Investor interest in tokenized real-world assets (RWA) is expected to grow in three asset classes, namely fixed income, alternatives, and investment funds. This, despite continuing challenges such as the uncertainty and lack of standardized tokenization protocols.
In an interview with The Asset, Justin Chapman, global head of digital assets and financial markets at Northern Trust, discusses ongoing trends in the tokenization space that are expected to move the market in the next 12-14 months.
In fixed income, a number of assets are looking to be tokenized globally, particularly impact bonds, green bonds, and transition bonds.
Chapman cites the HK$6 billion (US$756 million) digital green bonds issued by the Hong Kong Monetary Authority (HKMA) on behalf of the government as an example of a successful tokenization of a multi-currency bonds issue. In Singapore, telecommunications firm Singtel issued a S$100 million (US$75.6 million) sustainability-linked bond in April 2022.
“This is a trend that will continue since it is well supported by governments in each country for transparency purposes, and regulators are well aligned with this effort,” he says. “However, while there’s a lot capability to tokenize the front end, there are still the challenges of building liquidity in the secondary market for tokenized bonds.”
Non-liquid assets
One major challenge is the lack of secondary market liquidity as the principal investors in these tokenized bond issues are governments and large corporates that hold them as part of their portfolios.
“As these assets come live, they produce good income but they become non-liquid assets since their investors, particularly governments and large corporates, hold on to them for the long term,” Chapman says.
“For these to really go mainstream, we do need some secondary market liquidity. So that's a problem the industry is working on and we hope we will start to see interoperable networks and liquidity pools start to appear in the next 12 to 18 months.”
In alternatives, Chapman says large private equity funds are being fractionalized and tokenized to provide more access to individual investors who cannot afford the US$5 million cap for investing in such funds.
“Tokenization makes private equity more accessible. We’ve seen a lot of use cases where we are looking at things that weren’t fungible before being created as fungible tokens. Our voluntary carbon credit [platform], powered by Matrix Zenith, is a really good example of a great access to a market where it's very difficult to access. Gold is another really good example,” Chapman says.
Greenfield networks
The challenge here is that while a number of networks are being established for tokenized alternative assets, there is still a lack of market infrastructure to support such asset classes.
“These [networks] are mostly greenfield sites for innovation and technology. So being able to put infrastructure in place to support those particular asset classes and make them usable is really key. So that's another trend that you'll certainly see grow over the next 12 months, and the markets are already moving in that space,” he says.
In the investment fund space, the tokenization of money market funds, mutual funds, and exchange-traded funds (ETFs) is a trend that will strengthen in the coming year.
“We will see some things like liquidity funds and ETFs being produced in support of the crypto market, with the giants of the asset management business creating large liquidity pools. They are now being used on programs for cryptocurrency. It becomes a much more efficient way of providing digital cash. You're starting to see the liquidity funds being used as digital cash on the crypto rails, which is interesting,” Chapman says.
Risk management
Tokenization is providing a form of risk management as tokenized funds can be used for liquidity management, collateral management, etc.
“We’re seeing a big push by institutions in tokenizing funds to act as like they cash for economic settlements and things like margin calls and collateral, support of repo margining, and for supporting other transactions in the financial base. For example, the tokenized money market fund could be more liquid and also gives you a higher rate of return than just pure cash. You're not having to liquidate into cash to margin. You can use another asset class. We're starting to see that pick up as well, and that's very attractive for the large institutional players as they start to look at collateral netting liabilities across their networks,” Chapman says.
Over the past year, RWA tokenization has gained momentum, with the tokenized asset market reaching US$2.77 billion by early 2024. This trend has been driven by both demand for new types of asset liquidity and by significant interest from institutional investors.
