Global securities regulator IOSCO issued a report Tuesday warning that tokenization of traditional financial assets introduces fresh investor risks, despite growing industry interest in the blockchain-based technology. The International Organization of Securities Commissions highlighted concerns about ownership clarity, counterparty exposure, and potential contagion from crypto markets, even as firms like Nasdaq advance tokenization initiatives.

What to Know:

• IOSCO finds most tokenization risks fit existing regulatory frameworks, but the underlying blockchain technology creates new vulnerabilities that could leave investors uncertain about asset ownership
• Commercial interest in tokenization has increased this year with online brokers selling tokenized products to retail investors, though actual adoption remains limited across financial markets
• The regulator questions industry efficiency claims, noting that market participants still rely on traditional infrastructure rather than replacing it with blockchain systems

The Regulatory Warning

Tokenization involves creating blockchain-based digital tokens that link to real-world assets such as stocks or bonds. The practice has attracted renewed attention from crypto advocates in 2024, with new tokenized products entering retail markets through online brokerage platforms.

IOSCO, whose member regulators oversee nearly all global securities markets, stated that while most tokenization risks fall under pre-existing regulatory frameworks, the technology itself presents novel dangers.

"Although adoption remains limited, tokenization has the potential to reshape how financial assets are issued, traded, and serviced," said Tuang Lee Lim, chair of IOSCO's board-level fintech taskforce.

The report identified structural concerns that could create investor confusion. Different tokenization approaches may leave buyers uncertain whether they own the underlying asset or merely possess a crypto token representing that asset. The involvement of third-party token issuers adds counterparty risk to transactions.

IOSCO also warned of "potential spill-over effects from increased inter-linkages with the crypto asset markets." The European Union's securities regulator raised similar concerns in September, signaling growing international scrutiny of tokenization practices.

Industry Split on Adoption

Financial institutions have experimented with blockchain-based asset versions for years, but the sector remains divided on tokenization's value. Nasdaq has moved forward with tokenization projects, while other Wall Street firms have voiced reservations about the technology's practical benefits.

Tokenization proponents argue that blockchain implementation can reduce trading costs, accelerate settlement times, enable continuous 24-hour trading, and appeal to younger investors.

These claimed advantages have driven commercial interest higher, though IOSCO characterized actual market adoption as "limited."

The regulator challenged efficiency assertions, noting that "efficiency gains are uneven" because market participants continue using traditional infrastructure for trading processes rather than replacing legacy systems with blockchain alternatives. "Issuers do not tend to publicly disclose actual quantifiable efficiency gains, if any," IOSCO stated in the report.

Understanding Tokenization

Tokenization converts ownership rights of traditional financial assets into digital tokens recorded on blockchain networks. Each token represents a claim on the underlying asset, with the blockchain serving as the distributed ledger system tracking ownership and transactions. Counterparty risk refers to the danger that one party in a financial transaction might default on contractual obligations, which increases when third-party token issuers mediate between investors and assets.

Final Thoughts

IOSCO's assessment reveals a disconnect between tokenization's marketed potential and its current implementation. The regulator's findings suggest that blockchain-based asset trading faces significant hurdles beyond technological adoption, including unclear efficiency benefits and unresolved regulatory questions about investor protection.