On-Chain Funds Face Scrutiny as Prometheum Co-CEO Highlights Risks Amidst Institutional Influx

Executive Summary

Prometheum co-CEO Aaron Kaplan warned against on-chain investment funds potentially hiding costs, offering weaker protections, or proving overly complex. This caution emerges as blockchain-based fund assets nearly tripled to $30 billion, attracting major financial institutions and prompting increased market scrutiny.

The Event in Detail

Kaplan's critique, encapsulated by the adage "Timeō Danaōs et dōna ferentēs"—"Beware of Greeks Bearing Gifts"—underscores the risk of products that might "repackage old strategies or justify high fees under the guise of 'digital innovation.'" He emphasizes the need for investors to differentiate between genuinely efficient, natively issued on-chain securities and less beneficial tokenized securities that merely mirror existing assets without delivering meaningful improvements.

The Securities Transfer Association (STA) advocates for Native Tokenization, where underlying securities are natively tokenized on a transfer agent's register in conjunction with issuers. This approach establishes a single source of truth, grants full ownership rights akin to traditional shareholders, and maintains regulatory integrity. In contrast, "Intermediated Tokenization," often by non-transfer agents, presents risks such as a lack of true ownership, significant counterparty risk, market fragmentation, and regulatory enforcement challenges. Carlos Domingo, CEO of Securitize, reinforces this view, stating that only native tokenization allows blockchain technology to realize its maximum potential for securities, ensuring transparency, security, and compliance. Examples like BlackRock's BUIDL fund illustrate the potential for natively issued on-chain securities.

Market Implications

Kaplan's commentary could lead to increased investor scrutiny on new on-chain products, potentially moderating the adoption of less transparent or inefficient offerings. The long-term implication is a reinforcement of the demand for genuine innovation, transparent fee structures, and robust investor protections, which could foster a more mature and trusted on-chain financial market capable of attracting significant institutional capital.

Despite the warnings, institutional adoption trends remain strong. A State Street global research report indicates that nearly 60% of institutional investors plan to increase their allocation to digital assets within a year, with average exposure projected to double in three years. By 2030, most respondents anticipate that up to a quarter of institutional investments will be conducted through tokenized instruments, driven by benefits such as enhanced transparency, faster trading, and reduced compliance costs. JPMorgan notably executed a tokenized money market fund transaction on its Onyx blockchain platform in 2024.

However, a report by credit rating agency Moody's, featuring insights from Vice President and Senior Analyst Cristiano Ventricelli, highlights significant red flags within the booming tokenized fund market. Moody's identifies concerns such as the lack of experience among many fund managers, key person risks, the novelty-driven potential for blockchain interruption and smart contract vulnerabilities, and the increased risk of attacks on public permissionless blockchains. Moody's recommends off-chain backups, strict smart contract audits, and redemption mechanisms that support both stablecoins and fiat currencies. The report also notes that a patchwork of regulations across jurisdictions could create legal barriers for investor claims. The FBI reported a record $9.3 billion stolen in the United States in 2024 through various Web3 scams, including "honeypot" tokens and token impersonation, underscoring the acute need for advanced threat intelligence and investor vigilance.

Expert Commentary

Aaron Kaplan of Prometheum emphasizes the critical need for investors to be vigilant and scrutinize the underlying mechanics and true value proposition of on-chain offerings. Cristiano Ventricelli from Moody's advises investors to weigh the benefits of tokenized funds against risks related to underlying technology, security, scalability, and regulatory changes, highlighting the importance of robust risk management and diversified responsibilities within fund teams. The Securities Industry and Financial Markets Association (SIFMA) supports targeted updates to existing SEC regulations to enable blockchain-based innovation, provided core investor protections are maintained. This approach seeks to foster transformative change while ensuring compliance with established issuance, trading, and investor protection frameworks.

Further regulatory clarity is emerging, as evidenced by the SEC Division of Investment Management Staff's no-action letter permitting state trust companies to custody crypto assets for registered investment advisers and registered investment companies. This letter outlines strict conditions, including requirements for written custodial service agreements that prohibit lending or pledging of assets without prior consent, asset segregation, and comprehensive disclosure of material risks to clients.

Broader Context

The digital asset ecosystem is transitioning, with institutional investors increasingly viewing tokenization as a strategic lever for growth and efficiency. Yet, the rapid adoption mirrors historical periods of financial innovation where new distribution channels, fueled by hype, led to products that were riskier, costlier, or less transparent. Lessons from the SPAC boom, non-traded REITs craze, and ICO wave serve as reminders of the imperative for investor due diligence. The current environment underscores the ongoing tension between the transformative potential of blockchain technology for cost reduction and efficiency, and the necessity for rigorous oversight and investor protection to prevent the reintroduction of flawed strategies. Ultimately, the development of genuinely transparent, secure, and efficient on-chain financial products is crucial for attracting sustained institutional engagement and ensuring the long-term integrity of the Web3 ecosystem.