Runs on Tokenized Debt

We study how debt tradability in secondary markets affects efficiency and fragility. Motivated by fiat-backed stablecoins, we extend the Diamond-Dybvig framework by allowing a fraction of the issuer’s liabilities to be transferred to outside investors before the investment matures, while holders retain the option of redeeming with the issuer. Tradability improves efficiency by allowing the issuer to invest in less liquid, more productive investments. However, tradability has a non-monotone effect on fragility. When secondary markets are thin, tradability introduces self-fulfilling debt runs as an additional source of coordination failure, increasing fragility. Yet when secondary markets are sufficiently liquid, this additional source of coordination failure instead eliminates fragility altogether, as the issuer can meet all early redemptions from liquidation alone regardless of investor behavior. Thus, tokenizing demandable debts can decrease fragility although it in principle adds another source of coordination failure. Our results suggest that the designs of stablecoins, tokenized deposits, and tokenized MMFs should focus on ensuring sufficient depth in secondary markets.