CRS Identifies Policy Issues on Tokenization

The Congressional Research Service ("CRS") considered some of the policy implications on "tokenization," a potential "next step in the evolution of finance." Tokenized assets include real-world assets ("RWAs") that have been digitized, recorded and traded on a programmable platform. 

In an In Focus report, CRS highlighted that the term tokenization "has become a byword for how discussions about blockchains have shifted from cryptocurrency—one of their primary uses—to other applications," and may include: (i) stablecoins, (ii) commodities, (iii) non-fungible tokens, (iv) tokenized securities, (v) tokenized deposits and (vi) real estate. They noted that "as much as $16 trillion in assets could be available for tokenization by 2030."

CRS said that while the benefits of tokenization are largely unproven, they include "potentially faster transaction times, cost savings, improved efficiency, and greater access." Implementation challenges include:

• Adoption and scalability: According to CRS, tokenization depends to "some extent on public crypto infrastructure," and whether a tokenized asset will provide affordable services at scale. CRS cautioned that "[r]egulated traditional financial applications performing similar services may also impede adoption."
• Interoperability: CRS said that tokenized RWAs on one blockchain may be incompatible with those on another, which can cause market fragmentation (i.e., RWAs on different platforms may trade at different prices.) For instance, if different banks issue tokenized deposits on separate blockchains, payments cannot flow between them. CRS highlighted that "while traditional securities trading markets have set hours, blockchains are intended to operate continuously" and "simultaneous trading across platforms may create trading-platform-specific price differentials."
• Blockchain versus offline: CRS cautioned that existing legal frameworks may not recognize blockchain-recorded transactions as conferring legal rights. Additionally, RWA like real estate or art can still be traded offline, necessitating a system to reconcile blockchain transactions with traditional sales.

CRS said tokenization may require changes to statutory or regulatory frameworks, as existing regulations may be deemed insufficient to cover the risks. CRS identified the following policy issues:

• Systemic risk: CRS warned that in moments of uncertainty, faster transactions with tokenized deposits could intensify stress by enabling rapid fund withdrawals, potentially triggering bank runs. CRS questioned whether traditional financial safeguards like circuit breakers can be effectively applied to tokenized assets.
• Operational risk: CRS said that tokenization on public, decentralized infrastructure without a central authority presents significant operational risks, as financial institutions or their customers might find public blockchains and their validators unreliable and unaccountable. To manage these risks, financial institutions may develop their own private blockchains, which could further complicate interoperability and widespread adoption.
• Regulatory and legislative frameworks: CRS said that tokenization could alter markets (e.g., 24/7 securities trading) and necessitate on-chain transaction acknowledgments (e.g., in real estate), raising questions about whether issuers should have a say in the tokenization of underlying securities.

CRS said that Congress "may choose to introduce standalone legislation or consider tokenization among the ongoing legislative efforts on digital assets and stablecoins."