The International Organization of Securities Commissions (IOSCO) has published a review of tokenization. It concludes that tokenization activities are growing, but still small compared to mainstream capital markets. Most risks are similar to those institutions are accustomed to dealing with, with a few novel ones related to distributed ledger technology. Among IOSCO’s primary concerns is settlement finality, particularly related to Layer 2 blockchains.
The report “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 some areas such as bond issuance it doesn’t observe many role changes. For tokenized funds, the authors are not entirely convinced about efficiency gains. They note the “potential fragmentation of entities involved in the core phases of tokenization, such as the issuer, asset manager, provider of the tokenization platform and wallet management solution. This fragmentation risks compromising one of the main potential benefits of using DLT, namely disintermediation that was purported to be able to reduce the number of subjects involved in the overall value chain of the securities markets.”
Given IOSCO members are regulators, the paper delves into the risks, categorizing the tokenization specific ones into four buckets. First is the representation of financial assets in tokenized form. This comes with some legal uncertainty in several jurisdictions related to the creation of the tokenized assets and their legal transfer. Additionally, there are issues regarding investor rights based on how the tokenized assets are structured, especially if the asset is a digital twin. For example, in recent months several companies have launched tokenized equities. Some are backed one-for-one and give investors rights in the underlying assets. Others are simply derivatives. Finally, there’s some uncertainty around settlement finality. The authors are concerned about a lack of clarity with Layer 2 networks. Is a transaction final after a few blocks are confirmed on the Layer 2 or only once there’s a checkpoint on the Layer 1?
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