IMF Highlights Hidden Risks as Tokenization Eliminates Traditional Financial Buffers

Without public infrastructure underpinning tokenized finance, the IMF warns it could amplify instability through several compounding forces.

The International Monetary Fund (IMF) has warned that although the adoption of tokenized finance brings many efficiency and speed benefits, some of its features could also result in financial instability for the markets.

Tokenized Real-world assets (RWAs) also continue to grow rapidly, with the industry being worth roughly $27.5 billion as of early April.

Tokenization Risks

In an April 1 note, Tobias Adrian, the IMF’s financial counselor, says that the inefficiencies markets are trying to eliminate through tokenization are actually the shock absorbers keeping the global economy from crashing.

The paper argues that tokenization is actually a “structural shift in financial architecture” as opposed to being an efficiency improvement. This is because it removes the “temporal buffers” in traditional finance by allowing transactions to be settled instantaneously.

Tokenization changes how people move assets like money, stocks, and bonds by automating these processes via smart contracts on the blockchain. This reduces settlement lags by allowing banks to clear ownership and transactions almost instantly.

“These frictions are not only costly to end-investors, but they also provide temporal buffers that allow exposures to be netted, liquidity to be mobilized, and authorities to intervene before settlement becomes final. Tokenized systems reduce or eliminate these buffers.”

However, Adrian argues that removing these delays could actually mean getting rid of our safety nets. This is because the settlement window usually gives banks time to manage liquidity and risk exposure. It also leaves regulators room to monitor and intervene in case of anything.

The IMF has identified three major hidden risks that could come with the elimination of these financial buffers. One major source of concern is liquidity pressure. Per the paper, tokenization could create a need for financial institutions to always have the funds to meet the demands of instant transaction settlements.

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The other risks relate to governance and cross-border oversight. Since tokenization relies on smart contracts for automation, there is less room for human access when things go wrong. This could result in bigger consequences during events like a price drop, especially if a smart contract bug triggers automatic liquidations.

Additionally, regulators only have authority within their own borders, while tokenized assets can easily move across multiple countries. This, in turn, makes it harder for them to resolve issues in case of a crisis.

Finding a Public Anchor

In its report, the IMF also acknowledges the advantages that come from using the technology. For instance, asset managers and investors benefit from the efficiency that comes from lower costs, speed, and transparent transactions.

However, the paper argues that for tokenization to be successful, it must be built on public trust, which it says can be achieved through the use of safe settlement assets like Wholesale Central Bank Digital Currencies (wCBDCs).

According to Adrian, if we do not implement these public measures, tokenization could amplify financial instability through speed, concentration, and fragmentation.

Meanwhile, the tokenization industry has been experiencing a lot of growth lately, with data from RWA.xyz showing that right now, tokenized assets represented on the blockchain are worth roughly $27.6 billion. A previous research by Boston Consulting Group had also predicted that the sector would become a $16 trillion industry by 2030.