FSB report warns about risks of tokenization

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There has been much talk about tokenization in recent years, with financial titans like BlackRock’s (NASDAQ: BLK) Larry Fink and others touting its benefits.

Yet, tokenization has a downside, and the risks associated with it were the focus of a report by the Financial Stability Board (FSB) presented to the G20 this week.

The FSB is skeptical about tokenization, citing risks related to liquidation, contagion, automation, leverage and the blurring of usually distinct roles in financial processes.

Risks associated with tokenization grow as it scales

Other than highlighting some of the risks, the FSB report made two points clear: risks grow as tokenization scales, and they’re currently being mitigated by the fact institutions use private ledgers with limited programmability.

In other words, in its perception, tokenization risks worsen as the systems interconnect and as more and more parties use tokenized assets. Ultimately, it sees effective regulation as a way to mitigate these risks.

Elaborating on the risks themselves, the FSB perceives the following:

Liquidity and maturity mismatches. Tokenized assets could have different convertibility timelines, which could deviate between the tokens and the underlying assets.

Funding availability. While atomic settlement has its benefits, it increases the need for cash, which may not always be available. This could lead to liquidity stress events, which could cascade quickly due to the automation of many tokenized systems operating on blockchains.

Leverage. Those used to the volatile digital currency markets will relate to this risk; digital currencies can often be deposited to borrow more funds, which can then be used on other protocols to borrow more, etc. We’ve seen all too often how this can lead to massive bubbles and crashes.

Lack of understanding and transparency. The FSB also worries that a lack of transparency and general understanding of tokenization and associated tech like smart contracts will mean investors can’t properly appraise quality.

Interconnectedness and the blurring of roles. While traditional financial systems separate functions like issuance, custody and secondary trading, the FSB perceives that these roles can be blurred and intermingled in tokenized systems.

While all of these risks are real, and it’s correct to address them, there’s a solution: a single, scalable public ledger.

How a single, scalable ledger can help

Most of the FSB’s concerns stem from a lack of transparency and an inability to prevent crises from spreading. However, a globally scalable blockchain with tried and tested token protocols and smart contract languages can mitigate many of these risks.

The lack of transparency comes from the fact that, as the FSB report mentions, most institutions use private ledgers today. This creates ‘multiple sets of books’ across a fractured yet interoperable system, making it difficult to see the whole picture.

A single unified ledger with time-stamped records of every transaction would create unprecedented transparency. It would be akin to all financial institutions using one set of books, simultaneously making it possible to maintain privacy while enabling anyone, anywhere, to audit records in a way nobody can dispute.

Such transparency would also enable regulators to do their jobs more effectively. Whereas the 2008 crisis caught most off guard because rating agencies said risky assets were safe and banks’ positions were stronger than they were, this would not be possible with a system based on a scalable public blockchain. By analyzing records that cannot be falsified or tampered with, regulators could quickly verify or debunk positions, stress test systems, and ensure regulations were followed.

Regulations are also part of the equation

Of course, robust and unified regulations are also necessary. While some places, such as the European Union, are harmonizing regulations across member states, others are still in the beginning stages, and there will still be some discrepancies between nations.

Far from being a greater risk than the TradFi system, a blockchain-based one with tokenized assets would be much more transparent and, therefore, less risky than the current system. Add in smart contract audibility, improved liquidity mechanisms, decentralized identity verification, and artificial intelligence (AI) to spot anomalies and risks, and such a system would be far safer, more stable and more transparent than we have today.

For this to be possible, we need one scalable utility blockchain with all the necessary functionality to enable tokenization at scale. As of today, the BSV blockchain is the only one capable of playing this role.

Watch: Tokenovate milestones unveiled at the London Blockchain Conference