By Simon Maharaj.
2025 has brought a major shift in TradFi attitudes towards digital asset technology. Major financial institutions are actively embracing blockchain and Distributed Ledger Technology (DLT), cryptocurrencies and stablecoins are having a second wind, and some are now heralding the “third revolution in asset management”: fund tokenization.
By inserting blockchain technology into the core of asset management, fund administration tasks can be moved on-chain and automated in real time through smart contracts. Instead of having disparate participants executing workflows sequentially, participants can now work synchronously at once.
As the industry begins to make these incremental steps towards adopting fund tokenization, Simon Maharaj, D2 Legal Technology, explores the key considerations, from determining which blockchain to use, intertwining legal documentation within the set-up of a fund, and ensuring the structure aligns with current and evolving legislation.
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What is fund tokenization?
Fund tokenization involves the issuance of digital tokens representing interests in funds. Each token represents a share or unit of the fund and normally correlates to the capital contribution of the investor in the fund.
Traditionally investments such as private equity, hedge funds, and venture capital have been limited to institutional investors due to high barriers to entry and long lock-up periods. Fund tokenization offers the potential to break through these barriers, allowing digital tokens to be more accessible to other market players, traded more efficiently and enabling higher liquidity.
How does fund tokenization work?
Fund managers can either tokenize an existing fund or launch a digitally native fund. The tokenization process involves:
- Selecting the blockchain protocols for the fund and determining whether a public, private or hybrid blockchain is appropriate.
- Tokens are categorized according to agreed parameters e.g. share classes and number of shares per investor.
- Tokens are issued to each investor, each token containing ownership rights for the investor.
- The fund tokens are mapped to wallet addresses. in the blockchain.
- A digital asset custodian manages private keys applicable for each investor.
Benefits of fund tokenization
Fund tokenization provides a real-time electronic registration system in the blockchain to hold and register book-entry securities. Investor tokens are safeguarded in segregated digital wallets, enabling automated reporting, reconciliation and data storage.
Corporate actions can now occur automatically, for example, share issuances, redemptions, updating holder records, and cancelling and issuing certificates. NAV (net asset value) calculations can be integrated on-chain through smart contracts, creating auditable calculations intertwined with share issuance history.
These operational efficiencies will ultimately lead to lower costs for investors. There is potential to further widen the pool of investors. Previously illiquid funds can be fractionalized to facilitate lower minimum investment amounts and improved liquidity, making funds more accessible to retail investors.
Gaining Ground
This model has started to gain ground in low-risk areas such as money market funds (MMFs). Digitizing MMFs allows these assets to be used immediately as collateral. Blackrock’s USD Institutional Digital Liquidity Fund debuted on the Ethereum blockchain and has now been launched on 7 different blockchains, holding approximately $2 billion in cash and U.S. Treasuries. Franklin Templeton offers a similar tokenized fund that currently has a $692 million market capitalization. Tokenization removes the need for distressed sales to meet cash settlement obligations while providing KYC and AML efficiencies
Considerations for Fund Managers
Given the clear benefits, firms should consider these three factors for successful tokenization.
- Fund Operations: The choice of blockchain will depend on distribution strategy – public networks suit broad retail distribution, while private networks work for defined professional investor groups. Fund managers must determine interoperability with digital asset exchanges and decide how much information to reveal on-chain versus off-chain. Settlement can occur with digital or fiat currencies, but conversion costs currently apply with fiat settlement.
- Digital Asset Custodians: When tokens are issued, custodians hold them in a segregated wallet with private keys governed by the custody documentation. Key considerations include the legal basis for token segregation, alignment with fund regulations and client asset rules, and operational restrictions between blockchain providers and fund managers.
- Legal and regulatory implications: The Trump administration has signaled a decidedly pro-crypto legislative environment with a light-touch regulation to retain U.S global leadership on digital assets. Jurisdictions like Luxembourg, Switzerland and Singapore are leading in recognizing digitally native securities. The location of funds, blockchains, managers and investors will need to be analyzed on any tokenization so there is no ambiguity relating to legal and regulatory discrepancies between different jurisdictions. Delaware remains a popular state for the establishment of funds, with the state having passed laws to recognize blockchain-native securities and registries.
Conclusion
This is just the start. Significant regulatory and market change will continue to operationalize fund tokenization globally. It represents a fascinating innovation offering enhanced liquidity, greater accessibility, and operational efficiencies. However, both transparency and an understanding of how fund tokenization can work are needed. It is now time for TradFi to evaluate this approach and prepare for the next revolution in digital asset technology.
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Simon Maharaj is a managing director at D2 Legal Technology. His specialisms include smart contracts, digital assets, blockchain/distributed ledger technology and artificial intelligence (AI)/machine learning. He is a financial services lawyer and holds degrees from University of Cambridge and University of Oxford.
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