The International Organization of Securities Commissions (IOSCO) has raised fresh alarms about the rapid rise of asset tokenization—where stocks, bonds or other financial assets are converted into blockchain-based tokens—saying the phenomenon is creating a new set of vulnerabilities that existing regulatory frameworks were not designed to handle. In a detailed report, IOSCO notes that while many risks fall under traditional oversight mechanisms, the underlying infrastructure and operational models of tokenized assets introduce novel issues that merit deeper scrutiny and proactive mitigation.

Underlying Mechanics, Emerging Dangers

Tokenization allows a provider to issue a digital token that purports to represent ownership of a real-world asset such as a share, bond or even real estate. At its premise, the model promises better liquidity, lower transaction costs, 24/7 markets and global access. Proponents point to foundations such as programmable settlement, fractional ownership and the use of distributed-ledger systems. Yet IOSCO, echoing findings from other bodies like the Financial Stability Board (FSB), cautions that when the digital wrapper interacts with legacy financial-market infrastructure the risks can accumulate in unexpected ways.

The report highlights that investors may be uncertain about whether they hold the underlying asset or simply a token claiming to map to it. That distinction matters when things go wrong: if the issuer fails, is insolvent or mis-manages the underlying collateral, token-holders may lack the customary legal protections. Additionally, the third-party issuer acts as a counterparty in multiple senses—responsible for mapping, custody, redemption and interface with external markets. These layers introduce potential operational, legal and issuer-credit risks that extend beyond traditional securities frameworks.

The technological side adds further complexity. Tokenized structures depend on oracles, smart-contracts, chain interoperability and linkages to off-chain assets. Each linkage is a potential failure point for asset-mismatch, cyber-incident, privacy breach or reconciliation error. As the FSB report notes, challenges such as maturity mismatches, leverage, low liquidity, interoperability shortfalls and operational fragilities are endemic to tokenized markets when scaled. Moreover, when these tokens connect to crypto-asset markets, ripple effects may emerge, meaning losses or insolvencies in one corner may spill into the broader financial system.

Efficiency Promises vs. Real-World Performance

One of the critical tensions identified by IOSCO is the gap between the high-promise narrative of tokenization and the still-limited real-world adoption. While institutions such as Nasdaq, Inc. and other financial-market incumbents are exploring token issuance pilots, actual volumes remain modest and many systems still rely on legacy infrastructure for settlement, custody and clearing. In its report, IOSCO notes that “efficiency gains are uneven,” because tokenization often sits atop rather than replaces traditional infrastructure—thus retaining many of the same cost, risk and operational dynamics.

Indeed, studies such as the FSB’s show that despite the hype, many tokenized asset offerings remain illiquid, have long holding periods and see minimal secondary trading. Without robust network effects or active markets, the liquidity advantage touted by tokenization proponents is muted. Firms may issue tokens, but if redemption mechanisms, pricing transparency and trading venues are not fully developed, the market may fall short of expectations. For retail investors, this gap between promise and performance may translate into hidden cost, delayed liquidity or unexpected risk exposures.

Furthermore, regulatory clarity remains patchy. Jurisdictions often apply existing securities or derivatives rules to tokenized assets, but the mapping is imperfect and many token models feature hybrid or novel features that sit across regulatory boundaries. The OECD’s earlier analysis of tokenization underlines that while many regulators have adopted technology-neutral approaches, the pace of regulatory adaptation has lagged market experimentation—leaving investors and issuers both exposed.

Investor Protection and Market Integrity at Stake

Investor protection is a central motif in IOSCO’s warning. In tokenized asset schemes, the legal rights of token-holders may be ambiguous: the token may not confer full voting rights, redemption rights or pari-passu claims with the underlying asset. When governance structures are opaque, a token issuer may embed different rights sets for token-holders, leaving the investor with less than anticipated. Beyond that, the counterparty risk posed by token issuers—or those managing the token-asset interface—amplifies concerns: failure of the issuer or a service provider (custodian, platform, smart-contract manager) may lead to losses.

Market integrity is similarly challenged. Tokenization has the ability to widen access, but it also creates potential vectors for fraud, market-abuse, or lack of transparency. If tokens trade in less regulated venues, with fewer reporting requirements or weaker disclosure frameworks, then information asymmetries may widen. Regulators worry that tokenised markets may become conduits for speculative activity, layering of leverage, or connections to crypto-asset ecosystems that already exhibit higher risk characteristics. Spill-over across traditional and crypto-asset infrastructure raises systemic concerns.

IOSCO emphasises that tokenization may accelerate inter-linkages between token-issuers, crypto-platforms and traditional securities markets, so that a shock in one domain—say a token-asset redemption failure—could propagate into a broader market disruption. That points to the need for regulators to monitor not just individual token programmes, but also the network of inter-operating infrastructures, platforms and service providers. Regulatory silos—where crypto oversight and securities oversight diverge—may no longer suffice given the hybrid nature of tokenisation.

Strategic and Implementation Challenges for Market Participants

For issuers, platforms and institutional investors, tokenization presents strategic opportunities—but also requires careful execution. Firms considering token issuance must evaluate the legal architecture (what rights the token confers), the operational backend (custody, smart contracts, redemption), the liquidity environment (trading venues, market-making) and regulatory alignment (licensing, disclosure, governance). Without those pieces in place, what begins as a marketing innovation may end as a reputational or financial mis-step.

From a market-structure perspective, tokenisation may require parallel operation of traditional settlement and new-ledger systems. Many incumbent institutions may find their cost-benefit calculus less favourable than the public narrative suggests: replacing entrenched systems is expensive, fraught with legacy interoperability issues, and involves shifting regulatory and counter-party risk. For instance, even if blockchain allows 24/7 trading, if off-chain reconciliation or external custody remain slow, the benefit is diluted. The WEF-Accenture “Asset Tokenization in Financial Markets” report underscores that technical barriers, standardisation deficits, and regulatory infrastructure are still significant hindrances.

Moreover, market-makers and early adopters must design transparent redemption mechanisms, robust valuation practices and strong disclosure. A token whose pricing is opaque, whose redemption is cumbersome, or whose underlying asset is ill-iquid may attract speculation but also risk sudden liquidity freezes or value mismatches. Platforms must anticipate worst-case scenarios: for example, if the underlying asset falls in value or the issuer becomes insolvent, how will token-holders be treated? Without clear answers, investor trust may erode.

Regulatory Cross-Border Implications and the Road Ahead

The global nature of tokenized infrastructure means that regulatory coordination is paramount. Tokenised assets may be issued in one jurisdiction, traded on platforms in another and held by investors elsewhere—creating multilayer oversight challenges. IOSCO’s inclusion of tokenization in its work-plan as a priority fintech/asset-tokenization work-stream signals that regulators view this as more than a niche innovation—they regard it as a structural shift in how assets may be represented, held and traded.

Emerging frameworks will need to address questions such as: what disclosure is required when a token is sold, how investor protections map when the underlying asset is cross-border, how traditional clearing or settlement obligations may be replaced or supplemented, and how service providers across the chain are regulated. Some jurisdictions are moving towards tailored frameworks for token-assets, recognising that simply applying securities laws may not suffice. The OECD’s earlier analysis flagged that existing regulation often lacks clarity on token-asset models, ownership rights, custody segregation and transaction transparency.

Finally, the pace of legal-technological development means that firms and regulators must adopt agility and forward-looking governance. Tokenisation may eventually reshape issuance, trading and servicing of real-world assets—but only if the operational, legal and market-structure elements mature in tandem. Firms early in the game must assess not just the innovation upside but also the regulatory, liquidity and operational risks. As tokenisation continues to shift from pilot to production, the manner in which these risks are managed will determine whether the promise of asset-tokenization becomes mainstream or remains a niche experiment.

(Adapted from Reuters.com)

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