The Financial Stability Board (FSB) released a report Wednesday stating that the risks posed to the global financial system by institutional finance's exploration of tokenization are minimal, primarily due to the technology's limited adoption thus far.

In its report, the FSB, which was created in 2009 by the G20 in the wake of the global financial crisis, noted that initiatives like BlackRock’s BUIDL fund are still in their early stages, which helps to mitigate potential threats to the financial system for now. 

"The limited publicly available data on tokenisation suggest that its adoption is very low but appears to be growing, and the use of tokenisation in the financial sector does not currently pose a material risk to financial stability, mostly due to its small scale," the FSB report said.

Despite suggesting that the technology currently presents a low risk because of its inability to scale, the report identified several financial stability vulnerabilities associated with DLT-based tokenization.

Key concerns include liquidity mismatches, leverage issues, asset quality, interconnectedness, and operational fragility. The report warns that these risks could escalate if the tokenization of assets scales significantly, particularly if the industry can resolve interoperability issues and receive clearer regulatory guidance.

One of the main challenges highlighted is the potential for liquidity and maturity mismatches, where the timelines for converting tokenized assets into cash may differ from the assets themselves. This could lead to redemption run risks, which pose a threat to financial stability. Additionally, the report noted that as tokenization projects become more complex and opaque, the associated risks may increase, especially during times of market stress.

"Tokenization could have implications for financial stability if increased complexity and opacity of tokenization projects lead to unpredictable outcomes in times of stress, and if some vulnerabilities are not adequately addressed through oversight, regulation, supervision, and enforcement," the report said. 

Leverage was also noted as a significant risk, particularly because of the composable nature of smart contracts. This allows users to borrow tokens from lending protocols and then use those borrowed tokens as collateral for additional loans—a practice that is currently more common in decentralized finance (DeFi).

The FSB also expressed skepticism regarding the advantages of tokenization, arguing that existing technologies can often achieve similar outcomes without the associated risks. The report outlined various barriers hindering widespread adoption, including unclear investor demand, lack of interoperability among DLT platforms, and differing legal and regulatory frameworks across jurisdictions.

Furthermore, the report emphasized the importance of effective oversight and regulatory measures. It stated that if these vulnerabilities are not adequately addressed, they could create financial stability risks if the adoption of tokenization increases.

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