Major European Regulator Warns Tokenized Stocks Risk Misleading Investors

Europe’s top markets regulator has warned that tokenized stocks—blockchain-based representations of listed stocks—risk misleading investors, because they don’t grant them the same rights as owning equity directly.

In a keynote speech in Dubrovnik on 1 September, executive director of the European Securities and Markets Authority (ESMA) Natasha Cazenave said that some fintechs have introduced products that provide exposure to a company’s listed shares and that, while these tokenized assets provide always-on access and fractionalization, they don’t confer shareholder rights. In other words, when structured as synthetic claims, they increase the risk of confusion and misunderstanding. 

ESMA’s latest warning isn’t an isolated event, but part of a broader, coordinated effort to address the many concerns of global financial authorities, which continue to grapple with unclear legislation and a constantly changing regulatory environment. A few weeks prior, for example, the World Federation of Exchanges (WFE)—a global association of exchanges and clearing houses—called for regulators to crack down on tokenized stocks, arguing that they introduce new dangers to investors and threaten market integrity.

“What we are seeing is a blatant attempt to circumvent regulation, with some firms seeking “no action” relief from regulators or deliberately operating through legal grey areas," Nandini Sukumar, CEO of the World Federation of Exchanges (WFE), said in a statement. "Most concerning is the risk to retail investors, who may be misled into believing they hold the same rights and protections as traditional shareholders."

The sentiment has been echoed by many other industry regulators since, including the International Organization of Securities and Commissions (IOSCO).

At the heart of the problem is the synthetic exposure inherent to many tokenized products. When an investor purchases a listed share through a regulated broker, they acquire a direct, legally recognized ownership stake in the company. This ownership comes with several inviolable rights, such as the right to vote on corporate matters, receive dividends, attend shareholder meetings, and access official company disclosures. In comparison, tokenized stocks are structured as what Cazenave calls ‘synthetic claims’, where the holder doesn’t own the underlying share. The share is instead purchased and held by an intermediary. An example of such an intermediary is Robinhood, a fintech that has doubled up on tokenized stocks in recent months by allowing users to trade stock tokens over blockchains.

Because products are marketing with the familiar branding of well-known companies (e.g. tokenized Alphabet stocks), they may lead retail investors to understand they’re participating in equity markets in a new and more efficient way. In reality, though, they’re entering into a complicated contractual relationship with the company that issues the tokenized assets, thereby potentially exposing them to a broader array of risks. Even where these arrangements are held by a regulated custodian, the legal enforceability of any claims—such as in the event of platform insolvency—remains an untested area of law.