The Dual Edge of Tokenization: Efficiency Gains vs. Systemic Risk in Financial Markets

The financial markets are undergoing a seismic shift as tokenization redefines how assets are issued, traded, and settled. For institutional investors, this transformation presents a paradox: tokenization promises unprecedented efficiency gains but simultaneously introduces novel systemic risks. As the technology matures, the challenge lies in balancing innovation with prudence-a task complicated by evolving regulatory frameworks and the nascent nature of tokenized markets.

Efficiency Gains: A New Paradigm for Capital Markets

Tokenization is unlocking efficiency in financial markets by streamlining processes that have long been constrained by intermediaries and legacy infrastructure. According to a report by AIMA and PwC, over half of traditional hedge funds now have exposure to digital assets in 2025, with 52% exploring tokenized fund structures due to their operational advantages. These benefits stem from real-time settlement capabilities, reduced transaction costs, and enhanced liquidity. For instance, tokenized U.S. treasuries-forming the backbone of the real-world asset (RWA) market in 2025-enable near-instantaneous transfers, slashing settlement times from days to minutes.

Institutional adoption is accelerating, driven by use cases such as tokenized real estate and private credit. A New York-based luxury hotel tokenization project, for example, allowed investments starting at $1,000, democratizing access to an asset class traditionally reserved for ultra-high-net-worth individuals. Similarly, BlackRock's BUIDL fund, which tokenizes real-world assets, has attracted over $500 million in institutional capital, underscoring the appeal of programmable tokens for capital allocation.

Systemic Risks: The Shadow Side of Innovation

While efficiency gains are compelling, tokenization also amplifies systemic risks. The International Organization of Securities Commissions (IOSCO) has warned that the lack of interoperability across blockchains and the absence of high-quality settlement assets could create vulnerabilities. For example, tokenized investment funds, while reducing redemption pressures through liquidity transformation, may inadvertently increase interconnectedness between traditional and digital ecosystems. This interconnectedness could accelerate contagion during market stress, as 24/7 trading and programmable tokens enable rapid, uncontrolled capital flows.

A critical concern lies in the secondary market liquidity of tokenized assets. Despite their theoretical advantages, many tokenized products still rely on traditional infrastructure, and secondary market depth remains limited. This fragmentation introduces operational risks, including custodial complexities and counterparty uncertainties, which regulated custodians are only beginning to address.

Regulatory Evolution: Navigating a Fragmented Landscape

Regulatory frameworks are evolving to address these challenges, though progress remains uneven. The U.S. has taken a proactive stance, with the rescission of SEC Staff Accounting Bulletin 121 allowing traditional banks to custody digital assets. Meanwhile, the EU's Markets in Crypto-Assets (MiCA) regulation provides structured guidance for asset tokenization, offering legal clarity to institutional participants.

However, regulatory divergence persists. As noted in a Liberty Street Economics analysis, liquidity transformation in tokenized funds could destabilize markets if not managed carefully. Institutions must now navigate a patchwork of rules, from securities law to cross-border compliance, as highlighted in a legal guide to RWA tokenization.

Institutional Implications: Balancing Opportunity and Caution

For institutional investors, the dual edge of tokenization demands a recalibration of risk management strategies. Nearly half of institutional investors cite U.S. regulatory clarity as a key driver for increasing digital asset allocations, yet operational risks such as interoperability challenges remain unresolved. Smaller hedge funds and macro strategy managers are leading adoption, but their agility contrasts with the caution of larger institutions, which prioritize infrastructure development and compliance readiness.

The path forward requires collaboration between regulators, market participants, and technology providers. As IOSCO emphasized in its 2025 report, scalable tokenized markets depend on harmonizing blockchain protocols and ensuring access to high-quality settlement assets. For institutions, this means investing in custodial solutions, stress-testing liquidity models, and engaging with policymakers to shape frameworks that mitigate systemic risks without stifling innovation.

Conclusion

Tokenization is reshaping financial markets, offering efficiency gains that could democratize access to capital and redefine liquidity. Yet, its systemic risks-ranging from contagion amplification to regulatory fragmentation-demand rigorous scrutiny. For institutional investors, the key lies in leveraging tokenization's benefits while mitigating its shadows. As the market evolves, those who balance innovation with prudence will be best positioned to navigate this dual-edged revolution.