Moody’s Vouches For Efficiency Benefits Of Tokenization

Tokenized funds grew from $100M to $800M asset class in 2023

By: Samuel Haig Loading...

Moody’s Vouches For Efficiency Benefits Of Tokenization

Legacy financial institutions continue to take note of the increasing number of traditional assets being brought on-chain. In a new report, Moody’s, the investment risk assessment firm, highlighted the increasing groundswell of mainstream asset tokenization.

In a Jan. 15 report, Moody’s said the value of tokenized funds grew from $100M at the start of 2023 to around $800M today, propelled by the increasing tokenization of U.S. treasuries.

Moody’s said assets are being brought onto both public and private blockchains. Examples include Franklin Templeton’s U.S. Government Money Fund extending from Stellar onto Polygon, Backed Finance launching a tokenized short-term U.S. treasury bond ETF, and UBS Asset Management deploying a tokenized money market fund (MMF) on Ethereum.

“By tokenizing MMFs, issuers can combine the stability of MMFs with the technological advantages of stablecoins,” Moody’s said. “Additionally, applications of tokenized MMFs extend beyond mere purchasing and holding until maturity, suggesting the potential for a more diverse range of uses.”

The report also highlights the significant efficiency benefits associated with tokenized assets, suggesting such could drive up adoption among traditional investors as well.

“For traditional investors, tokenized funds can enhance market liquidity and accessibility, decrease costs, and enable fractionalization,” Moody’s said. “Tokenization can also reduce costs and dependence on intermediaries, shorten settlement times, automate processes with the help of smart contracts, and enhance transparency.”

DeFi investors turn to legacy assets for yield

Moody’s said the increased interest in tokenized treasury bills and bonds echoes increased interest from crypto investors seeking exposure to stable yields on-chain.

The company noted that web3 lending markets offered greater returns than traditional short-term securities compared to treasury bills or other traditional sources of fiat-denominated interest throughout 2021. However, the trend has since reversed.

“Now, in a higher-yield environment, as trading volumes and lending rates on DeFi protocols have declined, investments in assets such as U.S, T-bills have become more appealing,” Moody’s said. “This has motivated crypto investors to shift their funds from crypto assets like stablecoins to traditional investments that offer comparable or higher yields with lower risks.”

Compound stablecoin rates versus three-month U.S. Treasury yield. Source: Moody’s.

Moody’s added that tokenized MMFs could comprise an alternative to stablecoins as a source of collateral for DeFi lending protocols. However, Moody’s conceded that units in tokenized funds would likely be far less liquid than stablecoins.

Tokenization risks

Despite the report’s bullishness regarding the tokenization of traditional assets, Moody’s highlighted several unique risks associated with the burgeoning sector. The report said tokenization service providers could suffer from technological malfunctions and must traverse diverse and evolving regulatory landscapes.

“The management of a tokenized fund requires a wide range of expertise,” the report said. “Fund managers and administrators often find themselves handling operations such as token issuance and redemption, maintenance of an on-chain investors' register, and whitelisting wallets in compliance with KYC and AML checks. These are areas where they might not have extensive experience. They also have to navigate diverse regulatory regimes, considering both the location of the fund’s issuance and the domiciles of potential investors.”

The report also emphasized the technological risks associated with assets tokenized on public blockchains, including cybersecurity attacks and governance issues. Moody’s recommends the adoption of off-chain investor registers to protect against the risks associated with issuing assets on public blockchains.

Moody’s suggests that all relevant stakeholders — “the technology provider, fund manager, fund administrator, and custodian” — should also be independent and replaceable to protect against the impact of bankruptcy or other unforeseen circumstances.

The report also said tokens should be programmed so that fund administrators can restrict asset transfers between whitelisted wallets controlled by accredited investors that have completed know-your-customer and anti-money laundering checks.

“This should reduce the risk of cyberattacks or other fraudulent activities by external parties,” Moody’s said. “However, it also imposes an additional responsibility on the fund administrator to manage the technology effectively.”