How Close is Tokenization for Mainstream Investors?

With the continued development of asset tokenization, financial services firms see new opportunities to reach a broader set of investors, especially those seeking exposure to illiquid assets.

Widespread adoption of tokenization is likely many years out, however, with some digital asset experts saying it could take a decade to see a critical mass of investors buying or selling tokenized assets—and thus reaping the full benefits of the technology.

Tokenization on the blockchain creates a unit of measurement for tangible and intangible assets, with the aim of allowing investors to buy and trade more securely and efficiently, and therefore at a lower cost. Tokenized assets can also be more easily transferable for investors.

The market of tokenized illiquid assets is expected to reach $16.1 trillion by 2030, according to research  by Boston Consulting Group. That estimate would see an increase from only $310 billion in tokenized illiquid assets in the market as of last year. By 2030, BCG estimates the total tokenized market will represent 10% of global GDP.

Money managers are already dipping their toes in the water.

Franklin Templeton, KKR and Hamilton Lane recently began offering tokenized funds to investors. Meanwhile, the world’s largest money manager, BlackRock, revealed it is exploring tokenization  of stocks and bonds.

Franklin Templeton’s tokenized fund, the Franklin OnChain U.S. Government Money Fund, exceeded $270 million  in assets as of March 31, according to a release from the firm.

More Direct Access

For institutional investors wanting more control over their exposures to private assets, tokenization could allow for more flexibility, says Sandy Kaul, head of digital asset and advisory services at Franklin Templeton.

Tokenization would give investors the ability to fractionalize their ownership of a commercial real estate property, for instance, and better manage liquidity in their portfolio. As such, money managers could provide more opportunities for clients to access real estate deals, she says.

“I may own a token that gives me a 10% ownership of a multi-family residential property deal, and I can, within my own fund, allocate out that 10% to however many investors I want to put into that 10% portion,” Kaul explains. “I can put 100 investors in. I could put 1,000 investors in.”

“When we talk about the democratization of alternatives, this is a way that we can give individuals the direct access” to private markets, Kaul continues.

Easier, Safer Investment Exits

Investing via tokenized assets could also improve asset owners’ operational due diligence processes, giving them more options to exit investments.

This is because investors would have “new levers” they could pull if they wanted to exit a private investment earlier than a lock-up period might otherwise allow, according to Kaul. “By tokenizing each investment, then I have more flexibility, because I can sell that token and transfer it whenever I want,” she explains.

“I think this is going to be seen as a development that really helps make these investments safer over the long run for people and makes them an easier investment holding to have in the portfolio,” Kaul says. As an example, she adds that institutional investors may be able to stay in an investment longer, instead of having to reinvest in a commercial real estate fund to maintain a desired exposure.

Kevin Gallagher, a principal in the consulting firm Casey Quirk, believes investors would still risk losses should they aim to exit an investment quickly—even if their exposure is through tokenized assets.

“If an investor is trying to end a relationship with a particular asset manager because there is a scandal or regulatory issue or something else, that’s almost always going to be a money-losing, inefficient trade anyway,” he says.

While owning a token, which represents their interest in the fund, would allow investors flexibility in when they could trade, they are still beholden to market sentiment and valuations. They would have to use the blockchain to sell their token to someone else, not just cash out, which means it only “sort of solves the lock-up problem,” Gallagher explains.

In an instance when an asset owner wants to more easily exit an investment because they need cash, however, the transferability of tokenized assets could prove ideal.

“In that case, they might find someone who, at a very small discount, or potentially even at a premium, would buy the tokens from them,” Gallagher says.

For the asset management industry to fully realize the benefits of tokenization, there would need to be far more investors utilizing the technology, Gallagher notes.

“The fund tokenization that we’ve seen so far mostly involves private blockchains, or walled gardens that are set up with only a few participants, all working with the same asset manager,” Gallagher explains. “While it’s technologically interesting, you don’t really yet get most of the benefits of tradeability and convertibility of positions. … The technology and the promise are definitely there, but with many of these technologies, it’s a matter of having a critical mass of users.”

More Access to Wider Array of Alts

Justin Chapman, who leads the digital assets and financial markets group at Northern Trust Corp., believes transparency in investments is one of the major appeals of tokenization.

“For example, if you’re looking at an infrastructure investment, you’ll be able to look at how the debt that was raised to build the infrastructure is being spent against a timeline,” Chapman explains. His group works with regulators and other financial parties, including investment banks, fund managers and exchanges, to develop the framework that supports digital assets.

Marco Manoppo, a research director and team lead at data provider Digital Asset Research, noted that assets like real estate and art have been the most commonly tokenized in recent years.

“Art and real estate, definitely more on the luxury side of real estate, are what we’ve been seeing [tokenized] the most, so far,” Manoppo says.

Fine art—which has increasingly been tokenized through a non-fungible token structure—represents a major area in which alternative investment opportunities have opened up for individual investors, a recent report  by Franklin Templeton found.

“Art is an example of how the new technology can allow for democratized access to a type of luxury alternative asset typically priced out of the range of most individual investors and consumers,” the report noted. “Options for individual investors to own a larger diversity of alternative assets in their portfolio are likely to multiply and allow them to benefit from lower correlations across their investment holdings, just as many large institutional investors do today.”

Investor Caution, Developing Regulations

After last year’s blowup of crypto exchange FTX and the contagion that ensued in the market, many investors are weary of digital assets altogether, and of the risks they may carry. Such attitudes could have a chilling effect on tokenization adoption, at least for some time.

Even though the underlying technology for tokenization is “a mechanism for recordkeeping, not a mechanism for making money,” general skepticism about digital assets does “affect the eagerness of clients to invest in these types of structures,” Casey Quirk’s Gallagher says.

Another roadblock to widespread tokenization is the lack of a regulatory framework backing tokens. Coming regulation within the crypto market, however, may change that. The Markets in Crypto-Assets regulation was recently approved by the European Parliament  as its first regulatory framework for digital assets. MiCA is expected to take effect as soon as late 2024.

While U.S. regulators are far from leading the way on crypto and tokenization guidance, Franklin Templeton’s Kaul believes they will eventually catch on.

“I think over the next two to five years, you are going to see every major regulator in the world, including the U.S. regulators, really get much clearer on how they want to regulate these new types of investment instruments,” Kaul says.

Jonathan Piskorowski, a portfolio manager at Newton Investment Management, a subsidiary of BNY Mellon, expects that in 10 years, tokenization will be “pretty common” and “well-accepted in financial markets.”

Similarly, Manoppo at Digital Asset Research thinks the horizon for widespread adoption of tokenization is only several years out, but he expects the timeline to be delayed both by heightened risk concerns about digital assets and by the lack of regulatory frameworks for tokenized assets specifically.

“I would like to say five years,” Manoppo says. “But that’s probably going to be 10 years instead.”