, private, equity, funds, germany, direct, indirect, participation, feasibility
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Philipp Rothe (Author), 2023, Tokenization of Private Equity Funds in Germany. Direct and Indirect Participation and Feasibility, Munich, GRIN Verlag,


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