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

A risk manager reviews a tokenized fund on a permissionless public blockchain. The token's smart contract holds redemption logic and is upgradeable by a small group of developers holding administrator keys. Which risk is most directly highlighted by this design?

The most directly highlighted risk is governance and operational risk, because a few developers hold administrator keys and can change the contract code. This concentration of control creates key-compromise and misuse exposure, weakening the decentralization and immutability benefits that tokenization is often assumed to deliver.

  1. AInterest rate risk from the fund's duration
  2. BGovernance and operational risk from concentrated control over code and keysCorrect
  3. CBasis risk from hedging with futures
  4. DInflation risk from token supply growth

Explanation

Upgradeable contracts controlled by a few administrators create concentrated control, key-management exposure, and governance risk, which undermines the assumed trustless feature of the ledger. The other risks are unrelated to the described design feature.

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