Why tokenized funds are gaining momentum

Key Takeaways

• Tokenized funds expected to grow fast in next few years
• Some say it could be third revolution in asset management
• It has advantages over ETFs but DLT regulations still an issue

Tokenized funds accumulated over USD 2 billion in assets under management (AUM) by late 2024, and could reach 1% of global mutual fund and ETF AUM—over USD 600 billion—by 2030. Just as exchange traded-funds (ETFs) once redefined the asset management industry, fund tokenization is likely to drive the next major transformation in the sector.

Here’s what you need to know about tokenized fund investments and whether they are a threat to the ETF and mutual fund markets.

The third revolution in asset management?

Tokenization is the process of converting an asset or its ownership rights to a digital form using blockchain technology. It has witnessed steady growth over the past five years, with large financial institutions leading the way and regulators showing strong support, a BCG report notes.

Today, tokenizing funds is not just a small-scale experiment by a few asset managers, but a large-scale movement involving many major asset management companies. In 2021, Franklin Templeton launched the first US-registered fund on a blockchain, the Franklin OnChain US Government Money Fund. In 2024, BlackRock introduced the BlackRock USD Institutional Digital Liquidity Fund, which reached a market value of over USD 500 million within months.

And EY estimates that 7%- 9% of investors may allocate their entire portfolio to tokenized assets by 2027.

Sean Park, MD and Senior Partner at BCG, says, “enabled by blockchain technology, fund tokenization is likely to bring the third revolution in the asset management industry” following the rise of mutual funds in 1940 and the introduction of ETFs.

How tokenized funds works

A CMS report says that how tokenized funds work is not very different from conventional methods, but they can significantly lower the costs associated with maintaining investor registers and managing trades.

Like traditional funds, tokenized funds are calculated based on their net asset value (NAV). In this case, the valuation is shown as ‘NAV per token’ rather than ‘NAV per share’, and it is calculated by dividing the NAV by the number of tokens.

One key feature is that ownership of the fund is tracked by blockchain and updated accordingly, hence, unlike traditional funds, these funds do not need a central register of shareholders.

Comparing tokenized funds to ETFs and mutuals

Like mutual funds and ETFs, tokenized funds offer an array of benefits, but they also provide further advantages for investors.

Price transparency for investors: Mutual funds typically operate with a delayed pricing structure, where the execution price is confirmed only at the end of the trading day, commonly referred to as the “end-of-day (EOD) NAV” process, a BCG survey says. In contrast, ETFs and tokenized funds offer much greater transparency. For these, prices are updated instantly throughout the trading day based on secondary market activities, such as the latest bid/ask order book and indicative NAVs.

Time to fund and access cash: Traditional mutual funds need T+2 or T+3 settlement periods. The process is much easier for ETFs as it allows intraday funding and access to cash during exchange hours. However, there is one big challenge. According to Euroclear, ETFs can be listed on multiple stock exchanges in different countries and time zones, each with its own settlement times. Managing different settlement procedures across countries is not always efficient. The move by the US, Canada and Mexico to a T+1 settlement regime in May 2024, for example, means market participants have had to adjust their processes in the EU and UK, which are currently considering moving to the more compressed settlement period.

Potential as collateral for lending: Mutual funds face certain limitations when used as collateral, largely due to the costs and risks associated with managing liens and default risks. ETFs, however, are more commonly accepted as collateral, particularly in margin trading. Tokenized funds could revolutionize collateralization by allowing blockchain-backed near-instant transfers and the creation of “smart contracts”, the BCG report notes.

Use as underlying assets for derivatives: Mutual funds are relatively limited in their use as underlying assets for derivatives, while a few selected ETFs are used in exchange-traded options. Tokenized funds could significantly expand the role of underlying assets for derivatives, particularly with the advent of smart contracts.

Integration with on-chain money and digital finance: Tokenized funds offer advantages in terms of integration with digital finance systems and on-chain money. As compared to mutual funds and ETFs, tokenized funds, by virtue of their blockchain infrastructure, can provide “atomic settlement.” This means transactions settle instantly and securely, with delivery-versus-payment (DvP) capabilities that reduce settlement risks.

Tokenized funds have the potential to complement traditional funds and add value to the overall investment landscape.

For example, mutual funds have about USD 58 trillion in assets under management, with average annual returns of about 7.1% over the last decade. However, the current settlement process, which usually takes two to three days (T+2/3), ties up funds and creates challenges in delivering new, innovative financial products. But “by solving these problems, fund tokenization could produce about 17 additional basis points of annual return for mutual fund investors, representing about USD 100 billion,” according to the BCG report.

Regulations linked to tokenized funds

A digitally native fund, such as a tokenized one, is expected to follow the same regulatory rules as conventional funds. However, in many countries, current laws are not yet updated to accommodate DLT systems, which can make it difficult for digitally native funds to comply with the relevant rules, a Simmons and Simmons study reveals. Another issue for tokenized funds is how to determine which country’s laws apply when more than one country could be relevant.

The situation is evolving, and jurisdictions like Singapore, France, Germany, and the United Kingdom are making significant strides in developing a comprehensive legal framework for tokenization.

According to BCG, an inflection point for tokenized funds is likely to come in the next 12–18 months, driven by the rise of stablecoins and digital assets. Asset management firms that are eager to act early can capture a strong market position with simple, recognizable products.