Tokenisation – the representation of financial assets in the form of digital tokens – will create “unique” risks and vulnerabilities that will require additional controls to safeguard investor protection and market integrity standards, according to the body that co-ordinates financial regulators across 130 jurisdictions.
The International Organization of Securities Commissions (IOSCO) cautioned this month that retail investors could find themselves exposed to greater risks if tokenisation led to an increase in complex financial products that lacked transparency or were not easily understood.
Tokenisation could also encourage retail investors to “engage in excessive risk-taking activities” by enabling them to make trading decisions without first seeking financial advice, said IOSCO. Regulators worldwide are racing to ensure that rules covering traditional financial assets are still fit for purpose as innovations including cryptocurrencies, blockchain technology and the tokenisation of investment funds, stock and bonds move rapidly into the mainstream. Forecasts for the growth of tokenisation across financial markets vary widely. The market value of tokenised assets – excluding bitcoin, other currencies and stablecoins – could reach between $2trn and $4trn by 2030, according to McKinsey, the consultancy. A more bullish projection by Standard Chartered Bank and the consultancy Synpulse estimated that overall tokenized real-world assets could hit $30.1tn by 2034. Prominent supporters of tokenisation include BlackRock chief Larry Fink, who believes the technology will “make investing more democratic” and drive the “next wave of opportunity” for the world’s largest money manager. In his annual chairman’s letter sent in late March, Fink predicted that tokenised funds would become “as familiar to investors as ETFs” provided that a system of rigorous digital identity verification checks could be established. BlackRock also identified the tokenisation of ETFs as a strategic priority. But the growth of tokenisation could amplify the risks inherent in traditional financial markets, according to IOSCO. It noted that multiple key legal and regulatory considerations remain unresolved in a new ecosystem that is still in the infancy of its development. It remains unclear if current laws covering the ownership, transfers and treatment of financial assets are equally applicable to financial assets created or represented in the form of digital tokens traded on blockchains, says IOSCO. As a result, investors could face legal risks if ownership or transfers made using tokens on a distributed ledger technology are invalidated or not recognised as envisaged. This risk is further complicated in cross-border transactions given the wide variation in national rules covering DLT-based token ownership and transfers. Investment managers have also adopted different approaches to the authoritative source of ownership for financial assets they have tokenised. Some operators continue to maintain off-chain records as the official legal source of ownership records which takes precedence over on-chain records. Others primarily rely on on-chain records as the official legal source of ownership with off-chain records as back-up. “Such differences in approaches might confuse investors investing in tokenised assets on what is the authoritative record of ownership for their asset, and potentially lead to disputes, if not properly disclosed,” said IOSCO.
