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Optimal Design of Tokenized Markets

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Abstract

Trades in today’s financial system are inherently subject to settlement uncertainty. This paper explores tokenization as a potential technological solution. A token system, by enabling programmability of assets, can be designed to eradicate settlement uncertainty. We study the allocations achieved in a decentralized market with either the legacy settlement system or a token system. Tokenization can improve efficiency in markets subject to a limited commitment problem. However, it also materially alters the information environment, which in turn aggravates a hold-up problem. This limits potential gains from resolving settlement uncertainty, particularly for markets that depend on intermediaries. We show that optimal design hinges on joint design of settlement and trading systems, and in particular, that token systems work best when matched with direct trading.

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  • Michael Junho Lee & Antoine Martin & Robert M. Townsend, 2024. "Optimal Design of Tokenized Markets," Staff Reports 1121, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:98896
    DOI: 10.59576/sr.1121
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    More about this item

    Keywords

    tokenization; programmability; settlement uncertainty; asymmetric information;
    All these keywords.

    JEL classification:

    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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