Moody’s Warns of Risks in Rising Tokenized Investment Funds

Moody’s, the global financial services company renowned for its credit ratings, has issued a report highlighting the increasing adoption of blockchain-based tokenized funds and the potential efficiency gains in investing in assets like government bonds. While acknowledging the benefits, Moody’s analysts have also noted caution, emphasizing the emerging technological risks associated with these digital investment vehicles.

Moody’s Warns of Technological Risks in Tokenized Funds

The adoption of blockchain-based tokenized funds has witnessed significant growth, with Moody’s noting that it is enhancing the efficiency of investing in assets like government bonds. These tokenized funds are digital representations of traditional investment vehicles, allowing for increased market liquidity, accessibility, cost reduction, and fractionalization. The surge in popularity of tokenized funds has been particularly driven by investments in government securities, which have become more attractive due to recent interest rate hikes by the U.S. Federal Reserve.

According to Moody’s analysts, the issuance of tokenized funds backed by government securities, both by traditional financial institutions and crypto companies, grew from $100 million at the start of 2023 to over $800 million by the end of the year on public blockchains. Notable examples include Franklin Templeton, which registered share ownership of its U.S. Government Money Fund on the Stellar and Polygon blockchains, and UBS, which issued a tokenized money market fund on the Ethereum public blockchain via its UBS Tokenize platform.

Tokenized money market funds, Moody’s suggests, could serve as an alternative to stablecoin collateral in DeFi (Decentralized Finance) markets, although they may not offer the same level of liquidity.

While the growth of tokenized funds brings many advantages, Moody’s analysts have raised concerns about the associated technological risks. These digital assets require fund managers to possess a broader range of technological expertise, as service providers in this space often lack extensive track records, making them vulnerable to payment disruptions due to technological failures or bankruptcy.

Moreover, using public blockchains introduces technological risks, including potential cyberattacks and governance issues. The exposure of fund collateral to stablecoins also adds another layer of risk.

Standardization and Development NeededFunds

Moody’s highlights several examples of tokenized funds to illustrate the trend. Franklin Templeton’s issuance of its U.S. Government Money Fund on blockchain platforms and Swiss-based firm Backed Finance’s expansion of its Ethereum-based tokenized short-term U.S. Treasury bond ETF offering is noteworthy.

Additionally, UBS issued a tokenized money market fund on the Ethereum public blockchain via its UBS Tokenize platform. These examples reflect the growing interest and investment in tokenized funds across various financial institutions.

Despite the promise of technology-driven efficiencies, Moody’s emphasizes that the framework supporting tokenized funds is still evolving. There is a clear need for further development and standardization in this space. The report highlights that the allure of tokenized funds may wane if another crypto bull market emerges, underscoring the importance of establishing robust structures and risk management protocols.