The future of tokenization lies not in technology but in regulations.

Written by: Gonzalo Fernandez Dionis, Caio Ferreira, Mindaugas Leika, Athanasios Vamvakidis

Translated by: Chopper, Foresight News

The prospects of tokenization are very enticing: faster transaction speeds, lower costs, broader participation thresholds, and smoother market operations. However, the reality is much more complex. Despite rapid scale expansion, the tokenization market is still quite small and highly fragmented. As indicated in the latest Global Financial Stability Report from the International Monetary Fund (IMF), investors have shown interest in some of its core functions, such as around-the-clock trading and fragmented ownership of stocks.

The core distinction of tokenization from past financial innovations lies in its potential to reconstruct markets. It records assets directly on programmable distributed ledgers, integrating functions like issuance, trading, settlement, and asset servicing that were previously handled by different institutions and infrastructures. It can also parallel-process various workflows that would typically be executed sequentially. If adopted on a large scale, tokenization could reshape the operating model of financial markets, but this potential has mostly yet to be realized.

Starting from a small base and growing rapidly

The vast majority of tokenization business is concentrated in the repurchase agreement market, where short-term lending is collateralized by government bonds, and the parties agree to later redeem the assets in reverse. This market sees an average daily trading volume of about $300-350 billion, reflecting the appeal of tokenization in collateral management.

The remaining tokenized assets (credit, money market funds, stocks, etc.) are approximately $65 billion in size. While the growth rate is rapid, it remains insignificant compared to traditional financial markets: the average daily scale of the U.S. traditional repurchase market is about $13 trillion, and the total scale of global capital market assets reaches $300 trillion.

Tokenized asset issuance is concentrated in the U.S. and a few major offshore jurisdictions; trading is dispersed across numerous platforms, networks, and settlement systems, exhibiting significant fragmentation.

What is hindering the further development of tokenization? Research identifies four interrelated constraints: legal certainty, regulatory clarity, interoperability, and the availability of settlement assets.

1. Investors need legal protections to confirm that the rights corresponding to tokenized assets have judicial enforceability;
2. Regulatory agencies need to clarify how existing regulations apply to new ledgers and market operations;
3. Platforms must achieve interoperability instead of being isolated liquidity islands;
4. Settlement needs to rely on secure, widely accepted monetary instruments.

Impressive functionality but weak liquidity

Existing market practices show that investors recognize the new capabilities brought by tokenization. More than half of trades occur outside traditional trading hours, indicating real demand for around-the-clock trading. Fragmented ownership is also widely applied, enabling regular retail investors to purchase less than one share of stock, reducing the participation barrier. In the tokenized stock trading we analyzed, about 80% of transactions involved less than one share.

Additionally, the overnight returns from tokenized stocks quickly reflect in the prices of traditional stocks once the traditional market opens. This indicates that the tokenized market receives the same market information as the traditional market, and nighttime price signals from the tokenized market are also meaningful for traditional trading.

Despite the long-term potential for tokenization to enhance the efficiency of financial markets, the current tokenization market suffers from weak liquidity and volatility higher than that of corresponding traditional markets. The fragmentation brought by multiple networks and trading platforms further erodes liquidity, impeding effective price formation and causing price deviations.

The disconnection between platforms, lack of interoperability, and absence of universal settlement assets weaken the network effects that tokenization could have enjoyed. The value of a tokenized ecosystem depends on the number of assets, investors, and settlement tools within it. As the network continues to develop and integrate, the benefits of liquidity, operational efficiency, and composability will be significantly amplified.

How to achieve safe expansion

However, scaling up also magnifies risks. In the early stages of market development, the risks associated with technology and infrastructure can be pronounced, while some characteristics of tokenization can open new conduits for risk transmission, amplifying traditional financial risks, such as fire sales, liquidity squeezes, and risks of contagion from higher correlations and leverage.

In traditional finance, messaging, trading, delayed settlements, and reconciliation are carried out sequentially. These processes create friction and costs but also provide buffers, security assurances, and liquidity management tools; in a fully tokenized ideal environment, most of these buffering mechanisms would disappear.

As the tokenized market expands, opportunities and risks rise in tandem. Policymakers face the challenge of creating conditions for tokenization to develop safely and efficiently.

Upholding the principle of technological neutrality is crucial. Countries should clarify the legal rights corresponding to tokenized assets, ensuring that similar businesses are subject to consistent regulation regardless of the technology used, and promoting interoperability between tokenized platforms and traditional financial systems. At the same time, continuously monitor emerging risks, including rising correlation, leverage, and liquidity risks; as the market expands, protective measures must be updated in sync.

Tokenization does indeed have the potential to transform the financial industry, but its future largely depends on whether policies can ensure market depth, build trust, and enhance risk control, rather than solely on the possibilities of technology itself.