Unlocking the Future of Finance: The Power of Tokenized Funds

Tokenization is reshaping the financial landscape, offering innovative ways to represent and trade assets in a digital world. A panel discussion at the recent Cohen Client Conference shed light for audience members on what tokenized funds are, their benefits, challenges and the path to adoption. Below are some of the key insights from the panel — highlighting why tokenization could be a game-changer for investors, fund managers and the broader market.

What is Tokenization?

Tokenization is the process of converting ownership rights of an offchain asset, one that exists outside of the blockchain ecosystem, into a digital token on a blockchain. Think of it as creating a digital certificate that is transferable, tradable and securely recorded. Much like American Depositary Receipts (ADRs) allow U.S. investors to have access to and represent ownership of stock of a foreign company, tokenized assets represent the ownership of real world assets, like money market funds (MMFs) or private credit, available 24/7.

Tokenization leverages blockchain technology, a decentralized database with no central administrator. Tokenization operates on robust, rules-based computer code, ensuring transparency and security. Ownership is registered on the blockchain, enabling trading, pledging or transferring assets with unparalleled efficiency. Unlike stablecoins, which are pegged to assets like the U.S. dollar but typically don’t yield interest unless invested, tokenized funds can represent yield-bearing assets, such as MMFs, that generate returns within the blockchain ecosystem, blending traditional finance (TradFi) with decentralized finance.

Why Tokenization Matters: Key Benefits

Tokenized funds offer transformative benefits across three key areas: compliance, middle-office efficiency and client engagement. Here’s how:

• Private Equity and Portfolio Flexibility: Tokenizing underlying portfolio assets allows private equity firms to free up capital and enable co-investment opportunities. Third parties can invest directly in a fund’s portfolio, democratizing access to high-value assets.
• Peer-to-Peer Liquidity: Tokenized funds enable investors to trade fund interests peer-to-peer between net asset value (NAV) periods. This “unitization” empowers investors to manage their own liquidity without relying on fund managers.
• Fast, Low-Risk Settlement: Blockchain enables near-instantaneous settlement, reducing counterparty risk and eliminating the traditional trade date/settlement date delays. Transactions can occur intraday, enhancing efficiency.
• Fractionalization and Democratization: Tokenization breaks assets into smaller, affordable pieces, opening investment opportunities to retail investors who might otherwise be excluded from high-value funds.
• Transparency and Trust: Blockchain’s transparency allows investors to verify proof of reserves, monitor oracles, and track market data like secondary market prices or market capitalization, building confidence in the system.

Challenges to Adoption

While the potential is immense, tokenization faces hurdles that must be addressed for mainstream adoption:

• Regulation: Clear regulatory frameworks are crucial but should not stifle innovation. The proposed Genius Act, for instance, could define who can issue stablecoins and tokenized assets, providing clarity. The crypto industry is frustrated by the lack of cohesive policy, while TradFi is cautious due to compliance concerns.
• Market Structure and Liquidity: The tokenized asset market currently lacks sufficient liquidity, a critical factor for investor confidence. Banks have been hesitant to offer digital assets to clients, fearing regulatory missteps. Proposed legislation, like the Market Structure Act, could bring tokenized assets under oversight by bodies like the CFTC and NFA, fostering trust.
• AML/KYC Compliance: Anti-money laundering (AML) and know-your-customer (KYC) requirements are significant hurdles, particularly for real-world asset (RWA) tokenization. Fund managers must ensure robust onboarding processes, integrate with blockchain providers and monitor wallet histories to mitigate risks from bad actors.
• Accounting and Valuation: Tokenized funds require new approaches to accounting, such as daily or weekend NAV calculations and reconciling ownership tokens to underlying assets in custody. Transparent on-chain data helps, but standardization is needed.

The Path Forward: Considerations for Adoption

For tokenized funds to thrive, several factors need attention:

• Choice of Blockchain: Permissioned blockchains (not fully public) are often preferred for their controlled access and compliance alignment. Interoperability between blockchains is also critical to ensure seamless asset transfers.
• Smart Contract Design: Standards like EIP-3643 govern token structures, ensuring smart contracts align with their intended purpose. Regular audits of code are essential to prevent exploits and ensure security.
• Integration and Risk Management: Fund managers must integrate with blockchain providers, leverage oracles and APIs for real-time data, and use risk vendors to monitor wallet activity. Multisig wallets, for example, replicate traditional process controls in a digital asset (DA) context.
• Investor Education: Tokenization is a new concept, and its technical nature can be intimidating. Educating investors about digital assets and their benefits is crucial to drive demand.

The Future of Tokenized Funds

The panel discussion at our conference highlighted a growing demand for tokenized assets, with an estimated $3 trillion in non-yield-bearing assets already on-chain. As investors migrate to digital assets, they’ll likely seek yield-bearing opportunities like MMFs and private credit. Tokenization not only enhances market confidence but also paves the way for a fully digital financial ecosystem.

From enabling offshore investors to access U.S. markets, to providing instant liquidity and transparency, tokenized funds are poised to revolutionize finance. However, achieving this vision requires collaboration between regulators, fund managers and technology providers to address compliance, liquidity and technical challenges.

Tokenization is a paradigm shift that unleashes the power of blockchain to make financial assets more accessible, efficient and transparent. By tokenizing assets, the industry can democratize investment, streamline operations and unlock new opportunities for growth. As regulation evolves and market structures mature, tokenized funds could become part of the cornerstone of a new financial era. The future is digital, and tokenization is leading the way.

Contact Jamie Gasiorowski or a member of your service team to discuss this topic further.

Thank you to our panelists for participating in this session: Nick Carmi, Head of the Exchange, Figure Markets; Mike Dellavalle, Market Leader, Technology & Life Sciences, Cohen & Co; Kevin Hall, Head of RWA Strategy, Tokenyze; Cynthia Pedersen, Director, Cohen & Co; Aditya Sharma, Assistant Vice President – Fund Accounting, NAV Fund Services.

In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.