Moody’s, a global financial services company known for its credit ratings, said the growing adoption of blockchain-based tokenized funds is increasing the efficiency of investing in assets such as government bonds, suggesting “untapped market potential.”
Tokenized funds may also pose technology-related risks, requiring fund managers to have more diverse technology expertise, Moody’s analysts said in a report today.
The growth of bond token funds is primarily fueled by investments in government securities, with returns becoming more attractive following a series of recent interest rate hikes by the U.S. Federal Reserve, Moody’s said. The issuance of tokenized funds by traditional institutions and cryptocurrency companies backed by these securities on public blockchains increased from $100 million at the start of the year to more than $800 million by the end of 2023, according to analysts.
Issue tokenized funds based on government securities on a public blockchain. Image: Moody’s.
“The largest issuance to date was conducted by Franklin Templeton, which first registered share ownership of a U.S. government fund on the Stellar blockchain in 2021 and expanded its offering to the Polygon blockchain in 2023,” Moody’s said. .
Another example is Backed Finance, a Swiss-based company that last October expanded its Ethereum-based tokenized short-term U.S. Treasury bond ETF product to Base, a Layer 2 network incubated by Coinbase.
UBS also issued a tokenized money market fund on the Ethereum public blockchain through the UBS Tokenization Platform that same month. Moody’s argues that in the absence of widely accepted stablecoins or central bank digital currencies (CBDCs), tokenized money market funds can be used as an alternative to stablecoin collateral in DeFi markets, albeit not as liquid.
Last November, SC Ventures, the investment and innovation arm of Standard Chartered, launched a tokenization platform called Libeara. Last week, SGD Delta Fund, a tokenized Singapore dollar government bond fund, received an AA rating from Moody’s after becoming the first fund to use Libeara.
Last week, Nomura’s Laser Digital also unveiled the Polygon-based Libre protocol for the Brevan Howard and Hamilton Lane funds.
Increased efficiency and transparency
Analysts said that similar to traditional bond funds, tokenized funds typically invest in fixed-income long-term instruments, such as corporate or government bonds, or short-term securities, such as bills and notes. However, the key difference lies in their digital nature, where a fund’s shares are represented as digital tokens on a distributed ledger, replacing centralized shareholder registers.
Analysts say this not only improves market liquidity and accessibility, reduces costs, and allows for segmentation by existing investors, it also offers significant benefits to cryptocurrency investors. This is especially true in a high-yield environment where traditional assets become more attractive compared to the volatile returns of DeFi.
Compound v2’s 30-day weighted average lending rate and 3-month U.S. Treasury yield. Image: Moody’s.
Risk and technical expertise
Similar to regular bond funds, tokenized funds face risks associated with underlying assets and fund management. But tokenization also introduces additional complexities that require a much wider range of expertise, analysts said.
Service providers in this sector often have limited track records, putting them at high risk of payment disruption due to technology failure or bankruptcy. Exposure of fund collateral to stablecoins adds another layer of risk. Moreover, using public blockchains for tokenized funds creates additional technical risks, vulnerabilities to cyberattacks and governance issues, analysts argue.
The appeal of tokenized funds is high right now, but this interest could wane if another cryptocurrency bull market emerges. Ultimately, despite the promise of technology-driven efficiency, the framework underpinning tokenized funds is still evolving and requires further development and standardization, Moody’s said.
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