FSB: Asset Tokenization Accelerates Market Chain Reactions, Requires Addressing Regulatory Arbitrage and Asset Price Asynchrony

The Financial Stability Board (FSB) recently released a research report stating that while asset tokenization can enhance transaction transparency, reduce costs, and increase investment flexibility, the demand for asset tokenization in the market is currently unclear. This, coupled with regulatory uncertainties and technical challenges, has hindered the widespread adoption of tokenization applications. Although the scale of asset tokenization is currently small and its impact on financial stability is limited, the rapid expansion of technology and markets in the future may pose significant risks to the global financial system.

What is Asset Tokenisation?

Asset tokenisation refers to issuing tokens in the form of physical assets such as real estate or financial assets like equities and bonds through distributed ledger technology (DLT). The application of asset tokenisation can be used for trading, investing, and payments, although its adoption rate is relatively low at present, it is gradually growing.

Potential Benefits of Tokenisation, FSB: Tokenisation Not Always Necessary

FSB states that asset tokenisation has potential advantages, such as improving the efficiency of clearing and settlement, reducing transaction costs, increasing transparency, and providing investors with more flexibility to participate in asset division. However, these benefits are mostly still in the experimental stage and have not been fully proven.

FSB adds that utilizing securitisation for asset division can already provide similar functions. Some features considered unique to tokenisation may not necessarily require tokenisation to achieve; existing financial instruments can accomplish the same.

Composability of Tokenisation, Asset and Token Prices Asynchronous Issues

FSB indicates that while asset tokenisation currently poses minimal risks to financial stability, it could lead to three potential risks:

1. Asynchronous Liquidity and Maturity: FSB notes that tokens may sometimes be easier to buy and sell than the physical assets they represent, such as real estate or bonds. This asynchrony could cause significant price fluctuations in tokens under market pressure. For example, tokens may allow for instant trading or redemption, but the underlying physical assets may not be as readily liquid or transferable, resulting in an imbalance between token supply and demand, leading to excessive price volatility.

2. Leverage Risk: FSB believes that the composability of tokens, combining different tokens and smart contracts to create more complex financial instruments, could allow investors to engage in multiple borrowing and investing with increasing leverage. If not strictly controlled, such leveraged operations could trigger significant losses during market fluctuations, severely disrupting financial stability.

3. Asset Price and Quality: FSB argues that when token prices cannot accurately reflect the true value of assets, market participants may misjudge token values. This situation could erode market trust in tokens, leading to price fluctuations and market instability.

Addressing Overly Centralised Third-Party Services, Cross-Border Transactions and Regulatory Arbitrage

FSB also outlines new risks and challenges brought by tokenisation:

1. Chain Reaction: Tokenisation platforms can simultaneously handle services like token issuance, trading, and custody, making financial institutions that had no prior business dealings or interdependencies reliant on the platform. If this platform is large in scale and involves numerous transactions and tokens, any issues with the platform could affect other institutions.
2. Overly Centralised Third-Party Services: Tokenisation markets often rely on a few key tech service providers, such as oracles, databases, and token issuers. These critical technologies are often concentrated in a few companies or service providers, and any issues with one could impact the entire market.
3. Automation and Chain Reactions: Tokenised smart contracts can accelerate the transfer of funds or assets within and outside the platform. An event on one platform could affect another, especially when there is significant market pressure, making asset sales faster.
4. Cross-Border Transactions and Regulatory Arbitrage: Tokenisation allows financial assets to be traded without constraints of time or location, providing convenience to investors. However, differing regulatory frameworks across countries may lead investors to choose jurisdictions with more lenient regulations, potentially jeopardising global financial stability.
5. System Complexity and Opacity:
   As tokenisation technology advances, financial systems become more complex, making it challenging for regulatory bodies and market participants to track risks.

Regulatory Framework Improvement Remains Key Issue

In conclusion, FSB believes that for asset tokenisation to expand across the entire financial system, the primary requirement is for international regulatory bodies to strengthen data collection related to asset tokenisation and ensure consistency in regulatory frameworks across different regions. Additionally, enhancing communication among global regulatory bodies is crucial to collectively address potential risks arising from future asset tokenisation.

Binance Research: Overview of RWA Development Landscape, Understanding the Technological Risks and Limitations of Asset Tokenisation