BIS Points Out The Risks Of Tokenization

Tokenization of money has been a big topic in financial circles for years, and for a long time, central banks have been focused on the positives, as the process truly does bring numerous benefits. However, the Bank for International Settlements (BIS) highlighted the risks associated with the process, insisting that they cannot be overlooked.

Benefits Of Tokenization

When it comes to tokenization, the BIS defines it as the generation and recording of digital representations of traditional assets on a programmable platform. In its recent report for the G20, the institution said that this is a developing trend that might end up having implications for the role of central banks in several areas, including payments, financial stability, and monetary policy.

Earlier in 2024, the BIS and seven central banks joined forces to explore the tokenization of cross-border payments in a major joint effort. Known as Project Agora, the initiative is built on the unified ledger concept proposed by the BIS itself. 

Its goal was to investigate how tokenized commercial bank deposits can be integrated with tokenized wholesale central bank money in a public-private programmable core financial platform. However, the newly released report focuses on the potential benefits of tokenization when it comes to addressing existing frictions in financial markets, while at the same time, it examines new use cases and functions explored around the world.

The BIS noted that potential benefits include cheaper and faster transfers, which has attracted big interest from major financial bodies globally. However, it stresses that the costs and risks need to be considered as well.

In fact, the costs and risks may be a deciding factor in addressing how pre- and post-trade functions will be executed for money and other assets. Furthermore, being aware of them will ensure appropriate governance and legal frameworks, as well as liquidity and credit risks, and custody and operational risks.

The Risks That The BIS Intends To Focus On 

The report explained that risks may materialize in a completely different manner compared to the previously seen challenges faced by traditional market infrastructures. It said that tokenization actions provide platform-based intermediation for financial assets, which may lead to changes in how financial markets are structured and how they operate.

This means that policy implications for central banks may affect a number of areas. For example, things that are being questioned include f  interoperability needs to be fostered in case of fragmenting markets. Should the trade-offs between different types of settlement assets be considered? The banks also must assess the potential impact of token arrangements on monetary policy implementation.

Areas for regulation and supervision will also need to be identified. All of this and more needs a unique new approach, as the banks cannot rely on the rules they were used to in traditional finance. BIS’ general manager, Agustin Carstens, stressed that tokenization has significant potential to improve the safety and efficiency of the financial system, but it also poses economic, legal, and technical challenges.

These challenges must be addressed for it to fulfill its full potential. This is why the BIS is committed to exploring different aspects of all of these challenges through its analysis and Innovation Hub projects in the coming years.