Tokenization and Interconnectedness: A Numerical Exploration

Tokenization of assets has multiple implications for the operation of financial markets, among which are mitigating trade frictions and improving the interconnectedness of financial firms. This feature—if not properly managed—can propagate shocks more widely as compared to a traditional system. We study this double-edged aspect of tokenization using a matching model that makes explicit how firms are exposed to counterparty risk. We propose a way to manage this increased risk, through Financial Transactions Limiters, which exploit the technical advantages of tokenization in monitoring financial transactions of individual firms. We numerically analyze the possible social welfare consequences of tokenization, in both the short and long run, based on the economy’s fundamentals.