Tokenized Equities: A Double-Edged Sword in Market Modernization

The rise of tokenized equities has positioned blockchain technology as a transformative force in financial markets. By enabling 24/7 trading, fractional ownership, and programmable ownership rights, tokenization promises to democratize access to high-value assets and streamline settlement processes. However, as the sector matures, it has become increasingly clear that the benefits of on-chain equity trading are shadowed by significant risks. Regulatory ambiguity, liquidity constraints, and governance challenges are creating a complex landscape where innovation and caution must coexist.

Regulatory Developments: Progress and Persistent Gaps

Regulators in 2025 have taken notable steps to integrate tokenized assets into existing frameworks. The U.S. Securities and Exchange Commission (SEC) issued updated guidance in December 2025, clarifying how broker-dealers can maintain physical possession of crypto asset securities while complying with the Customer Protection Rule. This includes requirements for robust custody policies, access to private keys, and risk assessments for blockchain networks according to the SEC's guidance. Meanwhile, the Commodity Futures Trading Commission (CFTC) launched its Digital Assets Pilot Program, allowing futures commission merchants to use non-securities digital assets like bitcoin and ether as margin collateral-a move that broadens the role of crypto in derivatives markets according to Morgan Lewis analysis.

Nasdaq's proposed rule changes further illustrate regulatory alignment with tokenization, aiming to facilitate trading of blockchain-based securities while ensuring they retain equivalent rights and privileges as traditional shares according to the Federal Register. Despite these advancements, gaps remain. For instance, audit methodologies for tokenized assets and operational risk management protocols are still underdeveloped, leaving room for uncertainty in compliance as reported by Sidley.

Liquidity Challenges: Structural Barriers and Systemic Risks

While tokenization theoretically enhances liquidity through 24/7 trading and fractional ownership, real-world data from 2025 reveals persistent challenges. Market participants report low trading volumes, extended holding periods, and limited investor participation in tokenized equities, particularly for assets like real estate and private credit according to a 2025 SSRN paper. Structural barriers such as custodial concentration-where a few entities control access to tokenized assets-and opaque valuation methods further hinder tradability as detailed in the same study.

Tokenized investment funds also introduce unique risks. These funds often offer on-demand redemptions while investing in illiquid underlying assets, creating liquidity transformation risks akin to traditional money market funds. In times of stress, such as a market downturn, this could lead to run pressures and amplify interconnectedness between digital and traditional financial systems according to Federal Reserve research. For example, tokenized shares used as collateral in stablecoin systems could transmit shocks across markets if defaults occur as the Federal Reserve notes.

Governance Challenges: Shareholder Rights and Compliance Complexities

Governance remains a critical frontier for tokenized equities. While tokenized securities retain the same legal rights as traditional shares-including voting and dividend distribution-their digital format complicates compliance with existing corporate governance frameworks. Nasdaq's proposal to trade tokenized securities under the same CUSIP identification numbers as traditional shares underscores an effort to maintain parity in shareholder rights according to legal analysis. However, the SEC's recent no-action relief for a retail shareholder voting program-allowing shareholders to provide standing proxies aligned with board recommendations-has faced legal challenges from advocacy groups, raising concerns about conflicts with proxy rules as reported by Ropes & Gray.

The Trump administration's December 2025 executive order to curtail the influence of proxy advisory firms adds another layer of regulatory scrutiny according to Goodwin's analysis. These developments highlight the tension between leveraging blockchain's efficiency and adhering to traditional governance norms. Smart contracts, while automating processes like dividend distribution, also risk bypassing human oversight in critical decisions, potentially undermining investor protections according to TD Securities.

Balancing the Scales: Risks and Rewards

On-chain trading of tokenized equities offers undeniable rewards. Atomic settlement via blockchain reduces counterparty risk and capital inefficiencies, while fractional ownership lowers barriers to entry for retail investors according to TD Securities. Programmable ownership and automated compliance checks further streamline operations. Yet, these benefits come with heightened risks. The irrevocable nature of blockchain transactions exposes investors to irreversible losses from errors or fraud as noted by Yahoo Finance. Cybersecurity vulnerabilities on decentralized platforms and the surge in retail participation-driven by accessibility-heighten the likelihood of market panic and volatility according to GARP risk intelligence.

Moreover, the interconnectedness of tokenized assets with traditional markets poses systemic risks. If tokenized assets are liquidated en masse to meet margin requirements during a crisis, the ripple effects could destabilize broader financial systems as the Federal Reserve observes. Historical precedents, such as Bitcoin's price swings and NFT market corrections, underscore the speculative nature of tokenized markets according to GARP research.

Conclusion: A Path Forward

Tokenized equities represent a pivotal step in market modernization, but their success hinges on addressing regulatory, liquidity, and governance challenges. Regulators must continue refining frameworks to clarify custody practices, audit standards, and the legal treatment of tokenized assets. Market participants, meanwhile, need to develop robust risk management protocols and transparent valuation mechanisms. Investors, particularly retail ones, must be educated about the unique risks of on-chain trading, including cybersecurity threats and market volatility.

As the financial ecosystem evolves, the double-edged nature of tokenized equities will become increasingly evident. Those who navigate the risks with prudence while embracing the rewards of innovation may find themselves at the forefront of a new era in capital markets.