Tokenized Funds to Lead the Way Forward, Despite Crypto Winter

Asset managers and crypto exchanges will leverage the blockchain technology behind digital currencies to split funds into bite-sized units, or tokens, to sell to small-time investors despite the wild gyrations the markets have experienced this year, in what is widely termed as the crypto winter, according to a Blockhead survey.

A report from Boston Consulting Group (BCG) and ADDX estimates that asset tokenization will reach $16 trillion by 2030, or 10% of global GDP, with the majority of that coming from private markets.

While a US private markets manager this publication spoke to has delayed launching a tokenized fund earlier this year due to the volatility and the sharp plunge in cryptocurrency markets and issues because of reputational risk, he now intends to do so soon and venture into more product offerings.

Over the past year, investment management firms, private markets investment firms and crypto exchanges have jumped into the bandwagon of tokenized funds, with large investment management firms and crypto exchanges considering different products, according to a Blockhead survey of 25 investment advisors, asset managers, and analysts at research firms, conducted over the past month.

“While cryptocurrency is one of the most well-known applications of blockchain technology and tokenisation, the crypto winter has led to a rise in interest in many other important blockchain applications across the financial ecosystem. One such application is the use of tokenized securities to make private capital markets fairer and more efficient,” said Manuel Jaeger, co-founder and head of digital assets at ADDX.

ADDX is a private market exchange regulated by the Monetary Authority of Singapore. Backed by the likes of Singapore Exchange, the Stock Exchange of Thailand (SET), Temasek subsidiary Heliconia Capital, the Development Bank of Japan (DBJ), the company has raised a total of US$120 million in funding since its inception in 2017, including US$50 million in its Series A round in January 2021 and US$58 million in its Pre-Series B round in May 2022.

“The rise of blockchain-powered platforms have changed the game and transformed how investors view private market investments. Such investments, including private equity and hedge funds, were previously inaccessible to most individuals,” said Jaeger.

The traditional infrastructure for these assets was not set up to serve a large number of investors due to high cost and inefficiency, which translated into high minimum investment sizes of US$1 million or more,” he added.

Tokens or small-sized funds issued through a security offering entitle even tiny investors to participate, who can purchase illiquid assets like private equity, which tend to offer higher returns but can be challenging to trade in and out of quickly.

Blockchain for Token Funds

Blockchain supporters say that it makes it possible for tokens, or fund fractions, to be securely managed and offers a chance for small savers to invest in and enjoy potentially high returns.

Twenty-two of 25 participants in the Blockhead survey said asset managers are increasingly using blockchain technology to break funds into bite-sized units or tokens as an offering.

“Using tokens, investors can now access private market investments at a quarter of the usual minimum size thanks to blockchain and smart contract technology. Most products carry a minimum of US$10,000, and asset managers can reach a larger pool of investors by using technology to fictionalise investments,” said the chief investment officer at a large fund management firm in New York, with over US$1.5 trillion in assets under management (AUM).

Given the illiquidity of private market assets in the traditional market, the potential of blockchain technology also enables secondary trading at scale, giving investors a liquidity choice. This adds substantial value.

All 25 respondents said that crypto firms and exchanges would consider other tokenisation-related products over the coming year on strong demand and the ease of investing for small players.

An overwhelming majority of analysts – 23 of 25 – said tokens would enable secondary markets to develop and provide more liquidity for these low-trading funds and added that asset managers that want to offer private markets offerings to their clients and be a leader in that space should look into blockchain technology.

However, given the close connection between blockchain technology and cryptocurrencies, some prospective investors are apprehensive as investors do not fully understand the differences between blockchain, cryptocurrencies and tokens.

A majority of analysts, 20 of 25, in the Blockhead survey said investors’ understanding of the difference between tokenisation and cryptocurrencies was slowly improving.

“Digital currency is just one application of blockchain, which is the fundamental technology. Investors’ understanding is only “slightly improving” in its perception of how tokenisation differs from cryptocurrencies,” said the head of alternative investments at a large fund management firm in London, with about US$2 trillion in AUM.

But analysts agreed that the future of financial markets, including long-term fund management firms, was the adoption of blockchain to offer tokens to small investors is a growing market.

Due to the risks involved with investing in illiquid assets, many funds that do so only accept professional investors and have a US$10 million minimum investment requirement.

Fund managers can use blockchain technology to provide fractions of these assets for a small portion of the initial investment.

Industry specialists say that the tokens will enable secondary markets to develop, providing more liquidity. However, the Financial Stability Board has warned that this still leaves retail investors exposed to the underlying illiquid assets, which are difficult to exit quickly if prices fall.

According to analysts in the survey, the technology can reduce expenses for investors and asset managers.

Fund administrators and stock exchanges are working on upgrading the market infrastructure to make it simpler to offer tokenised funds.

“For issuers, the benefits are lower costs, lower issuance thresholds and a faster speed to market. Issuances are more efficient as tokenisation reduces manual interventions. We have already seen blue-chip names come on board, with tokenised products listed on ADDX: Hamilton Lane, Partners Group, Singtel, Mapletree, Fullerton Fund Management, Azalea, Seatown and CGS-CIMB. We expect greater adoption over the next 12 months,” said ADDX’s Jaeger.

Euronext owns the tokenisation platform Tokeny in Luxembourg, and ADDX, where Partners Group and Hamilton Lane launched their tokenised offers, is owned by Singapore Exchange. FundAdminChain and London Stock Exchange are developing a pilot programme for many tokenised funds.

In July, the British Investment Association urged the government and regulators to approve tokenised funds that use blockchain technology.

One of the top asset managers exploring the introduction of tokenised funds is Abrdn, as instead of the usual minimum investment of US$100,000, investors can enter with a US$10,000 outlay.

Issues, though, still exist.

Whether or not illiquid assets are tokenised, regulators may continue to be reluctant to permit retail investors to purchase them.

“It sounds good and shows that you are keeping up with the cryptocurrency industry to say, “we have this blockchain product,” but how is it any different or better?” said the head of research at a boutique investment firm in London.