Fund tokenization is small but growing rapidly around the world and the use of artificial intelligence in trading is becoming reality according to global agency broker Liquidnet.

The Liquidity Landscape report by Gareth Exton, head of execution & quantitative services EMEA at Liquidnet, said fund tokenization is growing rapidly around the world.

For example, the Monetary Authority of Singapore has launched Project Guardian, a  collaborative initiative with the financial industry to test the feasibility of asset tokenization and decentralized finance (DeFi) while managing risks to financial stability and integrity. Collaborators have included Schroders, the UK fund manager; Calastone, the global funds network; Citi, JP Morgan and UBS. The Financial Conduct Authority, the UK regulator, and the Investment Association have published a blueprint model for tokenization.

“The $800m market in tokenized bonds in Europe today is estimated to grow to a combined digital version of mainstream assets of $5 trillion by 2030,” said the report.

Tokenization and blockchain can increase efficiency by offering standardized processes across multiple participants in trade life cycles to allow automated order processing, settlement, ownership tracking and data management. The ownership and properties of an asset can be represented as a smart contract encoded on a distributed ledger. Smart contracts can be programmed with automated rules for settlement and corporate actions which update all the related data for the relevant participants.

Another possible benefit of tokenization is to make illiquid investments more cash-convertible for individuals. The technology offers the possibility of introducing new features such as tokenizing underlying investments, e.g. individual company shares within a private equity fund or real estate, to enable partial divestments.

Liquidnet warned that the ability to improve liquidity in the underlying asset classes is not a clear given.

“Settlement in the units of the fund would be carried out as they are today—off-chain, with no use of digital money, and on traditional timescales of a UK fund (i.e., T+2/3) with all the issues this represents for fund subscription and redemption,” added the report.

Ratings agency Moody’s has also warned that tokenization poses several unique risks, alongside the traditional risks in fund management. For example, many service providers in tokenization have limited track records, increasing the risk that payments could be disrupted if there is a bankruptcy or technological malfunction; and the potential exposure of the fund collateral to volatile crypto assets. In particular, public blockchains are particularly exposed to technological risks, cyberattacks, and governance issues.

However, Liquidnet also said broader mainstream adoption of crypto now appears to be a matter of time. The report also gave the example of market maker Flow Traders forming a partnership with DWS, the asset management arm of Deutsche Bank, and Galaxy, the digital asset manager. The partnership, AllUnity, is overseen by BaFin, the German regulator, and includes a euro-denominated stablecoin.

“On-chain money from reputable providers is a key remaining piece in crypto maturing and becoming further integrated within traditional finance,” added Liquidnet.

Another example of integration is FalconX, the institutional digital asset prime broker, forming a strategic partnership with Fusion Digital Assets, the FCA registered UK-based wholesale spot crypto asset exchange of TP ICAP.

Austin Reid, global head of revenue and business at FalconX, said in a statement: “Collaborating with Fusion Digital Assets is another significant step in our ongoing efforts to bridge traditional financial markets and the growing crypto asset ecosystem. It underscores our commitment to providing secure, efficient, and seamless access to the global digital asset market for our clients.”

AI in trading becoming reality

Liquidnet said that the recent report of an AI bot opting to trade knowingly using unlawful insider trading highlights the concerns about using AI in capital markets.

The firm expects there will be greater regulatory oversight on algo controls and usage, and for a distinction between decisions to execute made by an individual, rather than by technology. There are also concerns about the risks of market manipulation, misinformation through deep fakes, convergence of third-party AI models and the amplification of flash crashes or market disruptions.

“The industry can anticipate nearly all regulation having to be reconsidered post the introduction of AI,” added Liquidnet.