The prospect of tokenizing financial assets holds some promise of enhancing efficiency, but it also invites possible new risks, says a new report from the International Organization of Securities Commissions (IOSCO) — which calls on regulators to remain alert to novel risks from this evolving technology.
The umbrella group of global regulators published a report on Tuesday that examined the evolution of efforts to utilize distributed ledger technology to tokenize financial assets and deliver related services.
The report, which was developed by IOSCO’s fintech task force, analyzed potential use cases — such as tokenized money market funds and other fixed-income instruments. It finds that while industry interest in tokenization is rising, actual adoption remains limited.
“Interoperability challenges and the lack of credible settlement assets hinder scalability,” it said.
Additionally, while tokenization can enable faster settlement and improve the mobility of collateral, “many market participants still rely on traditional infrastructure for trading and post-trade processes,” it noted.
Moreover, the risks posed by current tokenization efforts — including legal, operational and cyber risks — are familiar to the industry and regulators alike, but they can emerge differently under a digital architecture, the report said.
“The manifestation of vulnerabilities and risks that are unique to the technology itself may require the introduction of new or additional controls to manage them,” the report said.
For instance, there may be uncertainty about whether the legal treatment of financial assets applies equally to assets that are created or represented by tokens, and the activities conducted on those tokens through the blockchain.
“For non-native tokens, the range of structuring options for token creation can lead to investor uncertainty about the rights to and ownership of the underlying assets,” it said.
There may also be risks to hosting tokenized financial assets on shared blockchains.
“These assets face operational vulnerabilities and risks unique to this infrastructure, including cyber-attacks on blockchain nodes, congestion in transaction processing, data leakage, market fragmentation, smart contract bugs, and loss of private keys,” it said.
Hosting different assets on common blockchains “will also inevitably increase dependencies and interconnectedness among market participants and stakeholders, leading to amplification of the risks currently faced in the conventional markets,” the report said. That there could also be spillover effects from increased connections to crypto markets, it added.
“The analysis reveals early signs of such inter-linkages, such as the increasing use of some tokenized money market funds as “stablecoin” reserve assets or as collateral for crypto-related transactions,” it said.
So far, regulators have taken varying approaches to these issues, the report noted, including issuing new guidance, providing bespoke relief and using regulatory sandboxes to test proposed innovations.
Looking ahead, it recommended that regulators apply IOSCO’s existing standards for digital finance, “which are technology-neutral, principles-based and outcomes-focused,” to ensure adequate investor protection under the overriding principle of “same activities, same risks, same regulatory outcomes.”
“As tokenization continues to evolve, this report provides timely insights into its adoption, associated risks, and the regulatory considerations related to market integrity and investor protection. It also contributes to IOSCO’s analysis of financial innovation by identifying shifts in market roles and infrastructure models that are emerging in tokenized financial assets,” said Jean-Paul Servais, chair of IOSCO’s board, in a release.