What Institutions Need to Know Before Allocating Capital to Tokenized Assets
- Harsim Ranjit Singh
- May 5
- 13 min read
Updated: 3 hours ago
May 5, 2025 | RWA | Crypto | By Harsim Ranjit Singh
Navigating the New Tokenized Landscape
As tokenized real-world assets move from pilot phase to practical reality, institutions – from banks and asset managers to family offices and corporate treasuries – are increasingly considering allocations to these digital assets. However, tokenized assets straddle two worlds (traditional finance and blockchain) and thus carry a unique set of considerations. Before allocating significant capital to tokenized assets, institutions need to perform due diligence across regulatory, operational, and risk dimensions. Here’s a guide to the key factors and best practices:
1. Regulatory and Legal Clarity
Institutions must first determine what exactly the token represents legally and ensure it fits within their regulatory constraints. Is the token clearly defined as a security, a loan participation, a derivative, or something else? Who is the legal issuer and what jurisdiction’s law applies? For example, if investing in a tokenized bond, the investor should confirm that it’s issued under proper prospectus exemptions or registrations. Regulatory uncertainty remains in some areas – as of 2025, the U.S. SEC treats most tokenized securities like the traditional ones, but there is still evolving guidance1. Institutions should seek counsel to confirm that buying or trading a particular RWA token is permitted for them (e.g., a U.S. pension fund can only invest in securities that meet certain criteria – if a tokenized real estate offering hasn’t filed the right exemption, it could be off-limits).
Additionally, many tokenized assets have lock-up periods or require transfers only to approved investors. If an institution might need to liquidate, they must know when and how they are allowed to sell. That means an institution should size the investment knowing it may be illiquid for at least that period (unless there’s a built-in secondary via a platform for accredited investors).
Action point: Insist on seeing the legal offering memorandum or token terms. Ensure it spells out investor rights (Is there recourse to an underlying asset? What happens if the issuer defaults? How are disputes resolved?) and compliance measures. Check if the token has an ISIN or other identifier bridging it to traditional frameworks – the more it fits into known legal categories, the better. In short, treat token due diligence like security due diligence plus an extra tech layer.
2. Custody and Control of Tokens
Next, institutions must have a plan for secure custody of the tokens. Unlike traditional assets that might be held by a bank in a custody account, tokens require managing private keys. The options are typically: use a reputable digital asset custodian or manage keys in-house with enterprise-grade solutions. For most institutions, engaging a regulated custodian (like a Fidelity Digital Assets, Coinbase Custody, Anchorage, etc.) is prudent. Having a sound custody solution for tokenized assets is vital. Unlike traditional assets that are held by custodians via book-entry, tokenized assets live on a blockchain and are controlled by whoever holds the private keys. Institutions should not treat this lightly – losing a private key means losing the asset irreversibly. Therefore, before investing, an institution must decide how it will custody the tokens:
Use a Qualified Digital Custodian: The simplest route is often to engage a regulated, insured crypto custodian. Firms like Anchorage Digital, Coinbase Custody, Fidelity Digital Assets, or BitGo specialize in holding digital assets for institutions. They offer secure storage (often via Hardware Security Modules and multi-signature approvals) and often carry insurance against theft. Many are qualified custodians under regulations, meaning they can satisfy requirements like the SEC’s custody rule for investment advisers. Using such a custodian also outsources the complexities – the custodian will manage wallet addresses, handle whitelisting your address with the token issuer if needed, and assist in transaction execution safely. As erable’s RWA report notes, many investors prefer third-party custodians with insurance and compliance standards2. When choosing one, ensure they support the specific blockchain your asset is on (Ethereum, Stellar, a permissioned chain, etc.) and that they have experience with security tokens (some custodians maintain separate whitelisted vault addresses for regulated tokens).
Self-Custody with Institutional Wallets: If an institution chooses to self-custody (perhaps to avoid custodian fees or because they want direct control), they must deploy enterprise-grade wallet infrastructure. This could mean using a solution like Fireblocks or Metaco that provides a secure wallet with multi-user approval workflows, or even running a dedicated hardware security module (HSM) in-house. They’ll need strict procedures: multi-factor authentication, multi-person approval for transactions (to prevent a rogue trader from moving assets), and disaster recovery plans (backup keys stored in secure vaults, etc.). For instance, a family office might use a multisig wallet requiring 2 of 3 partners to sign any transfer, and keep one of the seed phrases in a bank safe deposit box. Self-custody also means taking on the burden of monitoring the blockchain for corporate actions or relevant changes (e.g., if there’s a token contract upgrade or a new compliance rule, the investor needs to be aware). It’s doable, but requires significant IT security expertise.
In either case, institutions should also clarify with the issuer or platform how to recover assets if something goes wrong. Some permissioned token systems can, for example, redeploy tokens to a new address if an old one is proven compromised or lost – but this usually requires legal processes and is not always guaranteed. Knowing whether such a recovery mechanism exists provides peace of mind. As a best practice, conduct a test transaction (e.g., a small purchase and redemption) to ensure your custody setup works with the token’s system before allocating large capital.
3. Smart Contract and Technical Risks
When buying tokenized assets, institutions are not only taking on the underlying asset risk but also technical risk associated with the smart contracts and blockchain networks. Smart contract risk means the code governing the token or the platform could have bugs or vulnerabilities that might be exploited. For example, could someone mint unauthorized tokens? Could a flaw freeze your assets? These are not theoretical – DeFi history has many hacks due to coding bugs, leading to loss3. While tokenization platforms for RWAs tend to be more permissioned and audited, institutions should:
Review Audits and Security Certifications: Ask the issuer or platform if the smart contracts have been audited by reputable firms. Read the executive summary of any audit report. Many RWA platforms engage firms like Certik, Quantstamp, or Trail of Bits to audit their token contracts and related code. Ensure any critical contracts (the token contract, investor registry contract, etc.) have been audited at least once – and recently if there were upgrades. Also inquire about bug bounty programs or security frameworks in place. If the platform provides a Service Organization Control (SOC2) report or similar, that’s a plus indicating good internal security processes.
Assess Blockchain Network Risk: Consider the blockchain on which the asset lives. Is it a robust, decentralized chain like Ethereum or a smaller, new chain? If it’s a private or permissioned chain, who are the validators and what happens if they go down? For instance, if a token is on a permissioned Hyperledger network run by the issuer and that network fails, are there contingency plans (like moving tokens to a public chain)? On public chains, network congestion or outages can temporarily impede trading or transfer. E.g., an institution might recall when Solana had multi-hour outages or Ethereum had extremely high gas fees – how would that impact their ability to transact the token in a timely manner? These risks don’t necessarily bar investment, but they should influence decisions like which network to prefer or what time to execute large transactions (e.g., avoid moving tokens during known high-congestion events).
Custody Tech Risk: As discussed, even with good custody, technical issues can occur. Ensure that your custodian or wallet solution has proven uptime and incident response. If a transaction fails or a key shard is lost, what is the procedure? Does the platform have a designated support team for institutional clients? In essence, treat it similarly to operational risk in traditional systems and demand the same level of business continuity planning from service providers.
In practice, many institutions mitigate smart contract risk by starting with small pilot investments – they allocate a tiny percentage (say 0.1%) of capital to test the waters in a tokenized asset, monitoring how the tech behaves over a quarter or two, before scaling up. This “test and learn” approach can catch unforeseen issues in a low-stakes way.
4. Liquidity and Exit Strategy
Institutions should critically evaluate how they can exit or rebalance their tokenized asset positions. As covered in earlier blogs, while tokenization aims to improve liquidity, many tokens are still relatively illiquid compared to public markets. Before allocating, ask:
Where will I sell or trade this token if needed? Identify the secondary market venues – is it an exchange (ATS) like tZERO, a bulletin board on the issuance platform, or would you have to negotiate OTC with other investors? Understanding the likely liquidity source helps gauge how long an exit might take and what transaction costs (spread/slippage) might be. For example, if the only way out is to find a buyer privately and do a manual transfer via the issuer, that process could take weeks – plan your liquidity needs accordingly. On the other hand, if the token trades on a venue that publishes volume data, check the average daily volume relative to your intended position size. If you plan to invest $5 million and the token’s typical monthly volume is only $1 million, you know it could take months to fully liquidate without tanking the price.
Lock-ups and Redemptions: Determine if there are lock-up periods (common in private market tokens) or specific redemption windows. Some tokenized funds offer periodic redemption (e.g., Franklin’s fund allows daily redemption, whereas a tokenized real estate fund might only allow redemptions quarterly or upon asset sale). Align this with your liquidity preferences. If an asset is tokenized but still essentially as illiquid as the underlying (like a tokenized private equity stake that only liquidates when the company has an exit), you must treat it as such in your portfolio liquidity buckets. Also clarify redemption procedures: Do you redeem through a smart contract (some stablecoins and tokens allow on-chain redemption for the underlying asset or cash) or through an off-chain process with the issuer? And what fees or notice periods apply?
Valuation and Mark-to-Market: Illiquidity ties into how you value the asset on your books. If the token doesn’t trade often, you might not have a market price. You may need to rely on NAV reports from the issuer or third-party valuations periodically. E.g., a tokenized real estate fund may report NAV quarterly based on appraisals. Be prepared for how this fits into your accounting – auditors will want to know how you derive fair value. Some institutions use the last traded price but apply a liquidity discount when marking thinly traded tokens. The Chainalysis report on tokenization noted that lack of established markets can make valuation challenging, potentially leading to volatility or uncertainty in portfolio valuation1. Having a policy for this internally (perhaps treating it similarly to other Level 2 or Level 3 assets under accounting standards) is important.
In summary, an institution should invest in tokenized RWAs with the same clarity on exit as they would in any private investment: know the path to liquidity and assume it could take time. Tokenization is making strides, but one should avoid assuming “I can sell anytime” unless the data truly shows deep liquidity.
5. Counterparty and Platform Due Diligence
When you buy a tokenized asset, you are also implicitly trusting the issuer and the platform that facilitated the tokenization. It’s crucial to vet these parties:
Issuer/Sponsor Track Record: If it’s a tokenized bond or fund, evaluate the issuer’s reputation and financial health as you normally would. Tokenization doesn’t remove issuer risk. If anything, in some cases tokens may have less investor protection than traditional formats (depending on legal structuring). For example, if a token represents a loan participation in an originator’s portfolio, you’d want to deeply diligence that originator (their default rates, their capital reserves, etc.). In a Chainalysis blog, experts note that the legal enforceability of tokenized claims needs to be understood – e.g., ensure that token holders have a clearly defined claim on underlying assets or cash flow1. This might involve reviewing legal opinions or terms of the token contract.
Tokenization Platform Reliability: Many tokens are issued via platforms (e.g., Securitize, Polymath, Oasis Pro, etc.). Investigate the platform’s credentials. Are they regulated (FINRA broker-dealer, SEC ATS, MAS recognized market, etc.)? How long have they operated and with what results? Have there been any incidents (security breaches, legal disputes)? The platform’s systems are critical – if their tech has bugs, it could impact you. For instance, in 2020 a tokenization platform temporarily halted trading due to a smart contract error – an institutional investor in those tokens would have been stuck until resolved. So, ask the platform: “What’s your uptime? Do you have redundancy? How do you handle contract upgrades (and will investors be notified/have to do anything)?” A professional platform should have ready answers, much like a stock exchange would for its systems.
Legal Recourse and Governance: Understand the governance structure: If something goes wrong (fraud by issuer, or say the platform goes bankrupt), what happens to your tokens? Ideally, the tokens live on a blockchain independent of the platform’s existence (e.g., Ethereum), and the legal rights are such that even if the platform ceases, you still own the underlying or can transfer tokens to another service. In practice, it can be messy – if a platform runs the only whitelist/transfer agent function, and it disappears, token holders might need to coordinate to appoint a new transfer agent or petition a court for asset access. These are edge cases, but an institution’s risk management should contemplate them. Insurance for such scenarios is nascent but might be considered – e.g., some insurers offer policies for loss arising from technology failures or fraud in digital asset platforms.
6. Internal Preparedness and Training
Allocating to tokenized assets also requires ensuring your internal teams and systems are ready
Staff Training: The portfolio managers, traders, ops teams, and compliance officers all need at least a basic understanding of how the token works. For instance, the ops team should know how to initiate a transfer or corporate action on the platform, the compliance team needs to understand any on-chain monitoring needed (like checking that only whitelisted addresses hold the asset, if required by regs), and traders need to know the trading mechanics (e.g., “do I trade via a web interface or an API?”). Many institutions do a dry run where they simulate a token purchase, moving it to a custodian, and selling a portion, so that staff can practice the workflows. This flushes out issues and builds comfort.
System Integration: You may need to integrate the token holdings into your portfolio management system (PMS) and risk systems. Does your PMS support digital assets or at least manual entry of these positions? Can your risk models price them or at least bucket them (for example, a tokenized bond should be incorporated into your fixed income risk metrics for duration, credit, etc.)? You might need to work with vendors – many risk system providers are now adding crypto/token modules. Even something as simple as getting custodial data feeds – if using a new digital custodian, ensure you can get automated position and transaction reports that your accountants can ingest. If your institution has a middle-office for trade confirmation, decide how they will confirm a token trade (likely via the platform’s system rather than SWIFT or FIX messages they’re used to). These operational details, if sorted upfront, prevent headaches later. A common approach is to treat token transactions similarly to OTC trades operationally: more manual oversight, checklists for settlement, etc., until systems catch up.
Policy Updates: Internal policies around investment approval, risk limits, valuation, and compliance may need updates to explicitly cover tokenized assets. For example, an investment committee charter might need to mention that it can approve blockchain-based investments. Risk management policies should address concentration limits for tokenized assets (maybe initially keep them as a small percentage of the portfolio). Compliance manuals might need a section on handling wallets and MNPI (Material Non-Public Information) in blockchain context – e.g., if you have MNPI about a company whose loan is tokenized, how do you restrict trading of that token? Usually same rules apply, but ensure clarity. If employees are allowed to handle keys, there should be policy on that too (much like policy on handling physical stock certificates or cash).
7. Tax and Accounting Considerations
Early in the process, institutions should consult tax advisors on the implications of holding and transacting tokenized assets. Often, the token itself doesn’t change the tax character: income and gains are taxed as they would be for the underlying asset. For instance, interest from a tokenized bond is still interest income; if you hold a tokenized fund, you’ll get a 1099 or equivalent for dividends. But ensure the issuer has a plan for tax reporting – will they provide necessary forms? Cross-border issues can arise: if a Singapore fund is tokenized and a U.S. investor buys it, does that trigger any withholding taxes or FBAR (Foreign Bank Account Report) filings if the wallet is considered a foreign account? Probably not in the same way, but these are new questions. Accounting-wise, determine if the token will be treated as a security (likely marked-to-market or at fair value) or as an intangible. This impacts earnings volatility and capital charges. For banks, tokenized assets might attract the same capital charge as the underlying (e.g., a tokenized loan = a loan for Basel III risk weighting), but check with regulators if any additional charge for operational/tech risk is considered.
8. Embrace Gradualism and Partner with Experts
Finally, institutions should proceed gradually and partner with experts. This space is evolving daily. Engaging consultants who specialize in digital assets, or legal counsel who’s worked on token offerings, can provide valuable insight into pitfalls and best practices. Often, joining industry consortia or pilots (like Sandbox programs, or forums such as RWA Working Groups) can give an institution a safe environment to learn. Banks have benefitted from participating in central bank pilots for tokenized bonds to internally develop know-how. Family offices have joined platform advisory boards to influence how products are shaped to meet their needs (e.g., requesting monthly NAV reporting or certain governance rights in token form). Being active rather than passive can help shape an ecosystem that aligns with institutional requirements.
Conclusion – From Caution to Confident Participation
Tokenized real-world assets offer attractive opportunities – access to new markets, potentially higher yields, and improved liquidity over traditional private assets – but institutions must approach them with informed caution. By ensuring compliance, secure custody, technical robustness, and liquidity planning, institutions can turn the potential pitfalls of tokenization into manageable risks. Many who have taken the plunge (as we saw with those engaging BlackRock’s or Franklin’s offerings, or banks in JPMorgan’s network) report positive outcomes, but also emphasize the importance of the preparatory steps outlined above.
Importantly, institutions should recognize that the regulatory and best-practice environment is rapidly maturing. Regulators across major jurisdictions are actively providing guidance: for example, the SEC has issued some guidance on custody of digital securities (e.g., requiring qualified custodians), and the EU’s MiCA and pilot regime provide frameworks for tokenized instruments. Keeping abreast of these developments is part of due diligence – what is forbidden or unclear today may be allowed tomorrow (and vice versa). A case in point: an institution might initially limit itself to permissioned platforms due to uncertainty, but as laws clarify, it can expand to public network tokens.
Ultimately, tokenized assets are likely to become a regular part of the institutional portfolio mix in the coming decade. By treating the investment process with the same rigor as any other – just augmenting it with new areas of focus (like smart contracts and key custody) – institutions can seize the advantages of RWAs while safeguarding their fiduciary duties and client interests. As the adage goes, “do your homework”; in the realm of tokenization, that homework spans both finance and tech. Institutions that do it will move from cautious observers to confident participants in the tokenized economy, equipped to navigate its risks and reap its rewards.
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