In a previous post, we provided background information about the emergence of tokenized investment funds and their use cases. These use cases are currently limited to the digital asset ecosystem. However, the recent approval of cryptocurrency exchange-traded funds (ETFs) and the passage of the GENIUS Act raise concerns about the impact of these tokenized investment fund to the broader financial system. In this post, we assess this impact by considering three economic mechanisms based in part on market participants’ investment strategies and liquidity needs. They include: liquidity transformation, interconnections between the digital asset and the traditional financial system, and transaction settlement. Through these mechanisms, tokenization of investment funds can bring about financial stability benefits in the form of reduced redemption pressures and additional sources of liquidity for fund issuances, but may also increase interconnectedness between the traditional financial system and digital asset ecosystem, thereby amplifying existing financial stability risks.
Liquidity Transformation in the Financial System
Tokenized investment funds, like their traditional counterparts, engage in liquidity transformation by offering liabilities that can be redeemed on demand and at par while investing in a pool of less liquid assets, thereby making the funds prone to run risk. Tokenization might change the incentives of investors to redeem their shares with the fund that, in turn, could entail benefits for or risks to financial stability.
Investors have traditionally treated investment funds as cash management vehicles and a store of value. When capital is needed elsewhere, the shares are typically redeemed for cash directly with the fund. The ability to use the tokenized shares instead of cash to pay for transactions might reduce the need to redeem them to obtain liquidity and, consequently, alleviate the need for an investment fund to sell its assets to meet redemptions.
Using tokenized funds to meet margin requirements can simplify investors’ cash management and dampen redemption pressures. In March 2020, for example, money market fund (MMF) investors partly met margin calls in repurchase agreements and derivatives contracts by redeeming their MMF shares, amplifying stress and instability in funding markets. In contrast, the ability to post tokenized shares for margin requirements could mitigate such stress as those tokenized funds are considered as cash for margin purposes, and, thus, would not need to be sold. Only in the event of default might those margins need to be liquidated to close the position they secure.
Another potential benefit is the ability to source liquidity if secondary markets for tokenized shares develop, which might be especially valuable for institutions that perform maturity transformation and so are inherently fragile. The possibility of a secondary market for tokenized shares is presaged in recent market developments whereby investment funds and stablecoin issuers hold tokenized shares of other funds as part of their reserve assets. On the risk side, tokenization may make the fund more vulnerable to external shocks, increasing its funding fragility. While the ability to use tokenized shares in secondary markets likely contributes to the growth of the funds, it also enhances the funds’ exposure to shocks in secondary markets that could be unrelated to the underlying fund’s reserve composition. For example, a negative shock to the convenience yield (derived from the ability to quickly use tokenized shares to purchase other assets) that tokenized shares earn from their use in secondary markets would put downward pressure on the price of the tokens in the secondary markets and, in turn, increase the pressures to redeem shares.
Interconnections
Tokenized shares might affect financial stability through their increasing interconnections with the traditional financial system. The use of tokenized shares as collateral, as an instrument to access liquidity, and as a reserve asset all increase the convenience yield of tokenized shares while also expanding the channels of shock transmissions within the digital asset ecosystem and to the traditional financial system.
As a benefit, firms may take advantage of the convenience associated with tokenized shares to obtain funding through markets for digital assets, or to enhance their ability to collateralize their loans in the traditional financial market by appealing to a broader investor base. Hence, firms’ reliance on funding from traditional financial intermediaries and markets may decline. However, the ability of firms to diversify their sources of funding will depend on whether tokenization evolves into a readily accessible technology in the economy.
Tokenization, however, might cause bank disintermediation by displacing deposits if tokenized shares pay higher yields than deposits, and/or earn a higher convenience yield than deposits. In times of stress, tokenized shares might amplify the systemic impact of a run on an investment fund if tokens are used to meet margin calls while also being used as a reserve asset for other financial products. Moreover, recent market developments focused on introducing smart contract functionality to allow for instant redemption of tokenized assets through issuers of stablecoins, such as Circle, and of other tokenized funds, such as Ondo Finance, might trigger contagion, as redemption pressures at one issuer might transmit to another issuer.
Likewise, interconnections across various issuers of tokenized funds, and between issuers of tokenized funds and stablecoins in the form of cross holdings of their liabilities might spur additional interconnections when an issuer liquidates assets that are liabilities of another issuer. Relatedly, because the reserve assets of some issuers are held in the traditional financial sector, the digital asset ecosystem might amplify shocks at the same time as they are transmitted to the traditional financial system.
Settlement-Related Services
Features such as faster settlement times and 24/7 trading that are currently available on public blockchains may become particularly valuable in times of stress, as market participants may need to post collateral with counterparties outside of the trading day, or with central bank liquidity facilities. Furthermore, 24/7 trading and settlement could facilitate intraday liquidity if tokenization scales, which might strengthen the benefits from liquid secondary markets, as discussed above.
Tokenized shares could also be used like cash, while allowing the token holder to collect interest. The ability to use tokenized shares for settlement and posting collateral might allow asset managers to substitute tokens for cash holdings in their portfolios, possibly generating higher income and improving their resiliency.
As to risks, round-the-clock trading and settlement may speed up a run on an investment fund, if disruptions in the market for tokens outside normal market hours escalate. As tokenized shares scale, network externalities may result if the scaling occurs on a small number of platforms, possibly allowing such platforms to eventually become systemic. Tokenization is mostly occurring on so-called “permissionless blockchains” which have opaque and purportedly decentralized governance structures. Such blockchains, and any private proprietary infrastructure that may eventually compete with them, might undermine policymakers’ ability to preserve the integrity of payments systems, especially in times of stress.
Final Words
Strong growth in the use of tokenized investment funds shares can have important benefits if they are used as a medium of exchange, thereby improving liquidity and facilitating settlement as well as reducing risks arising from sudden redemption requests by investors. However, tokenization also 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.
Pablo Azar is a financial research economist in the Federal Reserve Bank of New York’s Research and Statistics Group.
Francesca Carapella is a principal economist in the Macroprudential Policy Analysis Section at the Federal Reserve Board.
JP Perez-Sangimino is a senior policy analyst in Innovation Policy at the Federal Reserve Board.
Nathan Swem is a principal economist in the Financial Stability Assessment Section at the Federal Reserve Board.
Alexandros P. Vardoulakis is chief of the Macroprudential Policy Analysis Section at the Federal Reserve Board.
How to cite this post:
Pablo Azar, Francesca Carapella, JP Perez-Sangimino, Nathan Swem, and Alexandros P. Vardoulakis, “The Financial Stability Implications of Tokenized Investment Funds,” Federal Reserve Bank of New York Liberty Street Economics, September 24, 2025, https://doi.org/10.59576/lse.20250924b
BibTeX: View |
Disclaimer
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).
You can follow this conversation by subscribing to the comment feed for this post.
RSS Feed
Follow Liberty Street Economics
