Tokenization: Balancing Unlimited Potential for Financial Markets while Navigating a Complex Landscape

Tokenization is no longer a futuristic concept relegated to the fringes of finance. It is rapidly emerging as a transformative force with the potential to reshape how we own, trade, and manage assets. While the initial hype surrounding blockchain¹ and cryptocurrencies may have obscured tokenization’s true potential, its underlying principles of fractionalization, automation, and enhanced transparency are poised to unlock unprecedented opportunities for investors, businesses, and the global economy. ^{2 3}

However, realizing this vision requires a thoughtful approach – balancing innovation with necessary safeguards to mitigate inherent risks both to consumers and financial systems. Clear easy-to-implement regulations are paramount for investor security. Fit-for-purpose rules would encourage adoption; on the contrary, merely customizing existing securities laws (the proverbial fitting a ‘square peg in a round hole’) could slow progress in this sector.  

Various forms of asset tokenization exist within the market landscape, but this article specifically examines two key categories: off-chain tokenization (commonly referred to as digital twins⁴) and on-chain tokenization (native tokens, excluding crypto assets⁵). Off-chain tokenization refers to the process of representing real-world assets (“RWAs”) on a blockchain, where the physical asset itself remains external to the blockchain, and its associated token functions as a digital proxy for ownership or rights. In contrast, on-chain tokenization involves the direct issuance of traditional asset classes exclusively in a tokenized format, with their entire lifecycle—from creation to settlement and redemption—taking place within the blockchain ecosystem.  This article is exclusively focused on the tokenization of RWAs and does not include an examination of native tokens, such as Central Bank Digital Currencies or tokenized deposits. Due to their unique and idiosyncratic risks, these asset types necessitate a more comprehensive evaluation that falls outside the scope of this article. 

When embarking on this new financial frontier we must pose several critical questions: What assets should be within tokenization’s scope? Should all or selected securities move on-chain? Should it be limited to issuers? What scalability issues exist for public blockchains? Some of these questions were posed by Securities and Exchange (“SEC”) Commissioner Caroline Crenshaw at the recent SEC Crypto Task Force Roundtable titled “Tokenization - Moving Assets Onchain: Where TradFi and DeFi Meet”⁶. On the issue of whether new legal frameworks are required to address tokenized asset ownership and transfer or are there existing principles of traditional commercial law that can inform the legal treatment of tokens, the International Monetary Fund (IMF) published a paper in 2023 (“2023 IMF Paper”) that argued that despite the novelty of tokens, their functions often parallel those of established commercial instruments, and as such, existing legal doctrines can provide a valuable starting point for analysis.⁷ Citing a different scholarly work, the paper also highlighted that while legal frameworks should not favor one technology over others, technology neutrality should not be taken as an absolute principle: “When legal regimes adopt technology neutrality as a general principle, it leads to rules that are over inclusive and speak poorly to unforeseen technologies. This makes technology neutrality socially undesirable. It also, in turn, results in inconsistent treatment of similar technologies and increases uncertainty about whether and how the law will be or should be applied.”⁸  That is to say, legal and regulatory frameworks should be adaptive to new technological innovations.⁹ Lastly, core business thesis often lies in the belief “if you build, they will come”¹⁰ - but we must pose (and answer) the question – why build? One instance of the benefit of a status quo process is the traditional securities T+1 settlement cycle – it protects the market from failed trades, eliminates most settlement issues through netting and provides retail markets safeguards from fraud.¹¹ Hence, it is important to critically analyze whether all change is progress or should there be a cohesive step by step approach to this revolutionary technology. 

While RWA tokenization signals a revolutionary stride forward from financial primitives to a future financial ecosystem, challenges exist for proliferation and large-scale adoption of tokenized assets. Complex legal, jurisdictional, regulatory and technical complexities must be addressed to achieve its full potential and benefits. This article examines those challenges and proposes actionable strategies to navigate these challenges to unlock tokenization’s true potential.

At its core, Tokenization can be defined as the process of representing RWA on a blockchain network as digital tokens.¹² It involves transforming claims on assets into tokens with a core (asset information and ownership) and service layer (platform rules and governance). By digitizing ownership rights and facilitating secure, transparent, and efficient transactions, tokenization offers a compelling path towards mitigating long-standing inefficiencies.  Tokenization can transform the financial market in several salient ways:

1. Enhanced Liquidity: By fractionalizing ownership, tokenization dramatically lowers the barrier to entry for investors. Previously illiquid assets, like real estate, private equity, or fine art, can be divided into smaller, more affordable tokens, expanding potential investor base and fostering greater liquidity. This allows for easier trading and exit options, benefiting both issuers and investors.

2. Increased Efficiency: Tokenization streamlines traditionally complex and arduous processes. Smart contracts can automate functions like dividend distributions, settlements,¹³ and compliance, reducing administrative overhead, eliminating intermediaries, and accelerating transaction speeds. This means significant cost savings and operational efficiencies.

3. Greater Accessibility: Tokenization democratizes access to investment opportunities, opening doors to retail investors previously excluded from participating in certain markets due to high minimum investment thresholds or geographical limitations. This promotes financial inclusion and broadens wealth creation opportunities.

4. Improved Transparency: Blockchain technology provides transparent and auditable transaction records transactions, fostering greater trust and accountability within the financial system. This enhanced transparency reduces fraud risk and manipulation and improves investor confidence.

5. New Financial Products and Services: Tokenization allows for innovative financial product and services creation previously deemed impossible such as, (a) Automated Lending and Borrowing where tokenized assets can be used as collateral for decentralized lending platforms, enabling borrowers to access capital more easily and lenders to earn yield (b) Algorithmic Trading where smart contracts can be programmed to automatically execute trades based on predefined parameters, enhancing market efficiency and reducing human error and (c) Fractional Ownership Platforms that allow investors to buy and sell fractional ownership shares in various assets, ranging from real estate to collectables

Despite its significant potential, tokenization must overcome numerous legal and technical challenges for widespread adoption:

1. Legal Uncertainty: The global legal and regulatory landscape surrounding tokenized assets is still evolving. Academics, policy makers, and international organizations such as UNCITRAL and Unidroit¹⁴ are contributing to developing legal rules and principles to be applied to crucial questions affecting the use of this innovative technology. The 2023 IMF Paper specifically highlighted rumination on the following vital legal considerations: (a) legal nature of tokens (b) applicable regime for transmission of tokens (i.e. in addition to legal rules recognizing the transfer of tokens using distributed ledger technology, there should be rules that allow DLT records to be accepted as evidence, and allow references to ‘written’ documents to be satisfied by tokens and DLT (c) connection of tokens to off-line assets or services (d) security interests over tokens (e) loss, fraud and illegal transfer (f) rights of token holders in insolvency (g) procedural remedies and (h) conflict of laws.¹⁵ Continued efforts towards clear and harmonized legal frameworks in tokenization are essential for wide adoption and investor protection.  

2. Regulatory Fragmentation: The lack of consistency in regulations across different countries poses significant challenges for cross-border tokenized asset transactions. Harmonized international standards and regulatory frameworks are needed to facilitate global interoperability and reduce compliance costs.

3. Data Privacy and Security: Tokenization relies on the secure storage and transmission of sensitive data on blockchain networks. Protecting data privacy and preventing cyberattacks are crucial to maintaining investor confidence and preventing fraud. Robust security measures, data encryption, and compliance with data privacy regulations are essential.

4. Financial Stability Vulnerabilities: Differences in convertibility and settlement timelines between tokens and underlying assets can create risks.  Rehypothecation of tokenized assets can lead to excessive leverage. Opacity and complexity in smart contracts can hinder accurate assessment of asset quality and price. Large tokenization platforms can create new interdependencies between institutions, and concentration risks can emerge from reliance on a limited number of service providers. Project-specific challenges (issuers, affiliated parties) and vulnerabilities in the digital ledger technology (“DLT”) infrastructure (limited capacity, continuous operations, permissionless networks, smart contracts) can cause operational issues. While tokenization isn't a major current threat due to its limited scale and specific characteristics, all indications point to wider, faster adoption trends elevating financial stability vulnerability risks.

5. Scalability Limitations: Many current blockchain technologies struggle to process high transaction volumes required for mainstream financial applications. Factors like consensus mechanisms, network architecture, and computational limitations can create bottlenecks, slowing transaction speeds and increasing costs. Overcoming these limitations necessitates exploring innovative solutions like layer-2 scaling, sharding,¹⁶ and efficient consensus algorithms, to enable tokenized systems to handle demands of a global financial market without compromising security or decentralization.

6. Interoperability Challenges: A key hurdle hindering widespread tokenization adoption of tokenization are significant interoperability challenges. Currently, many distributed ledger technology platforms operate as isolated silos, unable to seamlessly communicate and transact with each other or with traditional financial infrastructure. This lack of connectivity limits potential applications and benefits of tokenization, as assets tokenized on one platform may be difficult or impossible to transfer or utilize on another. Bridging these gaps requires developing robust and standardized protocols, potentially through multilateral or shared platforms, and addressing the significant costs and coordination efforts necessary to harmonize standards and procedures across diverse systems. Achieving interoperability is essential for tokenization’s success.

7. Smart Contract Security: Smart contracts, while offering automation and efficiency, are susceptible to bugs and vulnerabilities that can be exploited by malicious actors. Rigorous security audits, formal verification, and the development of secure coding practices are crucial to preventing smart contract vulnerabilities.

8. Custody Solutions: Secure and reliable custody solutions are needed to protect tokenized assets from theft, loss, or unauthorized access. Robust custody practices, insurance coverage, and compliance with regulatory standards are essential.

Tokenization holds immense promise for the future of the financial market. However, unlocking its full potential requires a collaborative effort from regulators and legislators (to amend existing commercial, civil, financial services etc. laws), industry participants, and technology providers across jurisdictions. Clear legal and regulatory frameworks, robust technical infrastructure, commitment to data security and privacy and most of all, need for consumer and investor protections are essential to create a thriving and sustainable tokenization ecosystem. By addressing such challenges head-on, we can pave the way for tokenization to transform the financial market and create a more efficient, accessible, and transparent global financial system.

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¹ In this article, “blockchain” and “DLT” are used interchangeably, despite some scope differences between the two terms. DLT (distributed ledger technology) comprises of different sets of techniques to ensure the integrity and reliability of decentralized ledgers. Blockchain is just one example of DLT.

² Several global institutions have led a wide variety of projects and approach considerations examining and outlining workstreams either directly related to or are adjacent to facets of tokenization. See Bank of International Settlements (BIS) Innovation Hub projects Mandala, Meridian, Genesis, FuSSE and Promissora etc. See https://www.bis.org/about/bisih/about.htm 

³ The global tokenization market was valued at USD 3.32 billion in 2024. The market is projected to be worth USD 3.95 billion in 2025 and reach USD 12.83 billion by 2032. See, Fortune Business Insights at:  https://www.fortunebusinessinsights.com/tokenization-market-107201
See also, Coingeek, RWA tokenization to hit $50 billion in 2025 at: https://coingeek.com/rwa-tokenization-to-hit-50-billion-in-2025-report/

⁴ OECD (2020). The Tokenisation of Assets and Potential Implications for Financial Markets, OECD Publishing

⁵ Idem

⁶ See Commissioner Caroline Crenshaw’s keynote speech at SEC Crypto Task Force RoundTable on Tokenization, held May 12, 2025, in Washington DC at https://www.youtube.com/watch?v=HSNBCy7oeRE

⁷ Garrido, Jose M, Digital Tokens: A Legal Perspective. IMF Working Papers, Vol. 2023, Issue 151.

⁸ ibid., citing Greenberg, B. A., 2016, Rethinking Technology Neutrality, 100 Minn. L. Rev., 1495, at 1562. 

⁹  Garrido, Tokenization: A Legal Perspective, at 8.

¹⁰ Robinson, Phil Alden, dir., Field of Dreams, 1989; Universal Pictures.

¹¹ See Commissioner Crenshaw, SEC Crypto Task Force Roundtable, Tokenization, keynote speech, at https://www.youtube.com/watch?v=HSNBCy7oeRE 

¹²  Note earlier reference to the scope of examination on RWA assets only in this article. 

¹³ The Commodity Futures Trading Commission (“CFTC”) has noted that by improving operational infrastructure for assets already eligible to serve as regulatory margin, blockchain or DLT can help reduce or eliminate some of those challenges without requiring any changes to collateral eligibility rules permitted, See ’Recommendations to Expand Use of Non-cash Collateral Through Use of Distributed Ledge Technology’, CFTC Digital Asset Markets Subcommittee report to the CFTC Global Markets Advisory Committee, November 2024.

¹⁴ UNCITRAL – United Nations Commission on International Trade Law; Unidroit – International Institute for the Unification of Private Law.

¹⁵ Garrido, Digital Tokens: A Legal Perspective. At 27. 

¹⁶ Sharding is a technique that divides a blockchain network into smaller, independent blocks called "shards" to increase scalability and transaction processing speed. Each shard handles a portion of the network's data and transactions, allowing the network to process more transactions in parallel. This reduces the load on individual nodes and improves overall throughput.