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

A tokenized money market fund trades on a platform that is open 24/7, while the underlying assets are priced and settled only during business hours. A stress event occurs on a weekend, and token holders rush to redeem. Which combination of issues is most likely to arise?

Token prices are likely to fall below net asset value, because holders can sell continuously while the underlying assets cannot be liquidated until markets open. This liquidity mismatch encourages runs and discounts, since smart contracts cannot force par when the underlying assets are illiquid.

  1. AToken prices fall below net asset value because redemptions into the underlying cannot be processed until markets open, creating a liquidity mismatch and run riskCorrect
  2. BToken prices rise above net asset value because 24/7 trading always adds a liquidity premium
  3. CToken prices remain exactly at net asset value because smart contracts enforce par
  4. DToken prices become irrelevant because no investor can sell on a weekend

Explanation

Continuous token trading combined with asset conversion limited to business hours creates a mismatch between liquidity offered and liquidity available. In stress, secondary prices can fall below NAV and encourage runs. Smart contracts cannot enforce par if underlying assets cannot be liquidated.

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