The debate over how the U.S. should regulate a potential market for tokenized equities is heating up as Wall Street's traditional finance (TradFi) firms clash with crypto executives over whether decentralized trading infrastructure should be treated in the same way as traditional exchanges, according to a Monday report by HSBC.

Tokenization is the process of converting ownership of real-world assets, from stocks and bonds to real estate, private equity and even art, into digital tokens recorded on a blockchain.

The bank pointed to a recent Securities and Exchange Commission (SEC) Investor Advisory Committee discussion, where views diverged on how on-chain equities trading should be supervised.

TradFi giant Citadel Securities has drawn criticism from crypto industry members for pushing for a tougher stance on decentralized finance (DeFi), the report noted. Scott Bauguess, the vice president for global regulatory policy at Coinbase (COIN), argued for rules tailored to decentralized exchange models.

As for the regulator, SEC Chair Paul Atkins reiterated the need for compliant pathways that still enable innovation, while Commissioner Caroline Crenshaw flagged concerns about risks tied to tokenized equities.

At the center of the flare-up is a 13-page letter from Citadel to the SEC, which argued that many DeFi trading protocols meet the definition of an exchange and should be regulated accordingly, wrote analysts Daragh Maher and Nishu Singla.

Citadel said broad exemptions for DeFi could encourage regulatory arbitrage and create a “shadow-market” with weaker investor protections than traditional venues.

Where the SEC ultimately draws the line remains unclear, the analysts said.

While Atkins has framed tokenization as part of modernizing U.S. capital markets, the agency is unlikely to permit a U.S.-facing, on-chain equities market to operate with materially lighter protections than traditional exchanges, according to the analysts.

One likely tool is a “sandbox” approach, allowing tokenized equity platforms to operate under constrained conditions while regulators test boundaries, especially around U.S.-facing activity and identifiable teams, the bank said.

Over time, HSBC said regulatory pressure could favor tokenized equities trading on fully permissioned, fully regulated blockchains.

Still, the report added, there is one point of broad alignment across TradFi, DeFi and regulators: Tokenization is expected to grow from a small base, and the intensity of the current fight is itself a signal that the stakes are rising fast.

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