Private Equity Firms in the Middle East Embrace Web3 Technologies for Continued Relevance

The sharp decline of nearly $3 trillion in web3-related asset value, representing over 70% shrinkage, has been unsettling, to say the least. Nevertheless, the real significance lies in the foundational technologies that underpin web3, which hold immense potential for various sectors of the global economy, including private equity.

The web3 ecosystem is rapidly expanding, with thousands of companies receiving substantial funding of around $94 billion from venture funds, hedge funds, private equity, and other investors.

Leading companies like JPMorgan, Goldman Sachs, Google, and Disney are actively considering the impact of web3 on their businesses and how it can revolutionize transaction management and customer engagement. The popularity of crypto and nonfungible tokens (NFTs) has introduced younger affluent consumers to essential web3 concepts, such as digital wallets that offer cross-platform usability.

Forward-looking private equity firms are closely examining the implications of blockchains, tokens, smart contracts, and other web3 technologies on their investment strategies and operational processes.

According to Brahim Laaidi, Partner at Bain & Company, and Thomas Olsen, Global Co-lead of Web3 and Metaverse Practice at Bain & Company, Web3 is increasingly gaining relevance for private equity as it continues to attract sophisticated investors, poses both disruptive threats and opportunities, and serves as a valuable tool for shaping new fund strategies. How? It all starts with the evolution of web3.

The evolution of web3

Despite all the Sturm und Drang around crypto, there’s no denying it has been an important proof of concept for how web3 technologies work together. Web3’s promise is an improved version of the Internet, one that is more interoperable than today’s siloed web.

Web1, which launched in the 1990s, was read-only, meaning content was pushed at users and nothing flowed the other way. Web2 ushered in social media and the ability to post your own content. Nevertheless, Web3 is evolving as a new kind of Internet, with open protocols and standards that allow for new avenues of value transfer, data sharing, and application development across platforms.

The foundational building blocks are blockchains, smart contracts, and tokens. Blockchains are open, decentralized databases and computing platforms that create security through a consensus mechanism. With the development of Ethereum starting in 2014, blockchains allowed users to securely execute lines of code—known as smart contracts—“on chain.”

Tokens, meanwhile, are digital representations of data or assets registered on the blockchain ledger. They can be imbued with clearly defined terms of use (such as trading or governance restrictions) and can carry with them reams of data (escrow information for a real estate asset, say, or gaming assets that can be moved from platform to platform).

From these building blocks come many core web3 concepts and tools. They include dApps (decentralized applications built on blockchain networks), DeFi (decentralized finance networks enabled by smart contracts), DAOs (decentralized autonomous organizations), digital wallets enabling persistent digital identity, and open metaverses.

Identifying disruption threat and opportunity across the portfolio

While funds that focus on more mature companies and industries may not want to play in the web3 arena, they’d be ill advised to ignore it. Over the next decade, the burgeoning set of web3 innovations could affect a broad sweep of industries and companies, some of which aren’t necessarily obvious today.

Funds need to understand what these changes might mean for more traditional portfolio companies—both in terms of disruption risk and opportunities to go on offense. Those insights come from scanning the current portfolio for potential web3 exposure and probing these issues in due diligence.

The most effective scans map a portfolio sector by sector, looking at the pace of potential disruption, regulatory changes, and other factors that might accelerate or decelerate change. That leads to a clearer picture of how and when web3 is likely to reshape the industry and how much opportunity there might be to capitalize on those shifts.

A web3 lens on fund management

Even as they consider how web3 is affecting companies in their portfolios, a growing number of private equity firms are moving decisively to explore how web3 might change the way they think about strategy and operations. The ability to tokenize real assets via blockchains and smart contracts could lead to important innovations and features for alternative asset products.

Notably, tokenization could allow fund managers to build in tailored secondary liquidity mechanisms or make it easier to use fund investments as collateral.

On the operations side, tokens could lower administration costs by automating manual processes and enabling structured secondary trading mechanisms, custody, margin lending, reporting, and other features that could also be tailored to different types of fund products.

Smart contracts and distributed ledgers promise to enhance efficiency and transparency by creating an immutable record of historical token ownership, lowering the cost and complexity of reporting and regulatory compliance. Nearer at hand  are solutions based on blockchains and smart contracts that can transform back-office operations. 

Whether you’re an investor funding the next generation of IT infrastructure, a fund manager performing due diligence on traditional companies exposed to web3 changes, or a PE strategist evaluating new types of funds and distribution channels, web3 is very likely to emerge as a critical theme over the next 10 years.

It may not be time yet to dive in headfirst. Nevertheless, for many funds, it is time to begin building depth in web3 and evaluating how to turn this technological shift into an advantage.