Tokens promise to unlock real‑world value — especially in real estate — but without protections baked into the code, they also unlock the door for crime. Can targeted tokenization solve the problem?
Key Insights:
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Tokens are being more critical to security — Tokenization, especially of real-world assets like real estate, unlocks value but also invites criminal exploitation; protections and controls must be coded into protocols from the start, not bolted on later.
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Recent collapse is a warning — The collapse of Terra, the third largest cryptocurrency ecosystem, and its Luna coin in 2022 shows how absent KYC and unsustainable yields amplify financial‑stability risks.
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Regulators now stress risk‑based supervision — Programs must rigorously implement KYC, risk assessments, transaction monitoring, and sanctions screening. Design-thinking can translate these requirements into enforceable on‑chain controls.
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Today, the digital world vibrates with excitement because of tokens, which have shown the potential to unlock value in real world assets. Tokens are digital assets built on blockchain technology, but unlike cryptocurrency, which also used blockchain, tokens are solely used for transactions or as a value currency.
In fact, tokens can represent many different types of value within the digitized world, including digital assets, ownership stakes, and even real-world assets like real estate.
In the real world, of course, buying and selling real estate requires compliance, such as anti-money laundering (AML), counter-financing of terrorism compliance, and other standards promulgated by the intergovernmental Financial Action Task Force (FATF).
With tokens, these regulations can be coded in, but will they? Take for example, due diligence, or know your customer (KYC) regulations, which require some background checking of with whom a financial institutions is doing business.
KYC is arguably the most critical aspect of overall AML compliance; yet failures in this area continue to make the news more and are often cited for being at the root of massive penalties and enforcement actions. If tokenization intends to transform the future of money, then compliance must be in the code.
The tokenization race
The race to unlock value in real-world assets and bring them onto the blockchain is only gaining momentum. Tokenization already is alluring to traditional finance and FinTech crowds alike, and its use in real estate is an easy sell. Luxury villas, coveted penthouse apartments, contemporary homes in the mountains infused with rustic accents — tokenization offers the tantalizing prospect of fractional ownership, input on property management decisions (through governance tokens), investment opportunities, or a combination of these and other options. The movement of value into tokenized real-world assets unlocks amazing opportunities for all — unfortunately, that includes criminals as well.
The criminal element has always been early adopters. In fact, much of the risk-based approach to AML compliance has evolved, in part, from that fact. Criminals exploit any security gaps and continually try novel approaches to mitigate against their risks of being detected and caught.
The initial aversion to regulation in some corners of the crypto community provided a utopia for the criminal element. Then, innovators sought to remove friction from financial services and thus oiled the gears for everyone, again, including criminals. And so, the risks continue to evolve.
Case studies for tokenized compliance
As the tokenized world is being built, efforts to bake in compliance are varied. To understand how to address compliance, consider the focus of the regulator: Their roles is to mitigate any threats to financial stability and prevent money laundering, terrorist financing, proliferation financing, and other crimes. Case studies are often used to cement lessons from compliance training, and the Terra/Luna case study is an excellent reference point for anyone looking to build better tokenomics that incorporates robust compliance.
The Terra/Luna collapse and the ensuing unraveling of the Anchor Protocol, an over-collateralized Terra-based lending and borrowing system, occurred in May 2022. Regulators focused on the threat to financial stability presented by the cascading effects that de-pegged stablecoin TerraUSD that caused the value of the Luna token to free-fall. Criminals exploited the lack of compliance. The Anchor Protocol’s risks were scrutinized, and the impact of no KYC being required and unrealistic yields that gave off Ponzi vibes also were dissected. The entire episode also triggered renewed vigor in the need to develop regulatory mandates for virtual assets and stablecoins.
AML compliance may be construed as friction, but it should not. The challenge with AML compliance in tokenization only lies in the limitation of code and a true understanding of risks. Simply put, the financial utopia that tokenization can bring about will only happen if compliance is coded in up-front and not as an afterthought. Compliance as an afterthought is like baking a cake and then adding raw eggs before serving.
Managing risk continues to be an increasing challenge for traditional financial institutions and FinTech companies, and the usual compliance weak-spots — KYC, risk assessment, transaction monitoring, and sanctions screening — are already known but too often not properly addressed.
Indeed, Elisa de Anda Madrazo, FATF President, continues to emphasize the importance of effective risk management for AML compliance, stating last year that “a significant change has also been made in separating out the assessment of the effectiveness of risk-based supervision of the financial (including virtual asset service providers) and non-financial sectors into two immediate outcomes.” This is a clear signal to regulatory authorities and virtual asset service providers alike that risk assessments, integral to the risk-based approach, must be a foundational element of operations.
Tokens of affection
In a tokenized world, real-world assets can be a darling example of FinTech and compliance symbiosis. Designing the AML compliance business requirements into code can be quite easily done if coders truly understand the desired outcomes from compliant tokenomics.
Whatever the course of action, regulatory inaction concerning virtual assets and stablecoins has evaporated and regulatory clarity continues to be enhanced. Perhaps, the next step to help tokenization gain traction is to provide regulators with true tokens of affection: Tokenization in which AML compliance is baked into protocols.
You can learn more about the challenges faced in fighting money laundering and other financial crimes here
