Tokenized Finance: What Are The Tradeoffs?

There’s a lot of talk about “digital currency,” but as far as I can tell, my bank account and retirement account, along with my credit cards and mortgage payments, have already been maintained in digital form for many years now. I benefit from greater speed, less paperwork, and probably greater accuracy, too. The genuinely new idea at present is “tokenization.” Tobias Adrian dispassionately lays out the potential risks and benefits in “Tokenized Finance” (International Monetary Fund, Note/2026/001, April 2026).

In the current conventional form of digital currency, money flows between institutions and their balance sheets: my credit card company pays the restaurant for my meal, at the end of the month my bank pays my credit card bill, my employer puts money into my bank account, and so on. The institutions in this system provide checks and balances, making sure the payments are correct. For example, maybe 2-3 times each year year I get an email from my credit card company asking if I have authorized a certain transaction. My answer is often “yes,” but sometimes “no.” As Adrian writes:

In traditional architectures, trust is embedded in regulated intermediaries, layered institutional processes, and the sequencing of settlement over time. … Financial sector policy frameworks have evolved around institutions, balance sheets, and markets that operate with temporal frictions: end-of-day settlement, batch processing, and delayed reconciliation. These frictions are not only costly to end-investors, but they also provide temporal buffers that allow exposures to be netted, liquidity to be mobilized, and authorities to intervene before settlement becomes final.

In the current form of digital money, the safety of transactions involves each main party having their own account, or “ledger,” which records payments made and received. Maintaining and checking these records involves a behind-the-scenes series of delays and double-checks, which imposes costs and fees. But tokenization is different. As Adrian writes:

Tokenization enables financial claims—including money, securities, and derivatives—to be represented as programmable digital tokens recorded on shared ledgers. This capability allows for real-time atomic settlement, collapsing multiple stages of the traditional financial value chain into a synchronized process … Tokenization challenges crisis management and resolution frameworks that are built around nationally domiciled institutions, territorially bounded infrastructures, and jurisdiction-specific legal authority. In tokenized systems, transactions are executed on shared ledgers spanning multiple jurisdictions, allowing assets, liabilities, and collateral to move across borders at machine speed and without a clear geographic anchor. This creates a fundamental mismatch between the global, continuous operation of tokenized finance and resolution regimes that rely on jurisdictional control over institutions and locally situated assets, as the key levers of control may instead lie in governance keys, consensus mechanisms, or smart contract logic operating across borders.

As Adrian puts it, the fundamental shift here is that instead of financial transactions being carried out, monitored, and double-checked by an interlocking set of institutions–each with their own ledger–a tokenized financial system would shift these responsibilities to the programming and infrastructure behind the tokenized system. There are obvious concerns about such an approach, which Adrian enunciates clearly:

As financial logic migrates into smart contracts, governance must extend beyond institutions to algorithms. In tokenized financial institutions, smart contracts calculate margin requirements, execute collateral transfers, and initiate default procedures. These functions are central to systemic stability, yet they are increasingly encoded in software. Therefore, the governance challenges concern not only code quality but also the processes that design, validate, modify, and, if necessary, override code.

Algorithmic risk differs from traditional operational risk in important aspects. Errors can propagate instantaneously and autonomously, without human intervention (FSB 2024). A faulty price feed or coding error can rapidly trigger cascading liquidations before authorities respond. The very features that make smart contracts efficient—speed, determinism, and automation—can also amplify the consequences of design flaws or data errors.

Therefore, effective governance requires multiple layers of control. Formal verification and independent audits should be mandatory for systemically important contracts. Change management processes must be transparent and subject to regulatory approval. Crucially, tokenized systems should incorporate clearly defined ex-ante intervention mechanisms in governance frameworks that allow contract execution to be paused or adjusted under predefined emergency conditions.

Tokenization embeds governance in code, which could be referred to as “code is law.” In important financial entities, legal mandates for stability must ultimately prevail over automated execution. Embedding this principle into technical design is one of the central policy challenges of tokenization (see Garrido 2023). When assets exist as tokens on a distributed ledger, questions arise regarding the applicable law, the location of the asset, and the enforceability of claims in insolvency.

Legal uncertainty is a major barrier to scaling tokenized systems beyond pilot projects. Market participants require clarity on whether tokenized records constitute a definitive proof of ownership and whether the settlement finality achieved on a ledger is legally recognized. Without such clarity, tokenized markets risk remaining fragmented and peripheral. A dual-layer legal approach is likely to emerge as best practice. Smart contracts define operational rules, whereas traditional legal agreements establish rights, obligations, and dispute resolution mechanisms. Legislators and courts must clarify the relationship between these layers, ensuring that legal certainty is preserved even as execution becomes automated.

I admit to skepticism about a broad-based shift to tokenized finance in the near term. I can see the potential benefits of a dramatic reduction in transactions costs, especially for transactions that are small, or international, or both. But trying to set up a single global financial ledger with a “code is law” framework seems to me a utopian project, with the stability of national and global economies at stake. Perhaps this just confirms my status as a 20th-century fuddy-duddy. But I’d prefer to see tokenized finance bubble up through the private sector first, and if and when it shows viability, scaleability, resilience, and stability in that context–or in response to the specific and limited problems that arise–then we can talk about possibilities for making tokenization more widespread.