Fund Tokenization, the Next Financial Revolution?

Traditional financial institutions are accelerating their embrace of cryptocurrency technology.

Original: Fund Tokenization: How Close To The Next Financial Revolution? (Forbes)

Author: Alexandra Andhov

Translator: Luffy, Foresight News

Cover: Photo by Pepi Stojanovski on Unsplash

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

According to the white paper, fund tokenization has the potential to create tens of billions of dollars in value for financial institutions and investors. By the end of 2024, the AUM of tokenized funds from BlackRock, Franklin Templeton, and WisdomTree had exceeded $2 billion. While $2 billion is just a fraction of these three firms' overall AUM, it indicates that fund tokenization has attracted investor interest. Furthermore, an increasing number of banks are also launching tokenized investment funds, with the latest news being UBS launching a tokenized money market fund called uMINT on November 1, 2024.

What is Fund Tokenization?

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

Let's compare company stocks and fund tokens:

Stocks are traditional paper or electronic records managed within the systems of stock exchanges or banks. They represent ownership in a company and carry certain rights, such as voting on company decisions or receiving dividends. Buying and selling stocks typically requires brokers and is recorded in centralized financial systems. This business model has existed for centuries.

Tokens, on the other hand, can be seen as decentralized and digitized ownership. They have similar rights and obligations as stocks, but their records are maintained on decentralized digital ledgers. The form of tokens is different because they do not rely on traditional stock exchanges or brokers. Instead, they are fully digitized, 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 by 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 key benefits can be summarized as follows:

• Enhanced liquidity and flexibility: Tokenized funds provide 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.
• Reduced costs through automation: Smart contracts on the blockchain can automate compliance, record-keeping, and settlement processes, thereby lowering management costs. These operational savings ultimately translate into lower fees for investors, and net returns may be higher due to the simplified automated trading.
• Fractional ownership and broader access thresholds: Tokenization breaks down investment barriers by allowing fractional ownership, meaning smaller and more manageable investment sizes. This is particularly important for alternative assets like real estate or private equity, which typically require higher capital commitments. By lowering the access threshold, tokenized funds have the potential to attract a more diverse investor base.
• Instant collateralization: Tokenized assets can be used as collateral for lending in a more flexible manner. Leveraging the secure blockchain record, investors can quickly borrow funds using their tokenized assets, creating new liquidity without the traditional lending process.
• Yield generation opportunities: Tokenized funds open up new investment channels for both traditional and digital-native investors. Experienced investors can leverage the intraday price movements of tokenized funds to generate 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 around 1% of global (approximately $600 billion) by 2030. Additionally, tokenized funds could generate up to $400 billion in annual returns from activities such as lending and price volatility trading.

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

Which funds are most 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 holding illiquid assets (such as private equity or real estate) that may benefit.

Funds suitable for tokenization include:

• Real estate funds: Typically illiquid with high entry costs; tokenization can create a secondary market, improve liquidity, and lower minimum investment amounts.
• Debt funds: Tokenization of debt funds, which currently face challenges in raising capital.
• Private equity and venture capital funds: Often restricted by minimum investment thresholds; tokenization can enable fractional ownership and expand access to these high-growth assets.
• Hedge funds: Known for their structural complexity and limited access; tokenization can make them more accessible and manageable.
• Infrastructure funds: If large-scale project investments are made public, tokenization of these infrastructure funds will allow for broader investor participation and higher transparency.
• Commodity funds: Tokenized funds investing in commodities like gold or oil can make trading more convenient 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, at least considering the following:

• Regulation and investor protection: While the U.S. has introduced some tokenized funds, and Singapore has a few as well, blockchain-based financial products still lack clear and comprehensive regulation. Although regulators seem hesitant about crypto assets, they have given the green light to financial products. The lack of standardized rules increases uncertainty around investor protection, compliance, and oversight.
• Operational challenges and interoperability: Tokenized funds need to integrate seamlessly with traditional financial infrastructure, which is often incompatible with blockchain systems. To achieve a frictionless interface, tokenized assets require interoperable standards and systems, which are still in development. The current lack of integration may result in transaction friction and increased complexity in management.
• Smart contract reliability: Smart contracts can automate key functions, but any errors in the code can lead to losses and security vulnerabilities. Smart contracts are immutable, making it difficult to easily correct errors or security flaws, posing risks of financial losses and legal liabilities.
• 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 potential for liquidity and efficiency.

Tokenized funds represent an intriguing innovation with tremendous potential value: improving liquidity, accessibility, and operational efficiency. Open discussions about the advantages and limitations are crucial for building trust between investors and stakeholders.

It is worth noting that a few years ago, the financial industry generally viewed crypto assets as speculative and marginal. But now, we see major financial institutions not only recognizing the potential of blockchain technology across a range of financial activities but also actively embracing it. As the underlying technology of digital assets begins to meaningfully reshape traditional finance, perceptions are rapidly evolving.

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