Moody's: Tokenized funds are becoming increasingly popular, market potential remains to be developed

Analysts from the international credit rating agency Moody's stated that the increasing popularity of tokenized funds is enhancing the efficiency of investments in assets such as government bonds. Tokenized funds grew sevenfold last year and there is still much "undeveloped market potential."

Tokenized Funds Increased Sevenfold Last Year

According to a report by The Block, international credit rating agency Moody's stated in its report that an increasing number of blockchain-based tokenized funds are enhancing the investment efficiency of assets such as government bonds. With the violent rate hikes by the Federal Reserve last year making fixed-income products more appealing, the tokenized funds issued on public blockchains by traditional institutions and cryptocurrency companies backed by such securities have grown from over $100 million at the beginning of 2023 to over $800 million by the end of the year.

The largest player in this space is the traditional financial firm Franklin Templeton. Franklin's OnChain U.S. Government Money Fund (FOBXX) was established in April 2021, with 99.5% of its total assets invested in U.S. government securities, cash, and repurchase agreements fully collateralized by U.S. government securities or cash. Initially launched on the Stellar blockchain, FOBXX expanded to Polygon in April 2023, with potential future issuances on Avalanche, Aptos blockchains, and Ethereum layer 2 solution Arbitrum.

The Real World Asset RWA Battle between Traditional Finance and DeFi: Franklin FOBXX vs. Ondo Finance

Other examples include:

• Switzerland-based Backed Finance expanded its Ethereum-based tokenized short-term U.S. Treasury ETF issuance to Coinbase-incubated Layer 2 network Base in October.
• UBS Tokenize platform by UBS issued a tokenized money market fund on the Ethereum public blockchain in October.
• Standard Chartered Bank's investment and innovation arm SC Ventures launched a tokenization platform named Libeara in November. The tokenized new coin government bond fund SGD Delta Fund, after becoming the first fund to use Libeara, received an AA rating from Moody's.
• Laser Digital under Nomura Securities introduced the Polygon-supported Libre protocol for Brevan Howard and Hamilton Lane funds.

Tokenization Enhances Efficiency and Transparency

The report points out that similar to traditional bond funds, tokenized funds typically invest in fixed income assets such as corporate or government bonds. However, the key difference lies in their digital nature, with fund shares represented in the form of digital tokens on a distributed ledger, replacing centralized shareholder registers.

Analysts state that this method enhances market liquidity and accessibility, reduces costs, allows traditional investors to diversify, and brings significant benefits to cryptocurrency investors - especially in a high-yield environment where traditional assets become more appealing compared to the volatile returns of DeFi. As shown below, the 3-month U.S. Treasury bill yield (green line) has been significantly higher than DeFi products since June 2022.

Risks of Tokenization

However, the report also highlights risks of tokenization, such as its complexity requiring diverse expertise.

Service providers in this field are typically startups, increasing the risk of payment interruptions due to technical failures or bankruptcies. Collateralizing funds with stablecoins adds another layer of risk. Additionally, analysts believe that using public blockchains in tokenized funds introduces additional technical risks, vulnerability to network attacks, and governance issues.

Lastly, the report notes that while the appeal of tokenized funds is currently high, another cryptocurrency bull market could diminish this interest. Despite the assurance of technology-driven efficiency, the frameworks supporting tokenized funds are still evolving, necessitating further development and standardization of such products.