Tokenized stocks are progressing on three fronts, but liquidity is being torn apart vertically and horizontally.

Written by: @100y_eth

Translated by: AididiaoJP, Foresight News

Key Points

Despite the overall slowdown in the RWA sector over the past few months, tokenized stocks continue to expand at an unusually rapid pace. Currently, the tokenized stock sector is expanding mainly through three channels:

• Linked Security tokenized stocks provided by Ondo, xStocks, Robinhood, etc.;
• Issuer-Sponsored tokenized securities provided by Securitize, Figure, Superstate, etc.;
• Growth of perpetual contract exchanges (which strictly speaking do not fall under tokenization).

While the overall tokenized stock sector is growing, liquidity fragmentation has begun to surface as a side effect. Even with the same underlying stocks, liquidity is being split in two dimensions:

• Vertically, between different tokenized structures;
• Horizontally, among different tokenized providers using the same structure.

From a more positive perspective, especially regarding improving accessibility, this phenomenon may not necessarily represent fragmentation of existing liquidity. On the contrary, tokenized stocks may have attracted investors who previously had no access to the liquidity of the U.S. stock market, and fragmentation is merely a byproduct that accompanies this.

Nevertheless, the liquidity fragmentation of tokenized stocks is a real issue. Potential solutions may include:

• The emergence of orchestration or clearing platforms similar to those in the stablecoin sector;
• Industry consolidation into an oligopoly or monopoly structure driven by economies of scale.

Tokenized Government Bonds Stall, While Tokenized Stocks Sprint Ahead

The market's interest in RWA remains strong. It is no exaggeration to say that tokenized U.S. Treasury bonds have been the main engine for RWA growth to date. From January 1, 2024, to now, the total cryptocurrency market cap has only grown from $1.65 trillion to $2.19 trillion, an increase of about 1.33 times; while during the same period, the tokenized U.S. Treasury bond market expanded from $695 million to $16.1 billion, a growth of 23 times.

However, the previously explosive growth of tokenized U.S. Treasury bonds has recently begun to slow. This trend is not limited to Treasury bonds. Other RWA categories including stablecoins, private credit, and commodities have recently shown signs of stagnation or even contraction. Yet within the RWA sector, one asset category has recently demonstrated rapid growth: tokenized stocks.

Over the past three months, the tokenized stock market has grown from $1.2 billion to $1.88 billion, an increase of 56%. In the same timeframe, tokenized U.S. Treasury bonds grew only 7.3%, private credit grew 16%, and commodities saw a decrease of 13%. These numbers reflect the steep growth of tokenized stocks recently.

The rapid growth of tokenized stocks can be attributed to several reasons. Fundamentally, the recent surge in AI and semiconductor-related stocks has drawn more attention to equities as an asset class. In addition, as the RWA market matures, the pathways and structures for stock tokenization have become quite clear. The result is that numerous tokenization platforms have begun offering tokenized stock services, and the market has begun to see scale growth.

Currently, the growth of tokenized stocks is mainly achieved through three primary channels:

The first channel is platforms that utilize offshore structures to tokenize debt instruments into Linked Securities, including Ondo Global Markets, Backed Finance xStocks, and Robinhood Stock Tokens. These stock tokens do not represent direct rights to the underlying shares. However, due to facing fewer compliance restrictions in secondary distributions, they can be actively used in on-chain DeFi protocols, allowing for rapid growth.

The second channel is the growth of platforms like Securitize, Superstate, and Figure. They directly tokenize existing shares through transfer agents. Since these platforms tokenize the shares themselves while fully complying with securities laws, they face strict compliance restrictions in issuance and secondary trading. This results in a smaller number of available stocks and more limited practicality. However, when these platforms collaborate with companies to tokenize their shares, the number of stocks may be limited, but the scale of tokenization for each stock can be very large. Thus, they have made significant contributions to the growth of the tokenized stock market recently.

The final channel is perpetual contract exchanges such as Hyperliquid, Variational Omni, and QFEX. Strictly speaking, the stock products traded on perpetual contract exchanges are not tokenized stocks. Nonetheless, a substantial number of users can trade products tracking stock prices on perpetual contract exchanges, which are large in scale.

However, from the perspective of financial market development, the emergence and growth of tokenized stocks cannot be entirely seen as positive. Just as growth often has its shadows, the expansion of tokenized stocks has also brought several issues. This report focuses on one such issue: liquidity fragmentation.

Liquidity Fragmentation of Tokenized Stocks

Even with the same underlying stocks, liquidity can be fragmented vertically and horizontally due to the differences in tokenization structures and platforms.

Vertical Liquidity Fragmentation Between Different Tokenization Methods

There are many ways to tokenize stocks:

• Custodial Tokenized Stocks: Third parties tokenize rights to shares held within the DTC custodial system. Representative examples include DTCC, Ondo, and Dinari.
• Issuer-Sponsored Tokenized Stocks: Issuers or transfer agents directly tokenize ownership of shares. Representative examples include Securitize, Figure, and Superstate.
• Linked Securities: Third parties issue and tokenize a single security, providing economic exposure to the underlying stocks. Representative examples include Robinhood Stock Tokens, Backed Finance xStocks, and Ondo Global Markets.
• Security-Based Swaps: Third parties tokenize derivative contracts that provide economic exposure to the underlying stocks. A representative example is Robinhood Classic Stock Tokens.
• Stock Fund Tokenization: Tokenizing shares of a fund composed of stocks. Representative examples include Centrifuge and WisdomTree.
• Perpetual Futures: These platforms do not tokenize stocks but operate exchanges providing markets for tracking the stocks through perpetual contracts. Representative examples include Hyperliquid, QFEX, Variational Omni, and Lighter.

Even with the same underlying stocks, liquidity fragmentation exists between different tokenization methods. Custodial tokenized stocks and issuer-sponsored tokenized stocks are based on the original shares; Linked Securities tokenize debt securities, while security-based swaps tokenize derivatives, and stock fund tokenization involves fund shares. As a result, these tools are not interoperable. Perpetual contracts fundamentally do not tokenize stocks and are therefore traded in separately liquid markets.

Horizontal Liquidity Fragmentation Within the Same Tokenization Method

Even when the tokenization method is the same, liquidity can be fragmented due to different entities conducting the tokenization.

• Original Stocks: Even if the tokens are based on original shares, they may not be interoperable. Shares held within the DTC custodial system and tokenized as custodial tokenized stocks differ from shares that are directly registered with the transfer agent and tokenized as issuer-sponsored tokenized stocks. Thus, liquidity is fragmented among the following three categories: 1) shares held in DTC custody corresponding to custodial tokenized stocks; 2) shares with ownership directly registered through DRS; 3) issuer-sponsored tokenized stocks. Because these three categories are not interoperable.
• Linked Securities: Under this tokenization method, liquidity is fragmented among different tokenization platforms. Even with the same underlying stocks and tokenization structures, the final tokens may differ due to the tokenizers, such as Robinhood, xStocks, or Ondo Global Markets.
• Stock Fund Tokenization: In this method, liquidity is also highly fragmented, depending on the type of fund and managing entity. However, it is hard to say that the tokenization itself causes this fragmentation. Funds and ETFs made up of stocks have existed in various forms in traditional financial markets, and their liquidity itself is also fragmented.
• Perpetual Contracts: Following the success of Hyperliquid, many perpetual contract exchanges have emerged. Even if they list the same stock, that stock will be traded separately on different exchanges, each with fragmented liquidity.

A Hypothetical Scenario

Imagine a hypothetical scenario: TSLA shares are tokenized through each of the methods and platforms mentioned above. Then TSLA can be traded in the following forms:

• Original TSLA: TSLA shares traded on NASDAQ. Even in the traditional stock market, TSLA is not only traded on the U.S. NASDAQ but also on several public electronic trading venues, alternative trading systems, and over-the-counter markets. It is also traded on various overseas exchanges and in the form of depositary receipts. Its liquidity is therefore already fragmented to some extent.
• Various Custodial Tokenized TSLA Products: These are products tokenizing rights to TSLA shares already held in existing DTC and brokerage account systems. DTCC can tokenize TSLA, and different brokerages can also tokenize their respective rights to TSLA shares. However, since these tokens merely represent rights within the traditional stock market system in the form of tokenized receipts, their liquidity is hard to view as separate from the original shares.
• DRS TSLA: TSLA shares held through DRS, where ownership is directly registered with Tesla or Tesla's transfer agent. This asset has already fragmented from the original TSLA shares.
• Issuer-Sponsored Tokenized TSLA: Tokenized TSLA shares with ownership directly registered in token form with Tesla or Tesla's transfer agent. To trade within the same liquidity pool as the original TSLA shares, ownership needs to be moved back from direct registration to the DTC custodial system.
• Various Linked Security TSLA Products: In this structure, the tokenization platform tokenizes debt securities that are one-to-one backed by TSLA shares. Since platforms like Robinhood, Ondo, and xStocks can each tokenize TSLA into different tokens, liquidity fragmentation occurs accordingly.
• Various Security-Based Swap TSLA Products: In this structure, the tokenization platform tokenizes derivative contracts based on TSLA stocks.
• Various Tokenized Stock Fund Shares including TSLA: In this structure, shares of funds that include TSLA in the portfolio are tokenized.
• TSLA traded on various perpetual contract exchanges: TSLA is traded separately on each perpetual contract exchange, each possessing independent liquidity.

In summary, even if TSLA liquidity has already fragmented within the traditional securities system, this fragmentation has historically been limited to alternative trading systems, DRS, and overseas exchanges. However, within the tokenized stock ecosystem, there could be numerous forms of tokenized TSLA under different legal structures, including derivative contracts, debt securities, and fund shares. These products may also target entirely different investor groups, such as U.S. versus non-U.S. investors or retail versus institutional investors.

None of these products are interoperable and trade in markets with independent liquidity. As a result, tokenization may lead to a level of fragmentation in TSLA liquidity far exceeding that of today.

The Paradox of Tokenized Stocks: How to Solve Liquidity Fragmentation?

The value proposition of tokenized stocks is very clear. They offer benefits like greater accessibility, 24/7 trading, faster settlement, and integration with smart contracts. Tokenization aims to provide better financial services to people around the world. However, in the case of tokenized stocks, it seems to have resulted in the paradoxical side effect of liquidity fragmentation.

Personally, I believe this viewpoint is partly correct and partly incorrect. How this issue is interpreted depends on how one views the tokenized stock ecosystem.

If looking at the current situation, the tokenized stock ecosystem undoubtedly has a liquidity fragmentation issue. A stock may simultaneously experience vertical liquidity fragmentation between different tokenization structures and horizontal liquidity fragmentation among various platforms using the same tokenization structure.

However, if viewed from the perspective of improving accessibility, the situation is different. Rather than saying that tokenization fragmented the liquidity of the existing stock market, it is more accurate to say that the newly created platforms improved access to these markets, ultimately leading to liquidity fragmentation. Linked Security tokenization, security-based swap tokenization, and perpetual contracts have opened pathways for investors who previously found it difficult to access U.S. stocks, thereby bringing new liquidity into the market.

Regardless of whether liquidity fragmentation is an inherent issue of tokenized stocks or a final byproduct during their growth process, if the scale of the tokenized stock market far exceeds current levels, this issue will become more pronounced. Thus, solving it will become essential.

In the stablecoin sector, companies have attempted to address liquidity fragmentation through stablecoin orchestration platforms and clearinghouse-like services. So, how can we solve the liquidity fragmentation of tokenized stocks? Two potential scenarios can be considered.

The first scenario is the emergence of a platform that plays a role similar to stablecoin orchestration or clearing in the tokenized stock sector. However, unlike stablecoins, which typically use consistent tokenization methods with relatively simple rights structures, tokenized stocks utilize a wide variety of tokenization structures involving complex rights and covering a number of individual securities far exceeding that of stablecoins. Therefore, it's hard to imagine a single entity handling all of this at scale.

The second scenario is market consolidation into oligopoly or monopoly. In the early stages of any industry, many participants often emerge. However, factors like liquidity and network effects are likely to lead the industry to eventually reorganize around a few dominant or monopolistic platforms. Tokenized stocks will likely be no exception. As regulatory conditions become clearer and restrictions are progressively lifted, a specific stock tokenization structure or platform may grow significantly, causing liquidity to become concentrated.

Tokenized stocks have only just begun. Following stablecoins and tokenized government bonds, how the tokenized stock market evolves and whether it can provide investors with value aligned with the fundamental purpose of tokenized equity remains to be seen.

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