The Financial Stability Board (FSB) and the Bank for International Settlements (BIS) have both identified risks associated with tokenization in their latest reports, urging a need for stricter regulations.

Key Highlights:

• Tokenization, which refers to the conversion of real-world assets (like securities) into digital formats, includes the use of distributed ledger technology (DLT).
• In its findings, the FSB pointed out three main vulnerabilities regarding tokenization: the reference asset being tokenized, the participants involved in DLT-based tokenization projects, and the interaction of new technology with traditional systems.

"Tokenization could have implications for financial stability if it scales up significantly, if it is used to create complex and opaque products that trade in an automated fashion, and if identified vulnerabilities are not addressed through oversight, regulation, supervision, and enforcement," said Klaas Knot, chair of the FSB, in a letter to the G20 nations.

Earlier in the year, the FSB highlighted the monitoring of tokenization as a priority. As of September, over 40 firms joined a BIS initiative to explore tokenization for cross-border payments.

The recent BIS report indicated that while tokenization could streamline the trading process by minimizing friction from different systems, it still poses existing systemic risks, such as credit, liquidity, and cyber risks. Moreover, the report cautioned that conflicts of interest might arise, necessitating effective governance practices.