Traditional financial institutions are accelerating their embrace of cryptocurrency technology.

Written by: Alexandra Andhov

Translated by: Luffy, Foresight News

Last month, the Boston Consulting Group, Aptos Labs, and Invesco jointly released a white paper titled Tokenized Funds: Decoding the Third Revolution in Asset Management. The title is captivating and thought-provoking, but does it make sense? Is fund tokenization the next step in financial evolution? If so, what will the endgame look like?

In 1889, investors traded in the New York Stock Exchange hall

According to the white paper, fund tokenization has the potential to create billions of dollars in value for financial institutions and investors. By the end of 2024, the assets under management of tokenized funds from BlackRock, Franklin Templeton, and WisdomTree are expected to exceed $2 billion. Although $2 billion is just a fraction of the total assets under management of these three institutions, it indicates that fund tokenization is attracting investor interest. Additionally, an increasing number of banks are launching tokenized investment funds, with the latest news being UBS's launch of the tokenized money market fund uMINT on November 1, 2024.

What is Fund Tokenization?

Fund tokenization is the process of converting ownership of a fund (such as real estate, mutual funds, or private equity funds) into tokens. Each token represents a small portion of the fund, similar to shares of a company.

Let’s compare company shares and fund tokens:

Shares are traditional paper or electronic records managed within a system by a stock exchange or bank. They represent ownership in a company and come with certain rights, such as voting on company decisions or receiving dividends. Buying and selling shares typically requires going through a broker and is recorded in a centralized financial system. This business model has existed for centuries.

In contrast, tokens can be seen as decentralized and digitized ownership. They carry similar rights and obligations as shares, but their records are kept on a decentralized digital ledger. The form of tokens differs as they do not rely on traditional stock exchanges or brokers. Instead, they are fully digital, allowing people to buy and sell them directly without intermediaries.

What is the Value of Fund Tokenization?

According to the BCG white paper and analyses from Bain & Company and JPMorgan, the value of fund tokenization lies in transforming the asset management landscape by creating more accessible, efficient, and liquid markets. The additional value is briefly outlined as follows:

• Enhanced liquidity and flexibility: Tokenized funds offer 24/7 trading, allowing investors to buy and sell fund shares at any time. This continuous liquidity is similar to the flexibility of exchange-traded funds (ETFs), suitable for those who want better control over timing without the constraints of traditional mutual funds.
• Cost reduction through automation: Smart contracts on the blockchain can automate processes such as compliance, record-keeping, and settlement, thereby reducing management costs. These operational savings ultimately translate into lower fees for investors, and due to streamlined automated trading, net returns may be higher.
• Fractional ownership and broader access: Tokenization breaks down investment barriers by allowing fractional ownership, meaning smaller and more manageable investment sizes. This is particularly important in alternative assets like real estate or private equity, which typically require higher capital commitments. By lowering the entry threshold, tokenized funds have the potential to attract a more diverse group of investors.
• Instant collateralization: Tokenized assets can be used more flexibly as collateral for lending. With secure blockchain records, investors can quickly borrow funds against tokenized assets, creating new liquidity without traditional lending processes.
• Access to yield opportunities: Tokenized funds open new investment channels for traditional and digitally native investors. Experienced investors can leverage intraday price movements of tokenized funds to achieve additional returns through faster and more precise trading strategies that are not possible with traditional mutual funds.
• Scalability and revenue potential: Industry estimates suggest that the assets under management of tokenized funds will grow significantly, reaching 1% of global AUM (approximately $600 billion) by 2030. Additionally, tokenized funds could generate annual returns of up to $400 billion from activities such as collateralization and trading on price fluctuations.

Essentially, fund tokenization can provide significant value by lowering entry barriers, improving liquidity, and enhancing efficiency for both investors and asset managers. It prepares the future growth of asset management to respond to changing market demands while improving investor experience and returns; it may also bring more oversight and trust to the industry.

Which Funds are More Suitable for Tokenization?

Certain funds are more suitable for tokenization, particularly those with high entry barriers (such as high minimum investment amounts or geographic restrictions) and those with illiquid assets (such as private equity or real estate) that may benefit from it.

Funds suitable for tokenization include:

• Real estate funds: Typically illiquid with high entry costs; tokenization can create a secondary market, enhancing liquidity and lowering minimum investment amounts.
• Debt funds: Tokenized debt funds currently face challenges in raising capital.
• Private equity and venture capital funds: Often limited by minimum investment amounts; tokenization can enable fractional ownership, expanding access to these high-growth assets.
• Hedge funds: Known for their complex structures and limited access; tokenization can make them more accessible and manageable.
• Infrastructure funds: If large project investments are public, tokenization of these infrastructure funds would allow broader investor participation and greater transparency.
• Commodity funds: Tokenized funds investing in commodities like gold or oil can make trading easier and faster.

How Far Are We from the Next Financial Revolution?

Before looking ahead to the next financial revolution, we need to recognize the potential risks and limitations of tokenized funds, and at least consider the following points:

• Regulation and investor protection: The U.S. has launched some tokenized funds, and Singapore has a few as well. However, blockchain-based financial products still lack clear and comprehensive regulation. While regulators seem to be wary of crypto assets, they are greenlighting financial products. The lack of standardized rules increases uncertainty regarding investor protection, compliance, and oversight.
• Operational challenges and interoperability: Tokenized funds need to integrate smoothly with traditional financial infrastructure, which is often incompatible with blockchain systems. For seamless integration, tokenized assets require interoperable standards and systems, which are still under development. This current lack of integration may create trading friction and complicate management.
• Reliability of smart contracts: Smart contracts can automate critical functions, but any errors in the code can lead to losses and security vulnerabilities. Smart contracts are immutable, so errors or security flaws cannot be easily corrected, posing risks in terms of financial loss and legal liability.
• Dependence on stable on-chain currencies: The advantages of tokenized funds, especially in real-time settlement and instant collateralization, depend on the availability of stable, regulated on-chain currencies (such as stablecoins or central bank digital currencies). Without widely accepted on-chain currencies, tokenized funds may face challenges in realizing their full liquidity and efficiency potential.

Tokenized funds represent a fascinating innovation with significant potential value: increased liquidity, accessibility, and operational efficiency. Open discussions about the advantages and limitations are crucial for building trust among investors and stakeholders.

Notably, a few years ago, the financial industry widely regarded crypto assets as speculative and marginal. But now we see major financial institutions not only recognizing the potential of blockchain technology in a range of financial activities but also actively embracing that potential. As the underlying technology of digital assets begins to meaningfully reshape traditional finance, perceptions are rapidly changing.

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