Tokenized stock scale grew 56% in three months. How can crypto solve the liquidity fragmentation dilemma?

Original author: @100y_eth

Original compilation: AididiaoJP, Foresight News

Key Takeaways

Although the overall growth of the RWA sector has slowed in recent months, tokenized stocks continue to expand at an exceptionally rapid pace. Currently, the tokenized stock sector is expanding through three main channels:

• Tokenized stocks as Linked Securities, offered by Ondo, xStocks, Robinhood, etc.;
• Issuer-Sponsored tokenized securities, offered by Securitize, Figure, Superstate, etc.;
• The growth of perpetual futures exchanges (strictly speaking, this does not constitute tokenization).

While the tokenized stock sector is growing overall, liquidity fragmentation has begun to emerge as a side effect. Even when the underlying stock is the same, liquidity is fragmented across two dimensions:

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

From a more positive perspective, especially in terms of improving accessibility, this phenomenon does not necessarily represent a fragmentation of existing liquidity. Instead, tokenized stocks may have attracted investors who previously had no access to US stock market liquidity, with fragmentation being merely a byproduct.

Regardless, 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 oligopolistic or monopolistic structure driven by economies of scale.

Tokenized Treasuries Stagnate, Tokenized Stocks Surge

Market interest in RWAs remains strong. It is no exaggeration to say that tokenized US Treasuries have been the primary engine of RWA growth to date. From January 1, 2024, to now, the total crypto market cap has only grown from $1.65 trillion to $2.19 trillion, an increase of approximately 1.33 times. In contrast, the tokenized US Treasury market expanded from $695 million to $16.1 billion during the same period, a 23-fold increase.

However, the previously explosive growth of tokenized US Treasuries has recently begun to slow. This trend is not limited to Treasuries. Other RWA categories such as stablecoins, private credit, and commodities have also shown signs of stagnation or even contraction recently. Yet, within the RWA sector, one asset class 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, a 56% increase. During the same period, tokenized US Treasuries grew only 7.3%, private credit grew 16%, and commodities declined by 13%. These figures clearly illustrate the steepness of the recent growth in tokenized stocks.

There are several reasons for such rapid growth. Fundamentally, stocks as an asset class have attracted more attention recently due to the rise in AI and semiconductor-related stocks. Furthermore, as the RWA market matures, the paths and structures for stock tokenization have become quite clear. Consequently, numerous tokenization platforms have begun offering tokenized stock services, and the market is starting to see scale growth.

The current growth of tokenized stocks is primarily achieved through three main channels:

The first channel involves platforms using offshore structures to tokenize debt instruments as 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, because they face fewer compliance restrictions in secondary distribution, they can be actively used in on-chain DeFi protocols, thus enabling rapid growth.

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

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

However, from the perspective of financial market development, the emergence and growth of tokenized stocks cannot entirely be viewed as positive. Just as growth always has a dark side, the expansion of tokenized stocks has also brought about several problems. This research report focuses on one such issue: liquidity fragmentation.

Liquidity Fragmentation of Tokenized Stocks

Even when the underlying stock is the same, liquidity becomes fragmented both vertically and horizontally, depending on the tokenization structure and platform.

Vertical Liquidity Fragmentation Between Different Tokenization Methods

There are various ways to tokenize stocks:

• Custodial Tokenized Stocks: A third party tokenizes the rights to shares held within the DTC custody system. Representative examples include DTCC, Ondo, Dinari.
• Issuer-Sponsored Tokenized Stocks: The issuer or transfer agent directly tokenizes the ownership of shares. Representative examples include Securitize, Figure, Superstate.
• Linked Security: A third party issues and tokenizes a separate security providing economic exposure to the underlying stock. Representative examples include Robinhood Stock Tokens, Backed Finance xStocks, Ondo Global Markets.
• Security-Based Swap: A third party tokenizes a derivative contract providing economic exposure to the underlying stock. A representative example is Robinhood Classic Stock Tokens.
• Stock Fund Tokenization: Tokenizing shares of a fund composed of stocks. Representative examples include Centrifuge, WisdomTree.
• Perpetual Futures: These platforms do not tokenize stocks but operate exchanges offering perpetual futures markets tracking stocks. Representative examples include Hyperliquid, QFEX, Variational Omni, Lighter.

Even if the underlying stock is the same, liquidity fragmentation exists between different tokenization methods. Custodial tokenized stocks and issuer-sponsored tokenized stocks are based on original shares; linked securities tokenize debt securities; security-based swaps tokenize derivatives; stock fund tokenization involves fund shares. These instruments are therefore not interoperable. Perpetual futures fundamentally do not tokenize stocks and thus trade in separate markets with their own liquidity.

Horizontal Liquidity Fragmentation Within the Same Tokenization Method

Even when the tokenization method is the same, liquidity can be fragmented depending on the entity performing the tokenization.

• Original Shares: Even if tokens are based on original shares, they are not necessarily interoperable. Shares held in the DTC custody system and tokenized as custodial tokenized stocks are different from shares whose ownership is directly registered with the transfer agent and tokenized as issuer-sponsored tokenized stocks. Therefore, liquidity is fragmented among: 1) shares in DTC custody and custodial tokenized stocks; 2) shares directly registered via DRS; and 3) issuer-sponsored tokenized stocks. These three types are not interoperable.
• Linked Securities: Under this method, liquidity is fragmented between different tokenization platforms. Even if the underlying stock and tokenization structure are the same, the resulting tokens differ depending on the tokenizing entity, such as Robinhood, xStocks, or Ondo Global Markets.
• Stock Fund Tokenization: Under this method, liquidity is also highly fragmented, depending on the fund type and the managing entity. However, it is difficult to argue that tokenization itself causes this fragmentation. Funds and ETFs composed of stocks have long existed in various forms in traditional financial markets, and their liquidity is inherently fragmented.
• Perpetual Futures: Following the success of Hyperliquid, numerous perpetual futures exchanges have emerged. Even if they list the same stock, that stock trades separately on different exchanges, each with its own fragmented liquidity.

A Hypothetical Scenario

Imagine a hypothetical scenario where TSLA shares are tokenized using every method and platform mentioned above. Then TSLA could be traded in the following forms:

• Original TSLA: TSLA shares traded on NASDAQ. Even in the traditional stock market, TSLA is traded not only on NASDAQ in the US but also on various public electronic exchanges, alternative trading systems, and over-the-counter markets. It is also traded on various overseas exchanges and as depositary receipts. Its liquidity is therefore already somewhat fragmented.
• Multiple Custodial Tokenized TSLA Products: These tokenize rights to TSLA shares already held within existing DTC and brokerage account systems. The DTCC could tokenize TSLA, and different securities firms could 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, it is difficult to view their liquidity as completely separate from the original shares.
• DRS TSLA: TSLA shares held via DRS, with ownership registered directly with Tesla or Tesla's transfer agent. This asset is already fragmented from the original TSLA shares.
• Issuer-Sponsored Tokenized TSLA: Tokenized TSLA shares where ownership is registered directly with Tesla or its transfer agent in token form. To trade in the same liquidity pool as original TSLA shares, ownership would need to be transferred back from direct registration to the DTC custody system.
• Multiple Linked Security TSLA Products: Under this structure, tokenization platforms tokenize debt securities that are 1:1 backed by TSLA shares. Since platforms like Robinhood, Ondo, and xStocks can each tokenize TSLA into different tokens, liquidity fragmentation occurs.
• Multiple Security-Based Swap TSLA Products: Under this structure, tokenization platforms tokenize derivative contracts with TSLA shares as the underlying asset.
• Multiple Tokenized Stock Fund Shares Containing TSLA: Under this structure, shares of funds whose portfolios include TSLA are tokenized.
• TSLA Traded on Multiple Perpetual Futures Exchanges: TSLA trades separately on each perpetual futures exchange, each possessing its own independent liquidity.

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

None of these products are interoperable with each other, and each trades in a market with its own liquidity. Consequently, tokenization could fragment TSLA liquidity to a degree far greater than what exists today.

The Paradox of Tokenized Stocks: How Can Liquidity Fragmentation Be Solved?

The value proposition of tokenized stocks is clear. They offer benefits such as higher 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 produced the paradoxical side effect of liquidity fragmentation.

Personally, I believe this view is partially correct and partially incorrect. How one interprets this issue depends on how one views the tokenized stock ecosystem.

From the current status quo, the tokenized stock ecosystem undoubtedly suffers from liquidity fragmentation. A single stock can simultaneously experience vertical liquidity fragmentation between different tokenization structures and horizontal liquidity fragmentation between different platforms using the same tokenization structure.

However, viewed from the perspective of improving accessibility, the situation is different. Rather than tokenization fragmenting the liquidity of the existing stock market, the newly created platforms have improved access to these markets, ultimately leading to liquidity fragmentation. Linked security tokenization, security-based swap tokenization, and perpetual futures have opened accessibility pathways for investors who previously struggled to access US stocks, thereby bringing new liquidity into the market.

Whether liquidity fragmentation is an inherent problem of tokenized stocks or a final byproduct of their growth, it will become more severe if the tokenized stock market scale far exceeds current levels. Therefore, solving it will become important.

In the stablecoin sector, companies have attempted to solve liquidity fragmentation through stablecoin orchestration platforms and services resembling clearinghouses. So, how can the liquidity fragmentation of tokenized stocks be solved? 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 generally use a consistent tokenization method and have relatively simple rights structures, tokenized stocks use a wide variety of tokenization structures, involve complex rights, and cover a number of individual securities far exceeding stablecoins. Therefore, it is difficult to imagine a single entity handling all this at scale.

The second scenario is market consolidation into an oligopoly. In the early stages of any industry, numerous participants often emerge. However, factors like liquidity and network effects make it highly likely that the industry will eventually reorganize around a few dominant or monopoly platforms. Tokenized stocks are unlikely to be an exception. As regulatory conditions become clearer and restrictions are gradually lifted, a specific stock tokenization structure or platform might grow significantly, leading to the concentration of liquidity.

Tokenized stocks are just getting started. Following stablecoins and tokenized Treasuries, it remains to be seen how the tokenized stock market will evolve and whether it can deliver value to investors consistent with the fundamental purpose of tokenized equity.