FSB Report Studies the Good and Risky Sides of Tokenisation

The Financial Stability Board (FSB) has published a report looking at a subset of tokenisation initiatives, specifically using distributed ledger technology (DLT), that are seen as relevant to financial stability.

In particular, the report focuses on the tokenisation of financial assets, such as tokenised money that may potentially be used as a settlement asset for payments and other financial assets. It does not examine tokenisation initiatives involving central bank digital currencies (CBDCs) or crypto-assets. It also analyses recent developments in DLT-based tokenisation, including the potential uses of tokenised assets and their interaction with the traditional financial system.

The FSB observes that the limited publicly available data on tokenisation suggest that its adoption is very low but appears to be growing. “Owing to its small scale, tokenisation does not, therefore, currently pose a material risk to financial stability,” it states.

Nevertheless, the report identifies several financial stability vulnerabilities associated with DLT-based tokenisation, which relate to liquidity and maturity mismatch; leverage; asset price and quality; interconnectedness; and operational fragilities. “Tokenisation could have implications for financial stability if the tokenised part of the financial system scales up significantly, if increased complexity and opacity of tokenisation projects lead to unpredictable outcomes in times of stress, and if identified vulnerabilities are not adequately addressed through oversight, regulation, supervision, and enforcement,” the FSB states.

More specifically, the report observes that the potential benefits of tokenisation may include improved efficiency, including in clearing and settlement, reduced costs, increased transparency, and greater flexibility, including expanded opportunities for investors. It adds, however, many of these benefits have yet to be proven, may not be uniquely achievable through tokenisation, and may involve trade-offs that might negate the benefits. As a result, tokenisation projects have not scaled significantly.

“Challenges for scaling up include unclear investor demand for these products; lack of interoperability among DLT platforms and between those DLT platforms and traditional financial infrastructure; the unavailability of money settlement assets; and differences in legal and regulatory frameworks, given the cross-border nature of many projects,” the report states.

On the vulnerabilities associated with DLT-based tokenisation, as noted the report identifies these as relating to liquidity and maturity mismatch; leverage; asset price and quality;

interconnectedness; and operational fragilities. “These vulnerabilities have been identified in the context of a number of constraints and assumptions, due to a lack of comprehensive data about the scale and activities of existing tokens and an understanding that tokenisation is rapidly evolving and its future state is unknown,” the report says. “In addition, there is a lack of information about how evolving forms of tokenisation fit into existing markets, legal and regulatory frameworks, and supervisory approaches that could address vulnerabilities.

“The vulnerabilities of DLT-based tokenisation relate to three factors, individually and in

combination: the underlying “reference asset” that has been tokenised; the participants in DLT-based tokenisation projects; and new technology as well as its interaction with legacy systems,” it continues. “Taken together, these factors can amplify many of the same vulnerabilities as in traditional finance, although they may play out differently depending on design choices, adoption, and scale of initiatives. For example, the choice of settlement assets (particularly tokenised private money) may amplify liquidity or other vulnerabilities; some of the entities involved in tokenisation are new entrants that may not be compliant with applicable laws and regulations or fall outside of the regulatory remit in some jurisdictions; and DLT is an evolving technology that is relatively untested, which could create operational fragilities.

As a result of the report, the FSB says its “initial issues” for focus on data and monitoring; legal a regulatory frameworks; and the sharing of information. It says, along with standard setting bodies and national regulators, it will consider ways to address data and information gaps in monitoring tokenisation adoption. Authorities could assess these gaps and explore various sources of data and information including through reporting by regulated entities, information from market participants, and open-source data available on DLT platforms or other public information sources.

The bodies will also consider ways to increase understanding of how tokenisation and its related features fit into legal and regulatory frameworks and supervisory approaches, taking into consideration ongoing relevant work by SSBs and international organisations.

Finally, the FSB urges cross-border regulatory and supervisory information sharing on

tokenisation. “The FSB working with SSBs could consider ways to facilitate information

sharing, including monitoring developments across member jurisdictions,” it states.