Tokenization Alone Won’t Solve Liquidity Challenges, Industry Leaders Warn

Introduction

During Paris Blockchain Week, one of the central stories of tokenization was refuted by industry leaders who pointed out that merely putting assets onchain does not necessarily turn it liquid.

As tokenized real world assets, often simply known as RWAs, have gained more and more hype, much of the investing and building community has come to think that blockchain technology will allow traditionally illiquid assets to become easily tradable instruments. But this assumption was debunked by executives who took part in a panel organized by Yana Prikhodchenko, with reference to a more nuanced reality.

They made it clear that tokenization enhances access and infrastructure, but liquidity is a different issue and demands more in-depth market dynamics.

The Core Misconception Around Tokenization

Digitization of real world assets such as real estate, private credit or commodities into tokens on a blockchain is known as the process of tokenization. The idea is that such tokens can be traded more easily than the underlying assets which can lead to liquidity and greater participation.

But Ondo Finance director Oya Celiktemur says this is a simplistic view of the issue.

She underlined that the popular myth about converting an illiquid asset into a token remains and that it does not turn it into a liquid. As a matter of fact, assets such as real estate and even personal credit have never been liquid since they are not liquid in nature, due to factors like protracted holding time, complicated valuation and a small pool of buyers.

These structural constraints are not eradicated by tokenization. It merely alters the form of recording and transferring ownership.

Liquidity Is a Market Function, Not a Technology Feature

Liquidity is usually confused with a technical problem. Practically, it is market based, demand-based and trust-based.

Although an asset is tokenized and can be traded 24/7 on a blockchain, it will not be liquid unless a sufficient number of buyers and sellers are actively involved with it. In absence of the regular demand, the price discovery becomes challenging and there is low trading activity.

This was reinforced by Francesco Ranieri Fabracci of Tether in the discussion. He observed that putting an asset onchain does not necessarily generate liquidity.

Rather, liquidity is based on the attractiveness, standardization and general familiarity of the asset by the market participants.

This is the difference that matters. Technology can facilitate trading, but not compel participation.

Why Some Assets Remain Illiquid

Some of the asset classes are illiquid by nature. These include:

Real Estate

There is legal complexity, high costs and long settlement times in property transactions. These underlying factors are present even in a tokenized form of a fraction.

Private Credit

There is no transparency and standard pricing of loans and debt instruments in private markets. This renders them hard to sell in the secondary markets.

Alternative Investments

Other assets such as art, collectibles, or niche funds are generally limited in terms of buyer pools and valuation, hindering liquidity.

These assets can be made more accessible through tokenization, without altering their fundamental nature. Consequently, trading can be onchain but thin.

Which Tokenized Assets Are Likely to Be Liquid?

Although there is doubt about illiquid assets, the panelists concurred that there are particular types of assets that are more likely to be liquid in tokenized form.

These include:

Bonds of governments and corporations.

Money market funds

USD Coin and others are stablecoins.

Financial instruments that are highly standardized.

These assets are already in high demand, they have clear pricing mechanism and existing market structures. They are suitable to be traded onchain, as tokenization will increase their efficiency, decrease settlement times, and increase access.

Conversely, less standardized and more complicated assets have a more steep journey to liquidity.

The Shift from Issuance to Usage

Over the last few years, the tokenized RWA industry has experienced a rapid expansion, and platforms are competing to make different asset classes onchain. But the emphasis is changing.

The industry is starting to question whether assets are being utilized and traded as opposed to how many assets can be tokenized.

This change is a significant development. Initial tokenization success was gauged by the amount of tokens issued and the value locked.

It is now focusing on such metrics as:

Secondary market activity

Trading volume

User participation

Depth of liquidity

In their absence, tokenized assets may fail to achieve their goal of being dynamic financial instruments and turn into just a static representation.

Distribution Still Matters

The other important aspect that has been mentioned in the panel is the issue of distribution. A tokenized asset that is the most well designed will not be able to reach traction unless it is made widely available.

Conventional financial markets are based on large networks of distribution, such as banks, brokers and exchanges. The same infrastructure is yet to be built in the tokenized world.

Platforms must make sure that tokenized assets are made accessible in multiple venues, are integrated into wallets and can be accessed by retail and institutional investors.

Liquidity will not be high without good distribution, no matter how sophisticated the technology behind it is.

The Role of Institutional Adoption

The importance of institutional involvement typically is regarded as one of the major liquidity contributors to tokenized markets. Big investors will introduce capital, credibility, and trading, which lead to more profound markets.

Nonetheless, institutions are no exception and their requirements are:

Regulatory compliance

Risk management frameworks

Reliable infrastructure

Transparent pricing

To draw institutional interest in tokenized assets they need to satisfy these criteria. This further complicates the quest to attain liquidity.

Technology Still Plays a Role

Although tokenization alone is not a panacea to liquidity, it still has substantial value.

Blockchain technology can:

Enable fractional ownership

Reduce settlement times

Improve transparency

Lower transaction costs

These benefits can assist in providing the liquidity environment, despite not necessarily ensuring it.

To illustrate this, through fractional ownership, high value assets can become more accessible to a larger audience which, in the long-term, may lead to a demand increase. Likewise, it is possible to make trading more efficient and attractive due to accelerated settlement.

The trick in this case is that they are enabling factors, but not solutions.

A More Realistic Outlook for Tokenization

The talk at Paris Blockchain Week is indicative of an evolving attitude in the industry. Stakeholders are starting to appreciate the drawbacks of tokenization instead of considering it a magic answer.

This realism is critical in the long term growth. Exceeding the positive aspects of tokenization may cause disappointment and mistrust in case the expectations are not fulfilled.

The industry can also concentrate on developing the market structures, incentives and participation required to ensure a sustainable growth by recognizing that liquidity will take more than technology.

Conculusion

The notion that one can instantaneously turn illiquid assets into liquid assets through tokenization is something that is becoming questioned among industry experts. Liquidity is not one of the features, which can be engineered with the help of blockchain only, as speakers of Ondo Finance and Tether emphasize at Paris Blockchain Week.

Rather it is a market demand, participation and infrastructure function. Although tokenization has the potential to enhance access and efficiency, it does not remove the underlying properties that make some assets hard to trade.

With the RWA sector still developing, the role of bringing assets onchain is no longer the primary concern but ascertaining that they are actively utilized and traded. This is a crucial move towards establishing a more operational and sustainable tokenized economy.

Ultimately, tokenization will be as successful as the markets underpinning it.