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The financial world is quietly undergoing a potentially transformative revolution: tokenisation. This process involves representing traditional or physical assets such as real estate, securities, or commodities as digital tokens on a blockchain, reshaping the contours of modern finance. The Financial Stability Board (FSB) recently released a report exploring the financial stability implications of tokenisation, highlighting its benefits, challenges, and the vulnerabilities it could introduce to global financial systems. Tokenisation relies on Distributed Ledger Technology (DLT), including blockchain, to create digital representations of assets. These can be classified into two types: native tokens, created directly on DLT platforms, and non-native tokens, which represent existing assets like government securities or gold.
While tokenisation offers immense potential, its adoption remains limited, primarily confined to private collaborations and controlled pilot projects. Financial institutions and governments are cautiously exploring use cases, such as tokenising government debt, equity stakes, or commodities, to enhance trading and settlement efficiencies. By leveraging DLT, these initiatives aim to automate processes, reduce costs, and expand market accessibility.
Tokenisation promises significant advantages in clearing and settlement processes, including payment versus payment (PvP) and delivery versus payment (DvP), by automating trade settlements. It can lower operational costs by reducing intermediaries and accelerating transaction speeds. Additionally, tokenisation enables fractional ownership, allowing smaller investors to access high-value assets like real estate or art, thereby democratising investment opportunities. The transparency and immutability offered by DLT enhance auditability, while smart contracts reduce human intervention and errors in complex financial operations by introducing programmability.
Despite these advantages, several challenges hinder the scalability of tokenisation. Uncertain investor demand is a primary concern—many of its touted benefits, such as fractional ownership, can already be achieved through traditional methods like securitisation. Interoperability issues among DLT platforms and between tokenised and conventional financial systems also pose significant barriers. Moreover, fragmented legal and regulatory frameworks create uncertainty regarding the enforceability of tokenised assets, complicating cross-border initiatives. The operational costs of maintaining tokenised systems alongside traditional infrastructure further impede adoption.
Liquidity and maturity mismatches present risks, as tokens may be instantly tradable while underlying assets remain illiquid. This could lead to liquidity stress during market volatility. Additionally, tokenisation could amplify leverage risks through practices like rehypothecation, where tokens are repeatedly used as collateral. Complex smart contracts and interconnected DLT platforms could obscure risks, making it difficult for investors to assess asset quality and pricing accurately. Operational risks such as cyberattacks, scalability issues, and technical failures loom large—particularly in permissionless blockchain environments with limited oversight.
Currently, tokenisation does not pose a material threat to financial stability due to its small scale and limited interconnectedness with traditional financial systems. Most tokenisation projects operate in permissioned environments with regulated participants, minimising systemic risks. However, the FSB warns that this could change if tokenised markets scale significantly or introduce greater complexity through advanced smart contracts. Unaddressed vulnerabilities could have far-reaching implications, especially in liquidity management, leverage, and operational resilience.
Standard-setting bodies recommend proactive measures to mitigate these risks. Regulatory authorities must close data gaps by improving the availability and consistency of information on tokenisation activities. Clarifying legal and regulatory frameworks is critical to providing certainty for market participants and addressing cross-border challenges. Authorities must also collaborate internationally to ensure consistent oversight and monitor the rapid technological evolution of tokenised systems to anticipate and mitigate potential risks.
In the Indian context, it offers the potential to democratise investment by enabling access to high-value assets such as real estate, government bonds, and infrastructure projects. By integrating tokenisation into initiatives like Digital India, the country could deepen financial inclusion, empowering smaller investors to own fractions of traditionally inaccessible assets. Moreover, tokenisation aligns well with India’s aspirations to become a global blockchain hub, leveraging its strong fintech ecosystem and expanding digital infrastructure. However, the absence of clear regulatory frameworks creates uncertainty, particularly regarding the enforceability of tokenised contracts under existing laws. Jurisdictional complexities, especially in cross-border transactions, and compliance with statutes add further layers of challenge.
Tokenisation represents a promising frontier in financial innovation, offering efficiency, transparency, and accessibility. However, its broader adoption and integration with traditional financial systems require careful navigation of the challenges and vulnerabilities it introduces. As tokenised markets evolve, ensuring robust regulatory oversight and risk management will be crucial to harnessing the benefits of tokenisation without compromising financial stability.
(The writer is a technology lawyer.)