In the ever-evolving landscape of finance and technology, the concepts of tokenization and blockchain have been making waves. These innovative paradigms have now entered the realm of investment funds, bringing about two distinct yet groundbreaking approaches: Tokenized Funds and On-chain Funds. Both these models offer unique advantages that challenge the traditional norms of investing, introducing efficiency, transparency, and accessibility. In this article, we delve into the essence of these two concepts, exploring their mechanisms, benefits, and the potential they hold for transforming the investment landscape.
Tokenized Funds embrace the concept of tokenization, which involves representing traditional assets as digital tokens on a blockchain. This innovative approach takes the conventional model of investment funds and gives it a digital makeover, breathing new life into an otherwise outdated system.
In a Tokenized Fund, the shares of the fund are transformed into digital tokens that are issued on a blockchain. These tokens encapsulate ownership of a portion of the fund and can be easily traded and transferred between investors. This tokenization process offers fractional ownership, making investing in high-value assets more accessible to a wider range of investors. Tokenization increases the efficiency and reduces costs in transmitting shares between holders, but the limitations of compliance remain. In practice, in most jurisdictions, whether your fund is tokenized or not, it still requires a full KYC of both sender and receiver.
However, it's important to note that Tokenized Funds, despite their digital representation, often retain the inefficiencies associated with traditional investment models. The underlying management practices might remain unchanged, potentially limiting the degree of innovation these funds can bring to the table.
In a PwC report , 23% of fund managers say that they want to tokenize their fund shares. More and more actors are starting to notice that tokenization and blockchain technology offer real benefits and are starting to put resources into researching it.
On-chain Funds take the concept of blockchain's decentralized nature to its logical conclusion by executing the entire investment lifecycle on the blockchain. Subscriptions, redemptions, Net Asset Value (NAV) calculations, and fee executions all happen within the realm of the blockchain, eradicating the need for intermediaries.
One of the most striking features of On-chain Funds is the elimination of intermediaries from the investment process. This new generation of funds leverages smart contracts to automate subscription and redemption processes, ensuring a seamless experience for investors while reducing operational complexities.
In practice, the investors’ capital flows from their wallets to a smart contract. At the next NAV calculation, it issues tokenized fund shares to the investors and transfers the capital to the wallet of the fund. And that’s it. Compared to a traditional fund where there are multiple banks, a clearing system / paying agent in between. Therefore, an on-chain fund could even operate without banks.
The assets of the fund can be held on-chain. Most appealing to digital assets funds investing in cryptocurrencies or tokenized assets.
Don’t trust, verify.
On-chain assets provide additional transparency for the investors as the fund can provide 24/7 proof-of-reserves of its underlying assets.
Moreover, On-chain Funds provide an unprecedented level of transparency. All fund activities, including transactions and holdings, can be recorded on the blockchain, and visible to both investors and regulators. (Note: the degree of transparency can be tuned according to managers’ needs).
This transparency not only fosters investors’ confidence but also helps regulatory bodies in monitoring and enforcing compliance effectively.
Let's delve into a comparative analysis of these two revolutionary investment models:
Although the tokenization of a fund shares is the next step in the shareholders registrar evolution, they bring limited benefits compared to a fully on-chain investment fund. The choice between the two depends on the level of transformation one seeks in the investment ecosystem. As the financial landscape continues to evolve, these innovative models hold the promise of reshaping the way we invest and manage assets.
At Fume, we provide the infrastructure to create on-chain funds.
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