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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.

Suggested Citation

  • 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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    References listed on IDEAS

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    1. Joseph Abadi & Markus Brunnermeier, 2018. "Blockchain Economics," NBER Working Papers 25407, National Bureau of Economic Research, Inc.
    2. Chiu, Jonathan & Koeppl, Thorsten V, 2017. "The economics of cryptocurrencies – bitcoin and beyond," Working Paper Series 6688, Victoria University of Wellington, School of Economics and Finance.
    3. Jonathan Chiu & Thorsten V. Koeppl, 2017. "The Economics Of Cryptocurrencies - Bitcoin And Beyond," Working Paper 1389, Economics Department, Queen's University.
    4. Chiu, Jonathan & Koeppl, Thorsten V, 2017. "The economics of cryptocurrencies – bitcoin and beyond," Working Paper Series 20278, Victoria University of Wellington, School of Economics and Finance.
    5. Martin, Antoine & McAndrews, James, 2008. "Liquidity-saving mechanisms," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 554-567, April.
    6. Easley, David & O'Hara, Maureen & Basu, Soumya, 2019. "From mining to markets: The evolution of bitcoin transaction fees," Journal of Financial Economics, Elsevier, vol. 134(1), pages 91-109.
    7. Mariana Khapko & Marius Zoican, 2020. "How Fast Should Trades Settle?," Management Science, INFORMS, vol. 66(10), pages 4573-4593, October.
    Full references (including those not matched with items on IDEAS)

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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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