Undeniable Sub-segment in RWA: The Value, Exploration, and Practice of Fund Tokenization

When we talk about RWA, we focus more on underlying assets such as US Treasury bonds, fixed income, and securities. In fact, apart from stablecoins, the largest RWA project by asset size is money market funds. The top three projects by asset size are: Franklin Templeton: $312 million (government bonds); followed by Centrifuge: $247 million (asset-backed); Ondo Finance: $183 million (government bonds).

Franklin Templeton is entirely a tokenized fund, Ondo Finance also has two tokenized funds, and Centrifuge has also established a tokenized fund in collaboration with Aave in the RWA project. This shows the importance of tokenized funds in connecting TradFi and DeFi. We believe that this asset form of funds, due to (1) being regulated; (2) having a relatively standardized digital representation, is the best vehicle for RWA assets.

Currently, what we are discussing about RWA is more about the one-sided value capture demand of Crypto (or DeFi) for the real world. From the perspective of traditional finance (TradFi), after funds are tokenized through blockchain and distributed ledger technology, they can release even greater value.

Therefore, this article will gradually analyze the value of funds after tokenization through observed cases in the current market, as well as the active exploration and practice of market participants.

1. Fund Tokenization

Tokenization is usually the expression of assets on the blockchain after digitalization, and it utilizes the advantages of distributed ledger technology for accounting and settlement. Assets applicable to tokenization can include financial instruments such as stocks, bonds, and funds, as well as tangible assets like real estate, and intangible assets such as music streaming copyrights. The tokens generated after asset tokenization serve as carriers of asset value and are certificates of asset rights.

This innovation and disruption also applies to funds. After tokenization, it forms a Tokenized Fund, which means that fund shares are recorded in a digital form as tokens on a blockchain distributed ledger, and the tokens can be traded on the secondary market. This Tokenized Fund is different from a Token Fund that merely invests in the primary and secondary markets.

The global asset management industry is facing numerous challenges. Although the overall asset management scale of the industry has grown with the market rise, fund management fees are being compressed due to peer competition and the industry's shift towards passive investment strategies. In addition to investment pressures, the market also demands higher digital capabilities from funds to meet the growing online distribution, asset reporting, regulatory compliance, and personalization needs of investors. The growth rate of fund management costs is outpacing revenue, and fund profit margins are being squeezed.

For private equity funds, due to their poor liquidity and high investment thresholds, their investors are long limited to a few institutional investors. The private equity fund market urgently needs to lower the investment threshold by launching alternative products through appropriate product design that can meet the investment needs of non-institutional clients such as small and medium-sized institutions, family offices, and high-net-worth individuals.

The tokenization of funds can address many issues currently facing the global asset management industry. Advocates of tokenized funds firmly believe that future funds based on blockchain and distributed ledger technology will not only increase the Assets Under Management (AuM) but also invest in a wider range of asset classes (diversity of RWA tokenized assets); they will attract new categories of investors (investors from unbanked regions in Asia, Africa, and Latin America investing through crypto assets), improve the user investment experience (embedded KYC in smart contracts); and help funds succeed in the competition of digital upgrade in the industry (digital upgrade), while significantly reducing their operational and marketing costs (advantages of blockchain and distributed ledger).

Tokenization will have a profound impact on the fund market.

2.1 Tokenization Aids in Advancing the Digitalization of the Fund Market

Currently, funds are separated from investors by a large number of intermediaries. The fund distribution side includes: financial advisors, fund platforms, and order-routing networks; the fund service side includes: paying agents, custodian banks, and fund accountants.

Transfer Agents assist funds by coordinating both ends, responsible for understanding customers (KYC)), anti-money laundering (AML)), combating the financing of terrorism (CFT), and screening verification for economic sanctions, settlement of fund subscriptions and redemptions, reporting to management, and maintaining investor registration records.

The operating process of traditional funds is essentially inefficient: (1) Fund shares are established to meet subscriptions and are canceled to meet redemptions; (2) Fund pricing is not based on buying and selling, but on the net asset value set by the fund accountant; (3) Transfer agents price based on the net asset value by receiving and consolidating orders, and settle orders in the centralized register through entry methods, then reconcile the orders with the investors' and the fund's cash positions; (4) Three days before the release of fund shares and cash settlement, the fund and investors face market volatility and counterparty risk; (5) The liquidity of the fund also forces fund managers to maintain cash positions to bear the cost of rebalancing the fund's net value.

In contrast, tokenization can significantly simplify the complex processes mentioned above: (1) When tokenized funds are issued and traded on the blockchain, subscription and redemption stages will be directly settled through fund tokens and payment tokens, entering the investor's account (electronic wallet), with transactions having finality in settlement, thereby eliminating market and counterparty risks; (2) Because all transactions are recorded on the distributed ledger of the blockchain, any change in ownership will be automatically recorded, eliminating the need for centralized registration; (3) Since all intermediary institutions can access and view data on the blockchain, there is no need for multiple reports and reconciliations.

At the same time, tokenization will help fund managers and investors achieve digital interaction: (1) The speed of investor account opening will increase due to the integration of KYC, AML, CFT, and economic sanctions screening verification; (2) More efficient atomic settlement based on blockchain will enable real-time pricing and settlements 24/7; (3) Access to a unified ledger by multiple parties will allow for real-time data sharing, enabling investors to directly access fund data and trade; (4) Fund managers will gain richer information about investors and transaction details.

2.2 Solv Protocol's On-Chain Fund Issuance and Fundraising Platform

Founded in 2020, Solv Protocol is dedicated to providing blockchain-based financial tools and diversified asset management infrastructure for the cryptocurrency industry, recently completing a funding round of $6 million. Solv Protocol's latest product, Solv V3, sets a new standard for on-chain fund issuance. The tokenized funds created through Solv Protocol enable on-chain fundraising, issuance, subscription, redemption, trading, and settlement, achieving efficient capital flow for tokenized funds.

We see from the official website that Solv Protocol has already issued and raised 74 tokenized funds (including Open-end Funds and Close-end Funds), serving over 25,000 investors and managing more than 160 million dollars in assets.

The core mechanism of Solv Protocol allows fund managers to create on-chain funds, depositing the raised capital (stablecoins, BTC, ETH, etc.) into the smart contracts of the Solv protocol, and generating corresponding NFT/SFT certificates that represent fund shares for investors, enabling fund managers to strategize their investments using the raised capital according to their investment strategies.

For example, we see that the Blockin GMX Delta Neutral Pool is an open-end fund managing approximately 2.6 million USD in assets, positioned according to the investment strategy of the fund manager Blockin; in addition, another open-end fund RWA: Generate Yield On Your Stable Coins, initiated by the fund manager Solv RWA, raises USDT stablecoin and invests in US treasury RWA assets to provide interest income from US treasury to stablecoin holders.

Open-end funds refer to investment funds where the total number of fund units or shares is not fixed at the time of establishment by the fund manager. The fund can issue shares at any time and allows investors to redeem shares regularly. Fund managers who typically use a high-liquidity investment portfolio as their investment strategy usually establish these funds using an open-ended corporate structure.

The fully on-chain tokenized fund issued through the Solv Protocol raises funds from BTC/ETH/stablecoins, and the assets invested are also native crypto assets or tokenized assets (such as US Treasury RWA). This fully on-chain tokenized fund structure allows for maximized enjoyment of the value brought by tokenization. For example, Solv Protocol's tokenized fund (1) enables fund managers to connect directly with investors, obtaining more investor data and trading information; (2) eliminates many friction points from fund service intermediaries, reducing costs; (3) fundraising, issuance, trading, and settlement of the tokenized fund are all realized through blockchain and recorded in a distributed ledger, ensuring efficiency and transparency; (4) the net asset value (NAV) of the fund is updated in real time, and fund share subscriptions/redemptions can occur anytime, anywhere, 24/7, among many other advantages.

Solv Protocol states: Currently, most cryptocurrency asset management services come from CeFi institutions, whose asset creation and fund management processes are opaque, leading to trust issues. Better decentralized solutions provide a transparent and secure investment experience while helping asset management companies gain trust and liquidity. Solv is building the infrastructure and ecosystem to provide comprehensive services, including creation, issuance, marketing, and risk management. This lowers the barriers to participating in Web3 while promoting the maturity of the cryptocurrency market.

Solv Protocol investors stated: "Solv has built a trustless institutional-grade DeFi platform that integrates brokers, underwriters, market makers, and custodians, creating the first liquidity financial infrastructure that bridges DeFi, CeFi, and TradFi on the blockchain."

3. Settlement of Tokenization Funds

Tokenization funds can partially replace certain intermediaries (such as fund distributors) to a certain extent and enhance the digitalization level of the fund market, but the market does not develop overnight. From the perspective of fund managers and investors, what will inevitably change with tokenization is the settlement method for fund subscriptions and redemptions.

3.1 Tokenization Fund Settlement

Currently, funds are generally priced based on net asset value, and fund managers settle by collecting or paying cash through the banking system, with settlement occurring three days later (T+3) in accordance with the issuance or cancellation of fund shares. However, the pricing of tokenized funds is calculated more than once a day, and since subscriptions and redemptions will be "automatically" settled on the blockchain, the settlement method based on the banking system (T+3) will be replaced. We can see in the case of the Solv Protocol that fully blockchain-based tokenized funds can achieve real-time pricing and real-time settlement in a 24/7 market.

This settlement method using blockchain and distributed ledger technology is called: atomic