Liquidity Lowdown: Tokenisation – big changes are on the horizon

The use of tokenisation within Money Market funds (MMFs) is starting to change the way investors think about liquidity management by leveraging blockchain technology to enhance traditional funds in new and innovative ways.

Tokenisation can be used to represent fund holdings as digital assets through distributed ledgers. These digital ledgers allow data to be stored in a trusted way that is readily accessible and verifiable. Further, decentralised digital ledgers can be distributed across many entities with all participants having simultaneous access to the same and only source of information.

Investors benefit in numerous ways, including lower transaction costs, fractional ownership, increased transparency and unparalleled liquidity.

The size of the tokenised market currently stands at over £1.5bn and estimates from various market participants suggest this could reach £200bn by 2030 as investors realise the many benefits from holding digital assets. Investors benefit in numerous ways, including lower transaction costs, fractional ownership, increased transparency and unparalleled liquidity.

Why are tokenised MMFs becoming so popular?

The rapid implementation of tokenised funds is being fuelled by several factors. First, transactions are settled in real time, reducing settlement delays and counterparty risk for investors. Second, the idea of fractional ownership is also appealing, as this allows smaller investors to enter the market resulting in a broadening investor base. Typically, investors who have previously used stablecoins as a temporary cash holding, can now invest in tokenised MMFs, which would normally offer the investor a return. Tokenised MMFs are poised to streamline various reconciliation processes between the books and records of the different stakeholders involved in a fund, eliminating reconciliation errors and strengthening core processes. One of the most significant advantages, however, is that investors can trade 24/7 and without the need for intermediaries like brokers, reducing transaction and other potential costs. Fund units can be transferred around the clock leaving investors unconstrained by traditional dealing times, taking liquidity management to the next level.

The use of Tokenised MMF units as collateral for margin calls and repo

Traditional MMFs are commonly used as a liquidity management tool for meeting margin calls for derivative and repo transactions. In 2022, the UK government’s mini budget triggered a large spike in demand for liquidity as government bond yields rose rapidly within days. Liability Driven Investment (LDI) funds, which typically hold derivative transactions, were forced to redeem out of their holdings of MMFs to pay margin calls to their counterparties. Work is underway looking at ways to allow MMFs units to be used as collateral and therefore not contingent on tokenisation. However, tokenised MMFs should lessen the pressure on MMFs (and their managers), as tokens can be transferred almost instantaneously to meet margin calls without the need to redeem units in the fund, and without any operational challenges or obstacles. This in turn means that money market managers will no longer need to redeem their holdings intraday to meet margin calls. This should go some way into stabilising money markets in periods of market stress.

Tokenised MMFs are breaking down barriers for investors

Money markets provide a backbone for the wider financial system and their role is key in providing finances for businesses to operate. A digital representation of an existing MMF has the potential to provide investors with an unwavering level of operational efficiency, security and flexibility. It also has the potential to bring a new investor base into the market and reduce overall costs significantly. Unlike traditional MMFs, tokenised MMFs are starting to break down some of the barriers that investors currently face when managing their liquidity, by utilising smart contracts, or business logic to automate key processes, such as subscriptions and redemptions and therefore removing any operational hurdles. Although the use of tokenisation in funds is still in its infancy, the challenges around technology adoption in an ever-evolving regulatory landscape makes utilisation and product rollout more difficult as the market is rapidly expanding and evolving. Waiting too long for things to settle could be a missed opportunity.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.