Here's how you can enhance transparency and efficiency in Private Equity using blockchain technology.

Smart contracts are a misnomer, as they are simply a set of pre-programmed immutable instructions that can be executed deterministically to achieve consensus in a distributed system like the blockchain. Therefore, they are only as smart as they are written by their very fallible authors and not necessarily a legal contract. However, underpinning this, is the novel idea of perfect determinism thru a collection of purpose built components, namely a virtual machine, a programming language and a compiler. Such that, for any given set of instructions and parameters, the resultant output and machine state will always be the same regardless of the differences in the underlying von Neumann architecture that the instructions are executed in.

Asset tokenization is the trivial act of deploying a not-so-smart set of token management functions based on basic templates such as ERC20 to loosely represent a real world asset such as private equity. This is not to be confused with the arduous and onerous asset issuance processes typical of private equity which involves due process and approval of existing shareholders in accordance the company's constitution/by-laws. Moreover, such private equity can also only be issued to KYCed individuals and in some instances only to accredited investors due to the risky and illiquid nature of private equity. Some private equity even have transfer conditions such as right of first refusal bestowed on existing shareholders along with other rights.

Tokenization is the way to go at the moment. The idea that you can introduce the transparency and decentralization of the blockchain technology to traditional finance makes it something to watch out for!

As we consider Blockchain a digital ledger, it can be incorporated to improve data collection and due diligence in private equity (PE) by providing immutable records of a company's operational and financial data, ensuring quick and accurate access to information. Before mass adoption, our industry and partners must address challenges such as technology complexity, costly integration, standardized data formats, and compliance with evolving regulations. Addressing these challenges through technology/vendor partnerships, pilot programs, and regulatory engagement should develop PE firms' confidence in leveraging Blockchain, improving visibility and shareholders return.

While the blockchain is almost immutable, due diligence is made more efficient ONLY IF, the data is accurately stored in the smart contract. In traditional business systems architecture, this is ensured through offline verification, validation and audit processes. In smart contracts based architecture, due processes can be implemented as algorithms governing the change management of the data. For e.g., capitalization tables are updated as a result of a fixed set of processes such as share issuance or transfer and if these processes are implemented in the smart contract, then due diligence becomes trivial. However, using the basic token smart contracts does not provide such controls, thus, it does not make due diligence more efficient.

There is a wide open space to start bringing a new level of effectiveness to reporting standards by being able to track and trace the actual data they rely on. In PE, this can start happening on an individual project basis - and financially justified by aligning with executing a proactive, industry-leading approach that also improves reporting efficacy.

Reporting standards along with accounting standards such as IFRS can be implemented as algorithms in smart contracts in a way that the accounting books are updated realtime via oracle bridge applications. For e.g. a Stripe oracle application can monitor all the incoming payments while another monitors out-going payments, to directly create accounting entries in the smart contract in accordance to standard IFRS principles. Reports such as cashflow statements, balance sheets and PnL statements can then be generated realtime and on-demand.

Regulatory compliance starts with onchain identity/KYC smart contracts with proof-of-identity, proof-of-address and liveliness verifications to ensure traceability of private equity ownership. Conventional business systems design, often segregates user registration and KYC from the tokenization processes which causes breaks in the chain of compliance, thus requiring conventional audits to ensure compliance. However, in a proof-of-due-process smart contract design, compliance is preemptive, realtime and complete from issuance to identity KYC. When done correctly, such a design could negate the need for periodical audits!