IMF warns tokenization could deepen flash crashes and spur government intervention

The IMF warns that tokenization threatens to deepen flash crashes despite promises of faster and lower-cost markets, prompting government intervention. Senior IMF economist Itai Agur notes that the nature of tokenized markets allows chains of programs to be stacked on top of each other, presenting opportunities for exponential failure (a domino effect).

Another risk is that many markets could emerge, and if their tokens lack interoperability, markets could become more fragmented. The problem here is that fragmentation may cause markets to fail to deliver faster and cheaper trading, Agur emphasises. 

The fund’s economist also notes that specific policies may be required for tokenization to truly deliver on its promises while limiting risks. He added that governments have rarely been content to stay on the sidelines during necessary adaptations of money, pointing out that governments may take a more active role in the future of tokenization.

IMF’s Agur partly defends tokenization

The senior economist explained that people need money to buy, consume, and save, and owning assets is one common way to save. Meanwhile, he noted that tokens can facilitate faster and cheaper transactions for buying, owning, and selling assets.

According to Agur, tokenized markets help avoid the long chain of intermediaries typically involved in most transactions between investors and companies, such as buying corporate stocks or bonds. He also noted that most conventional transactions, which require a go-between such as a clearinghouse or registrar, have more extended waiting periods for completion. Stressing that time is money in finance.

However, Agur emphasizes that tokenized markets have programs that can automate or reduce the role and functions of intermediaries. He also notes that researchers who have recently studied tokenized markets found significant cost savings. The economist further argued that tokenization’s promise is visible in the numbers, but cautioned that efficiencies from new technologies often come with new risks.

Automated trading has already led to sudden market plunges, according to Agur. He added that tokenized markets can be more volatile, particularly due to their instantaneous execution of trades.

Tokenization offers flexible settlement options

The IMF has been examining the structure of digital assets and tokenized markets for years, and it acknowledges that tokenization is currently more mainstream than an experimental niche. Meanwhile, the fund believes that tokenization offers flexible settlement options.

Tokenization can spur competition between middlemen, making it easier for investors to shop around and switch between brokers for the best price. The fund also noted that tokenization does not cut out all middlemen, but it is transforming the financial industry and reducing the need for specific roles. The IMF pointed out that some specialized intermediaries also reduce market frictions in financial markets at various stages of the asset lifecycle. 

Meanwhile, the IFM observed that tokenization works best when assets and money flow smoothly. The fund also noted that it is easier to accumulate debt through tokenized markets because investors or institutions can use the tokens as collateral to borrow and invest elsewhere.  

“But physical assets cannot be fully digitalized—they still require physical care to maintain their value…The tokenization of nonfinancial assets is best seen as a hybrid between physical and financial technology.”

–Itai Agur, Senior Economist at the IMF

However, Agur also argues that while the programmability of tokenized assets makes it easier to develop sophisticated financial products, regulators may not fully understand the inherent risks until it is too late. He pointed out that this was the situation back in the 2008-09 crisis, as the programmability of tokenized assets made it harder for regulators to track potential risks. 

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