Optimal design of tokenized markets

Trades in today's financial system are inherently subject to settlement uncertainty. This paper explores tokenization as a potential technological solution. A token system, by enabling programmability of assets, can be designed to eradicate settlement uncertainty. We study the allocations achieved in a decentralized market with either the legacy settlement system or a token system. Tokenization can improve efficiency in markets subject to a limited commitment problem. However, it also materially alters the information environment, which in turn aggravates a hold-up problem. This limits potential gains from resolving settlement uncertainty, particularly for markets that depend on intermediaries. We show that optimal design hinges on joint design of settlement and trading systems, and in particular, that token systems work best when matched with direct trading.