07/15/2025
Tokenization Is The Latest Crypto Fad But Is It a Derivative, a Security, or a Wager?
By Robert Wright
A new financial tokenization scheme hits the headlines daily these days and several books with titles such as Tokenization of Everything are circulating, making these digital assets one of the latest and hottest crypto fads.
But what is tokenization? And is it legal? If precedents hold, who trades may prove as important as what trades in specific cases.
As their name implies, financial tokens represent real-world assets so they can be traded on a distributed ledger (blockchain). The term comes from vouchers exchangeable for goods, like arcade or subway tokens (if you remember those) or poker tokens (a.k.a. chips). Tokenization refers to the process of creating the digital infrastructure necessary to issue and trade tokens.
But what is tokenization? And is it legal? If precedents hold, who trades may prove as important as what trades in specific cases.
As their name implies, financial tokens represent real-world assets so they can be traded on a distributed ledger (blockchain). The term comes from vouchers exchangeable for goods, like arcade or subway tokens (if you remember those) or poker tokens (a.k.a. chips). Tokenization refers to the process of creating the digital infrastructure necessary to issue and trade tokens.
Some look like stocks
Some financial tokens give token holders ownership rights to the underlying assets. Such tokens are akin to corporate equities because they allow multiple investors to own fractions of land or other real-world assets. Governance rules can be programmed into tokens with smart contracts. For example, multiple investors could buy tokens representing a $10 million mansion with management decisions preset: net earnings from renting will be distributed annually pro rata in USD; the mansion will be sold and the net earnings divided if some rent to market price ratio is achieved, and so forth.
The same business project could be achieved through a partnership agreement, but tokenization allows investors to trade some or all of their tokens at any time 24/7/365 efficiently and at low cost. It may also confer start-up cost savings or tax benefits depending on jurisdiction.
Under the Lummis-Gillibrand and Digital Commodity Exchange acts of 2024, U.S. regulators, including the SEC, CFTC, and FinCEN, recognize the legality of tokenization that serves legitimate business purposes so long as token issuers follow applicable laws, like anti-money laundering and know your client (AML/KYC) and disclosure transparency.
Regulatory guidelines remain in flux, however, and enforcement issues loom large due to the digital and global scope of blockchain technology and the unconventional nature of many crypto assets.
The same business project could be achieved through a partnership agreement, but tokenization allows investors to trade some or all of their tokens at any time 24/7/365 efficiently and at low cost. It may also confer start-up cost savings or tax benefits depending on jurisdiction.
Under the Lummis-Gillibrand and Digital Commodity Exchange acts of 2024, U.S. regulators, including the SEC, CFTC, and FinCEN, recognize the legality of tokenization that serves legitimate business purposes so long as token issuers follow applicable laws, like anti-money laundering and know your client (AML/KYC) and disclosure transparency.
Regulatory guidelines remain in flux, however, and enforcement issues loom large due to the digital and global scope of blockchain technology and the unconventional nature of many crypto assets.
Others look like derivatives
Some financial tokens do not confer ownership rights to the assets they represent. Instead, they merely track the market prices of those assets, allowing token holders to gain or lose in the process. Some tokens, for example, track the prices of stakes in private equity companies.
Allowing small investors to benefit from the success of companies that they cannot otherwise invest in due to accredited investor regulations may seem like a legitimate business purpose.
Like financial tokens, derivatives are contracts that may or may not give holders rights to underlying assets under pre-specified conditions. An American-style call option, for example, gives the holder the right to buy shares in a certain company at so many dollars per share until a specified date. Many futures contracts on commodities like gold, wheat, or cattle also require physical delivery unless closed out before expiration. Other derivatives, like some S&P 500 futures, merely track market prices and only settle for cash. Others, like weather derivatives, seem akin to bets on random events.
Derivatives, though, serve two main business purposes, hedging or the sale of risk (reduction of return volatility), and speculation or the purchase of risk (augmentation of return heterogeneity). Financial tokens can also be used to hedge or speculate while conferring cost and efficiency benefits as their markets increase in volume.
Futures and options markets today are integral parts of the US financial system with the Chicago Mercantile Exchange trading 3 billion contracts a year worth $1 quadrillion on everything from interest rates to agricultural commodities and stocks.
Allowing small investors to benefit from the success of companies that they cannot otherwise invest in due to accredited investor regulations may seem like a legitimate business purpose.
Like financial tokens, derivatives are contracts that may or may not give holders rights to underlying assets under pre-specified conditions. An American-style call option, for example, gives the holder the right to buy shares in a certain company at so many dollars per share until a specified date. Many futures contracts on commodities like gold, wheat, or cattle also require physical delivery unless closed out before expiration. Other derivatives, like some S&P 500 futures, merely track market prices and only settle for cash. Others, like weather derivatives, seem akin to bets on random events.
Derivatives, though, serve two main business purposes, hedging or the sale of risk (reduction of return volatility), and speculation or the purchase of risk (augmentation of return heterogeneity). Financial tokens can also be used to hedge or speculate while conferring cost and efficiency benefits as their markets increase in volume.
Futures and options markets today are integral parts of the US financial system with the Chicago Mercantile Exchange trading 3 billion contracts a year worth $1 quadrillion on everything from interest rates to agricultural commodities and stocks.
Some look like wagers
Historically, American securities regulators have been on guard against gambling instruments in securities markets, such as the “bucket shops” that proliferated in America’s major cities in the late nineteenth century. Those businesses also allowed small investors to gain or lose from changes in stock and commodity prices without owning the underlying assets.
Exchanges led the charge against the shops by successfully litigating their right to block them from accessing price information because they engaged in “gambling.”
But shuttering the shops was ultimately based on policy preferences rather than legal grounds. The problem was not so much with what the bucket shops did, which was difficult to distinguish from financiers’ derivatives, as it was who was involved. Prevailing views held that bucket shop operators and their clients were too poor and too poorly informed to do anything but gamble and hence needed to be protected from themselves. Importantly, anti-bucket shop attitudes and laws remain in force — the Commodity Futures Modernization Act (Section 408c; 7 USC 27f) had to explicitly exempt financial derivatives from state gambling regulations, including those pertaining to “the operation of bucket shops.”
Exchanges led the charge against the shops by successfully litigating their right to block them from accessing price information because they engaged in “gambling.”
But shuttering the shops was ultimately based on policy preferences rather than legal grounds. The problem was not so much with what the bucket shops did, which was difficult to distinguish from financiers’ derivatives, as it was who was involved. Prevailing views held that bucket shop operators and their clients were too poor and too poorly informed to do anything but gamble and hence needed to be protected from themselves. Importantly, anti-bucket shop attitudes and laws remain in force — the Commodity Futures Modernization Act (Section 408c; 7 USC 27f) had to explicitly exempt financial derivatives from state gambling regulations, including those pertaining to “the operation of bucket shops.”
The SEC stirs
On 9 July, Hester M. Peirce, speaking as an SEC commissioner and not on behalf of the Commission, issued a short statement that distinguished between securities-like and derivative-like tokens. She tacitly acknowledged that tokenization innovators gallop ahead of regulators but warned that market participants should consider the nature of specific tokens and reach out to regulators, including “the commission and its staff” when appropriate, so that staffers can “work with market participants to craft appropriate exemptions and modernize rules.”
Before a clear federal regulatory framework emerges, however, the risk remains that state regulators, which still largely control gambling laws, might use bucket shop laws to crackdown on the more derivative-like tokens, either to protect the public from themselves, or to reduce competition for taxpaying incumbents, from exchanges to hard hit casinos. Derivative-like tokenization might well move to the darker parts of the web as the result of such regulatory balkanization.
Before a clear federal regulatory framework emerges, however, the risk remains that state regulators, which still largely control gambling laws, might use bucket shop laws to crackdown on the more derivative-like tokens, either to protect the public from themselves, or to reduce competition for taxpaying incumbents, from exchanges to hard hit casinos. Derivative-like tokenization might well move to the darker parts of the web as the result of such regulatory balkanization.
