Tokenized Stock Paradox: When Greater Access Fragments Liquidity

Key Takeaways

• Although growth in the RWA sector has slowed somewhat over the past few months, tokenized stocks have continued to grow at an exceptionally rapid pace. The tokenized stock sector is currently expanding through three main channels: 1) Linked Security tokenized stocks offered by companies such as Ondo, xStocks, and Robinhood, 2) Issuer-Sponsored Tokenized Securities offered by companies such as Securitize, Figure, and Superstate, and 3) the growth of perpetual futures exchanges, which are not technically a form of tokenization.
• Although 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 being fragmented both 1) vertically across different tokenization structures and 2) horizontally across different tokenization providers using the same structure.
• From a more positive perspective, particularly in terms of improved accessibility, this phenomenon may not necessarily represent the fragmentation of existing liquidity. Instead, tokenized stocks may have attracted liquidity from investors who previously lacked access to US stock market liquidity, with fragmentation emerging as a byproduct.
• Regardless, liquidity fragmentation in tokenized stocks is a real problem. Potential solutions may include 1) the emergence of orchestration or clearing platforms similar to those found in the stablecoin sector, or 2) industry consolidation into an oligopolistic or monopolistic structure driven by economies of scale.

1. Tokenized Treasuries Stagnate While Tokenized Stocks Grow

Market interest in RWAs remains strong. It would not be an exaggeration to say that tokenized US Treasuries have been the primary driver of RWA growth so far. While the total crypto market capitalization increased by only 1.33 times, from $1.65T on January 1, 2024, to $2.19T today, the tokenized US Treasury market expanded 23-fold during the same period, from $695M to $16.1B.

However, growth in tokenized US Treasuries, which had previously been explosive, has recently begun to slow. This trend is not limited to Treasuries. Stablecoins, private credit, commodities, and other RWA categories have all recently shown signs of stagnation or even contraction. Within the RWA sector, however, one asset class has recently demonstrated rapid growth: tokenized stocks.

The tokenized stock market has grown by 56% over the past three months, from $1.2B to $1.88B. During the same period, tokenized US Treasuries grew by 7.3%, private credit by 16%, and commodities declined by 13%. These figures demonstrate just how steep the recent growth of tokenized stocks has been.

There are several reasons why tokenized stocks have been able to grow so quickly. Fundamentally, stocks have attracted greater attention as an asset class due to the recent appreciation of AI- and semiconductor-related stocks. In addition, as the RWA market has matured, the pathways and structures for tokenizing stocks have become considerably clearer. As a result, numerous tokenization platforms have begun offering tokenized stock services, and the market is now beginning to see the resulting growth in scale.

The growth of tokenized stocks is currently taking place through three primary channels:

1. The first is the growth of platforms that use 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 across onchain DeFi protocols, which has allowed them to grow rapidly.
2. The second is the growth of platforms such as Securitize, Superstate, and Figure, which directly tokenize existing shares through transfer agents. Because 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 fewer available stocks and more limited utility. However, when these platforms collaborate with companies to tokenize their shares, the number of stocks may be limited, but the amount tokenized for each individual stock can be extremely large. As a result, they have recently made a significant contribution to the growth of the tokenized stock market.
3. The final channel consists of perpetual futures exchanges such as Hyperliquid, Variational Omni, and QFEX. Strictly speaking, stock products traded on perpetual futures exchanges are not tokenized stocks. Nevertheless, a large number of users can already trade products that track stock prices through perpetual futures exchanges, and the scale of this activity is enormous.

However, from the perspective of financial market development, the emergence and growth of tokenized stocks cannot be viewed as entirely positive. Just as growth always has a darker side, several problems have emerged alongside the expansion of tokenized stocks. This research focuses on one of those problems: liquidity fragmentation.

2. Liquidity Fragmentation in Tokenized Stocks

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

2.1 Vertical Liquidity Fragmentation Across Tokenization Methods

There are many different ways to tokenize stocks:

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

Even when the underlying stock is the same, liquidity fragmentation exists across different tokenization methods. Custodial Tokenized Stocks and Issuer-Sponsored Tokenized Stocks are based on the original shares. In contrast, Linked Securities tokenize debt securities, Security-Based Swaps tokenize derivatives, and Stock Fund Tokenization involves tokenizing fund shares. These instruments are therefore not interoperable. Perpetual Futures do not tokenize stocks in the first place, so they are traded in separate markets with their own liquidity.

2.2 Horizontal Liquidity Fragmentation Within the Same Tokenization Method

Even when the tokenization method is the same, liquidity can become fragmented depending on the entity conducting the tokenization.

• Original Stock: Even when tokens are based on the original shares, they are not necessarily interoperable. Shares held within the DTC custody system and tokenized as Custodial Tokenized Stocks are different from shares whose ownership has been registered directly with a transfer agent and tokenized as Issuer-Sponsored Tokenized Stocks. As a result, liquidity becomes fragmented among 1) shares held in DTC custody and Custodial Tokenized Stocks, 2) shares whose ownership is directly registered through the DRS, and 3) Issuer-Sponsored Tokenized Stocks, because the three categories are not interoperable.
• Linked Security: Under this tokenization method, liquidity is fragmented across tokenization platforms. Even when the underlying stock and tokenization structure are the same, the resulting tokens differ depending on who tokenizes the stock, such as Robinhood, xStocks, or Ondo Global Markets.
• Stock Fund Tokenization: Liquidity is also highly fragmented under this method depending on the type of fund and the entity managing it. However, it is difficult to say that tokenization itself causes this fragmentation. Funds and ETFs composed of stocks already exist in a wide variety of forms in traditional financial markets, outside the tokenization sector, and their liquidity is also fragmented.
• Perpetual Futures: Following Hyperliquid's success, numerous perpetual futures exchanges have emerged. Even when they list the same stock, it is traded separately across different exchanges, each with its own fragmented liquidity.

2.3 A Hypothetical Scenario

Consider a hypothetical scenario in which TSLA shares are tokenized through every method and platform listed above. TSLA could then be traded in the following forms:

• Original TSLA: TSLA shares traded on Nasdaq. Even in traditional stock markets, TSLA is already traded not only on Nasdaq in the United States, but also across multiple public electronic exchanges, 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.
• Multiple Custodial Tokenized TSLA Products: These are tokenized rights to TSLA shares already held within the existing DTC and brokerage account system. DTCC could tokenize TSLA, while different securities firms could also tokenize their respective rights to TSLA shares. However, because these tokens merely represent rights within the traditional stock market system in the form of tokenized receipts, it is difficult to regard their liquidity as being fragmented from the original shares.
• DRS TSLA: TSLA shares held through the DRS, with ownership registered directly with Tesla or Tesla's transfer agent in the traditional stock market. This asset is already fragmented from original TSLA shares.
• Issuer-Sponsored Tokenized TSLA: Tokenized TSLA shares whose ownership is directly registered in token form with Tesla or Tesla's transfer agent. To trade these shares within the same liquidity pool as original TSLA shares, ownership would need to be transferred from direct registration back into the DTC custody system.
• Multiple Linked Security TSLA Products: Under this structure, a tokenization platform tokenizes debt securities backed one-to-one by TSLA shares. Because Robinhood, Ondo, xStocks, and other platforms can each tokenize TSLA into different tokens, liquidity fragmentation occurs.
• Multiple Security-Based Swap TSLA Products: Under this structure, a tokenization platform tokenizes derivative contracts whose underlying asset is TSLA stock.
• Multiple Tokenized Stock Fund Shares Containing TSLA: Under this structure, shares in funds that include TSLA in their portfolios are tokenized.
• TSLA Traded Across Multiple Perpetual Futures Exchanges: TSLA is traded separately on various perpetual futures exchanges, each with its own liquidity.

In summary, even when TSLA liquidity is fragmented within the conventional securities system, that fragmentation has historically been limited largely to alternative trading systems, the DRS, and overseas exchanges. In the tokenized stock ecosystem, however, numerous forms of tokenized TSLA could exist under different legal structures, including derivative contracts, debt securities, and fund shares. These products could also target entirely different investor groups, such as US and non-US investors or retail and institutional investors.

None of these products would be interoperable, and each would trade in a separate market with its own liquidity. As a result, tokenization could fragment TSLA liquidity far more severely than it is today.

3. The Tokenized Stock Paradox: How Can Liquidity Fragmentation Be Resolved?

The value proposition of tokenized stocks is clear. They offer benefits such as greater accessibility, 24/7 trading, faster settlement, and integration with smart contracts. Tokenization aims to provide people around the world with access to better financial services. In the case of tokenized stocks, however, it appears to produce the paradoxical side effect of liquidity fragmentation.

Personally, I would argue that this view is partly correct and partly incorrect. The issue can be interpreted differently depending on how one views the tokenized stock ecosystem.

• When viewed as it currently exists, the tokenized stock ecosystem undeniably has a liquidity fragmentation problem. A single stock can experience vertical liquidity fragmentation across different tokenization structures, as well as horizontal liquidity fragmentation across different platforms using the same tokenization structure.
• However, the situation looks different when viewed through the lens of improved accessibility. Rather than saying that tokenization fragmented the liquidity of existing stock markets, it may be more accurate to say that newly created platforms improved access to those markets, which ultimately resulted in liquidity fragmentation. Linked Security tokenization, Security-Based Swap tokenization, and Perpetual Futures have opened accessible pathways for investors who previously found it difficult to access US stocks, thereby bringing new liquidity into the market.

Regardless of whether liquidity fragmentation is an inherent problem of tokenized stocks or merely an eventual byproduct of their growth, the issue will become more severe if the tokenized stock market expands far beyond its current size. Addressing it will therefore be important.

In the stablecoin sector, businesses have attempted to solve liquidity fragmentation through stablecoin orchestration platforms and clearinghouse-like services. How, then, can liquidity fragmentation in tokenized stocks be resolved? Two potential scenarios can be considered.

• The first scenario is the emergence of a platform that performs a role similar to stablecoin orchestration or clearing within the tokenized stock sector. However, unlike stablecoins, which generally use consistent tokenization methods and have relatively simple rights structures, tokenized stocks use a wide variety of tokenization structures, involve complex rights, and cover an incomparably larger number of individual securities. It is therefore extremely difficult to imagine a single entity handling all of this at scale.
• The second scenario is the consolidation of the market into an oligopoly. In the early stages of any industry, numerous players tend to emerge. However, liquidity, network effects, and other factors make it highly likely that the industry will eventually be reorganized around a small number of dominant or monopolistic platforms. Tokenized stocks are unlikely to be an exception. As regulatory conditions become clearer and restrictions are gradually lifted, a particular stock tokenization structure or platform may grow significantly, causing liquidity to become concentrated.

Tokenized stocks are only at the beginning of their development. Following stablecoins and tokenized Treasuries, it remains to be seen how the tokenized stock market will evolve and whether it can provide investors with value that is consistent with the fundamental purpose of tokenized equities.