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Tokenized stocks can lack traditional investor rights and

protections

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Regulatory concerns grow over tokenization's impact on

market

stability

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Pushback from Wall Street on SEC's potential tokenization

exemptions

By Hannah Lang and Elizabeth Howcroft

NEW YORK/PARIS, Oct 8 (Reuters) - A race by crypto

companies to sell tokens pegged to stocks is raising alarm bells

among traditional financial firms and regulatory experts who

warn that the fast-growing novel products pose risks to

investors and market stability.

Buoyed by President Donald Trump's pro-crypto stance and his

administration's push for friendly regulations, the crypto

industry is rushing to capitalize on a global surge in

enthusiasm for the sector.

Robinhood, Gemini and Kraken among others have

launched tokenized stocks in Europe, while Coinbase,

Robinhood and startup Dinari are seeking approval to launch

similar products in the United States. Nasdaq, meanwhile, last

month became the first major exchange to propose offering

tokenized shares.

The industry says tokenized shares - blockchain-based

instruments that track traditional equities - could

revolutionize stock markets by allowing shares to be traded 24/7

and settled instantly, boosting liquidity and reducing

transaction costs. The combined value of tokenized public stocks

geared toward retail investors as of September grew to $412

million, compared with just a few million dollars 12 months ago,

according to tokenization tracker RWA.xyz.

Although many products are marketed like stocks, they rarely

offer the same rights, disclosures and protections as

traditional equities. Instead, they more closely resemble

riskier derivatives, according to a Reuters review of several

products and interviews with a dozen industry executives and

legal experts. That increases the hazards for investors, while

tokenization more broadly could undermine market integrity and

fragment liquidity if left unsupervised, critics say.

"You're buying exposures to those shares through creating

some sort of synthetic instrument," said Diego Ballon Ossio, a

partner at law firm Clifford Chance in London. "A lot of the

burden gets shifted on you to understand what exactly it is that

you're buying."

A few companies have issued their own experimental stock

tokens on the blockchain - software that acts as a shared

digital ledger - but most tokenized shares are pegged to public

companies and issued by third parties like Ondo Global Markets

and Dinari. Some tokens are backed 1:1 by underlying stocks,

while others provide economic exposure through derivatives.

The industry is divided over which regulations apply to

stock tokens, and investor rights and protections vary. Often,

the products provide no ownership, voting rights or traditional

dividends, while creating counterparty risk exposure to the

token issuer.

For example, there are multiple tokens pegged to Nvidia ( NVDA )

and Tesla with a range of structures and terms

and conditions.

"The fact that different tokenized offerings have different

rights and different disclosures ... that's a real big worry,"

said Gabriel Otte, CEO of Dinari, which offers 1:1

collateralization.

Robinhood in June launched trading in tokens pegged to public

companies and said it plans to offer tokenized stocks of private

companies. To promote the launch, it gave away tokens pegged to

OpenAI. Those tokens are derivative contracts backed by

Robinhood's ownership of fund units in a special-purpose vehicle

that holds OpenAI convertible notes, according to its terms and

conditions. The announcement drew pushback from OpenAI, which

said it had not blessed the offering. It also prompted scrutiny

from Robinhood's European regulator.

Johann Kerbrat, general manager of Robinhood Crypto, said

the company clearly flags that its tokens are derivatives.

"It's just one step forward to be able to have the benefits

of no longer having multiple days to settle," he added.

While Robinhood is issuing public company tokens on the

blockchain, it is not yet settling the trades on the blockchain,

a spokesperson said.

Gemini declined to comment.

CORE INVESTOR PROTECTIONS

In Europe, Robinhood, Kraken and others operate under the

"MiFID" derivatives rules but some legal experts say that law is

insufficient to oversee the novel products.

Trump's crypto-friendly chair of the U.S. Securities and

Exchange Commission, Paul Atkins, has indicated the agency plans

to grant would-be issuers exemptions from securities rules.

That plan is facing opposition from powerful Wall Street

players including Citadel Securities and the Securities Industry

and Financial Markets Association, which say such major

structural changes should go through a formal rulemaking

process.

"Just because a security is represented on blockchain, that

doesn't change the core investor protections and other

provisions that apply to securities," said Peter Ryan, head of

international capital markets at SIFMA.

In a July letter to the SEC, Citadel Securities raised concerns

that tokenization would siphon liquidity away from public

markets.

Spokespeople for the SEC declined to comment, while Citadel

Securities did not provide comment beyond the letter.

A spokesperson for the European Securities and Markets

Authority, which helps oversee MiFID, said it was aware of the

potential risks of tokenization and was monitoring

developments.

The World Federation of Exchanges recently urged regulators to

crack down on tokenization, citing insufficient investor

protections and liquidity fragmentation, although the group told

Reuters it supports Nasdaq's proposal because it would treat

tokens like traditional stocks.

Coinbase is also in talks with the SEC about launching

tokenized securities that would similarly grant investors the

full legal rights and benefits associated with conventional

stocks, according to a source familiar with the matter.

Other issuers said they hew closely to traditional

securities, anti-money laundering, bankruptcy protections and

other rules.

Mark Greenberg, Kraken's global head of consumer, said the

company offered the "gold standard" including 1:1

collateralization and investor disclosures, while dismissing

derivative offerings as "IOUs."

"Done right, tokenization enhances investor protections,

rather than eroding them," said Ian De Bode, chief strategy

officer at Ondo Finance.