Tokenized funds promise reduced risk by providing ‘atomic’ or near instant transaction settlement 24/7 on a blockchain. However, the very speed of fund settlement introduces a new risk when the fund holds slower settling assets like stocks, bonds, and currency. In this hybrid tokenized structure, the fund pays the redeeming investor immediately, while the proceeds funding that payment have market exposure. The result is dilution risk for fund investors and impaired net asset value (NAV) integrity for fund sponsors. The effect is levered in the presence of fund flows: large redemptions concentrate the risk on a smaller remaining shareholder base. Impacts can be more than 10% of remaining NAV in extreme scenarios. We call this phenomenon the “tokenization paradox.” Regulatory, risk management, and fund governance frameworks have not yet incorporated this particular risk, the impact of which is often most acute during fund launch. The current crop of tokenized funds are not affected, they hold near-cash instruments with short settlement windows or have incorporated the gated interval fund redemption cycle into the token layer. Neither protection carries into the expected wave of tokenized equities and fixed-income fund launches. These risks can be managed at minimal cost with derivative hedges, broker financing, or aligning tokenization settlement with underlying assets. However, these measures should be implemented prior to launch.
Dunegan et al. (Mon,) studied this question.