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FRM Part II · FRM Exam Part II · Tokenization and Financial Market Inefficiencies

A regulator assesses a tokenized securities platform where legal ownership is recorded on a distributed ledger. A coding error in the settlement smart contract wrongly transfers tokens worth USD 40 million. The ledger is immutable, and the legal framework in the jurisdiction does not clearly state whether on-chain records or the court-recognized register prevail. Which assessment is most appropriate?

The error is a combined operational and legal risk. The smart contract bug is an operational failure, immutability makes correction difficult, and the unclear legal status of on-chain records leaves settlement finality and ownership uncertain. Immutability does not eliminate risk, and VaR on token prices would not capture this exposure.

  1. AThe risk is purely operational and is eliminated because the ledger is immutable
  2. BThe risk is purely market risk and should be captured by VaR on the tokens
  3. CThe error combines operational and legal risk, because immutability hinders correction while legal finality of on-chain transfers is uncertainCorrect
  4. DThe risk is only liquidity risk, because the tokens can be sold quickly

Explanation

A smart contract bug is operational risk, and immutability makes reversing it harder. Uncertainty about whether on-chain transfers are legally final adds legal risk and settlement finality concerns. Immutability does not remove risk and the loss is not a market price move.

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