There has been a lot of press about the explosive growth seen in the tokenized cash products (US Treasuries, Money Market Fund, Repos). From Feb 2024 to April 2024, it grew by an astonishing 42%+. By 4th May 2024, the growth is at 50%. The asset class grew from $860mil to $1.3 billion. You can read more in my detailed analysis here.
Compared to this hockey stick growth trajectory, the older cousin, tokenized private credit market has been in a 0 growth mode since late 2020.
Why the stark divergence in fortunes?
About a year ago, in my research report on the onchain private credit market, I looked at the potential capital pool for both asset classes and predicted a growing trend towards allocating to tokenized traditional financial products.
Although there has been a clear increase in allocation towards tokenized traditional assets, why has private credit been in a cauldron while cash products are booming?
We will look at the rationale behind through 3 lenses:
Investor barrier
Product utility
Institutional participation
Let’s dive in.
Investor Barrier
While an unbridled enthusiasm to make loans to crypto prop trading desks in 2021 propelled the onchain credit market from $0 to $4 billion, ever since the implosion of FTX, the appetite from investors for such products has all but vanished.
Nowadays, tokenized private credits mostly consist of US leverage loans, receivables and property bridging loans.
See below for the rise, fall and stagnation of private credit tokenization. You can find out more about what went wrong here.
No significant capital has flown into this corner of tokenized assets since BlockTower’s 2022 structured credit deal with MakerDAO totalling $220 million. The bulk of loan volume origination since Jan 2023 has mostly been individual loans within this facility maturing and getting reinvested.
A lack of institutional grade assets as well as players, made tokenized private credit a less attractive option when compared to i) other opportunities onchain and ii) other opportunities available to institutional investors offchain.
One of the other opportunities available onchain was tokenized cash products in 2023 pioneered and led by Ondo Finance.
It was initially designed to help onchain capital access the attractive risk-free rate.
When compared to 10-12% return, long lock-up and uncertain liquidity options, tokenized cash products with a 5%+ yield backed by the US risk-free rate product (TBills, Money Market Funds and Repos) are much more liquid and useful.
Just like in the offchain world, Treasurys are far bigger in size and more liquidity than any type of private credit products.
Similarly, there are far more relevant capital sources onchain for these cash management products than for niche private credit deals. The investor base of the asset class doesn’t change just because an illiquid and hard to assess asset is brought onchain.
In concrete terms, referring to our previous stablecoin holder cohort analysis, there are over 7 million wallets holding USDT or USDC between 0-100k on Ethereum vs 550 wallets holding $10mil-$100mil. This means there are up to 7 million customers who can use a more capital efficient way to manage their stablecoin holdings but only 550 customers who may allocate a small % of their cash holdings to long-lockup private credits.
Product Utility
Of course, there is far more capital available offchain than onchain right now. The key is to provide enough benefits for these capital to move onchain.
As I wrote before, the higher legal & operational costs associated with setting up and participating in tokenization structures are often a barrier for major buyside players.
In order for them to enter, the fees need to be lower and/or the benefits need to outweigh their cost. Onchain private credits currently cannot satisfy either conditions.
Currently, not only is the set up fee more expensive, especially considering the deal size of $10mil or lower, there are no additional utilities when compared to offchain opportunities.
By contrast, tokenized cash products are leveraging blockchain’s composability to unlock significant additional benefits such as instant mint/redeem as well as DeFi integrations which could outweigh the 10-20bps extra cost.
For example, Ondo OUSG’s instant and 365 mint/redeem capability can allow traders to utilise their OUSG holdings as collateral to margin their trades. The potential upside from the trades is an order of magnitude bigger than any additional fees they have to pay.
Institutional Participation
One of the barriers of broader adoption amongst risk-averse institutional capital pools is reputation or PR risk.
BlackRock’s recent eye-popping success with its first-ever onchain US Money Market Fund not only put tokenized cash products front and center for traditional asset managers, it also supercharged an ecosystem development - the importance of collateral mobility/capital efficiency.
Following BlackRock’s BUIDL success, Securitize, announced that BUIDL, the token representing this onchain fund’s share, will be eligible to be used as collateral for borrowing through its Securitize Lend.
This creates additional opportunities for BUIDL holders to access liquidity as well as trading opportunities through collateral margining.
Collateral mobility and capital efficiency are huge unlocks that are not available to offchain versions of US Tbills. You can read more about the subject in detail here.
Conclusion
While tokenization may be the hottest subject since the invention of bread, not all tokenized assets are equal.
Cash products with yields are increasingly looking likely to be the first tokenized asset class to go vertical in growth.
Private credit may need to wait longer for it to find its groove. Market maturity and investor sophistication are required before significant allocation can happen.
Someone once told me timing was everything. In the exciting and nascent land of tokenization, right timing is the difference between not surviving and thriving with money men knocking at your door.
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Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.
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