Understanding Fund Tokenization and Its Impact
If you’ve been following the evolution of wealth management, you might want to pay attention now. The rise of ETFs was significant, but fund tokenization is set to bring about another major transformation in the field. So, what’s the scoop on investing in tokenized funds? And should we be cautious about it?
What Exactly is Fund Tokenization?
Tokenization, as explained by McKinsey, involves creating a digital version of a tangible item.
When it comes to fund tokenization, this refers to representing shares in traditional investment vehicles—like mutual funds, ETFs, and private equity—as digital tokens on a blockchain. Each token signifies a verifiable and legally binding ownership of a specific part of the fund.
How Does It Function?
Much like standard mutual funds, tokenized funds are evaluated using net asset value (NAV). However, instead of looking at NAV per share, investors consider NAV per token, which is found by dividing the total NAV of the fund by the number of tokens available.
A key aspect of tokenized funds is that blockchain keeps track of ownership and updates it automatically. This eliminates the need for a central registry of shareholders, changing the roles a bit while keeping the essence of the fund ecosystem quite similar.
Growing Acceptance of Tokenized Assets
We’ve seen a steady uptick in the tokenization of funds over recent years, largely driven by major financial institutions alongside regulators. For instance, in 2021, Franklin Templeton initiated the first US-registered fund on the blockchain—the Franklin On-Chain US Government Money Fund. Fast forward to 2024, and BlackRock launched the BlackRock USD Institutional Digital Liquidity Fund (BUIDL), which quickly hit over $500 million in market value in just a few months.
Interestingly, a report from EY anticipates that by 2027, between 7% and 9% of investors might channel their whole portfolios into tokenized assets.
Are Tokenized Funds a Threat to ETFs and Mutual Funds?
To really grasp this, we should look at how tokenized funds compare with traditional ETFs and mutual funds, including their unique advantages.
Transparency in Pricing:
- Mutual funds generally work with a delayed pricing model, meaning execution prices are only confirmed at the end of the trading day.
- On the flip side, ETFs and tokenized funds offer much better transparency, with prices updated in real-time during the trading day based on market activity.
Fundraising and Cash Access Speed:
- Traditional mutual funds follow a T+2 or T+3 settlement period.
- ETFs streamline this process, allowing for funding and cash access during trading hours.
- Tokenized funds take it a step further by offering 24/7 cash access.
Use in Derivatives:
- While mutual funds have limited options as underlying assets for derivatives, a select few ETFs are involved in exchange-traded options.
- Tokenized funds could considerably broaden the role of these underlying assets, especially with the introduction of smart contracts.
Connection with On-Chain Money and Digital Finance:
- Tokenized funds built on blockchain can facilitate faster and more efficient transaction settlements compared to traditional mutual funds and ETFs.
While tokenized funds do have various advantages over traditional mutual funds and ETFs, they don’t necessarily pose a threat. In fact, research from BCG indicates that they can complement and improve upon conventional investment funds.
Take mutual funds, for example. Despite managing around $58 trillion in assets over the past decade, with an average annual return of 7.1%, they still deal with a settlement process that typically takes two to three days (T+2/T+3). This lag can hinder capital efficiency and stall the development of new investment options. However, fund tokenization could potentially boost mutual fund investors’ returns by about 17 basis points annually—translating to around $100 billion in total.
