NY Fed Economists Examine Financial Stability Risks of Tokenized Funds
"[T]okenization ... ties the demand for investment fund shares to external factors other than the profitability of their assets. Such linkages could introduce new sources of funding risks for investment funds and amplify the buildup of vulnerabilities in the financial system."
NY Fed Economists
"[T]okenization ... ties the demand for investment fund shares to external factors other than the profitability of their assets. Such linkages could introduce new sources of funding risks for investment funds and amplify the buildup of vulnerabilities in the financial system."
NY Fed Economists
Federal Reserve economists analyzed the financial stability risks posed by tokenized investment funds.
In its Liberty Street Economics blog, Federal Reserve Bank of New York economists assessed the financial stability implications of tokenized investment funds. They explained that the recent approval of cryptocurrency ETFs and the passage of the GENIUS Act have heightened concerns about how tokenized funds could affect the broader financial system, as adoption expands. (The economists noted that they had previously provided background on the emergence of tokenized funds and their early use cases.)
The economists outlined the potential benefits and risks of tokenized investment funds across three areas:
- Liquidity Transformation. The economists said tokenization could reduce redemption pressures by allowing tokenized shares to be used for payments or margin requirements and could also provide new liquidity through secondary markets. They cautioned that funds may become more fragile if shocks in secondary markets depress token prices. They noted that such pressures could trigger redemptions even when the fund’s underlying assets remain stable.
- Interconnections. The economists said tokenized shares could diversify funding by providing firms with access to digital asset markets. They warned, however, that tokenized products could displace bank deposits and create new contagion channels across issuers. They emphasized that, because many tokenized funds hold reserves in traditional finance, disruptions could be amplified and transmitted between digital and traditional systems.
- Settlement-Related Services. The economists said tokenization enables faster settlement and 24/7 trading, which could help liquidity and allow asset managers to substitute tokens for idle cash. They cautioned that continuous trading could also accelerate investor runs during periods of stress. They added that reliance on a small number of platforms or permissionless blockchains with opaque governance could introduce systemic and governance risks.