Report

Composable Finance

Abstract: Composability—open interactions between assets and protocols—facilitates a modular financial architecture. I document the emergence of composed asset transformation, where tokenized assets are re-bundled to alter access, liquidity, and risk characteristics to broaden and enhance the set of tokenized U.S. dollar instruments. Yet, I argue that “naive” composability fundamentally conflicts with the provision of pooled arrangements needed for liquidity provision, risk-sharing, and capital backstops. I demonstrate this in an economy consisting of a vertical chain of protocols. Upper-layer protocols expand access to users, but bootstrap contingent liquidity from lower-layer protocols, resulting in a waterfall of externalities. In equilibrium, the base protocol rations liquid reserves, resulting in systemic illiquidity across the economy. Under severe circumstances, total utilization shrinks with composability. I offer principles and direction for building a sustainable, composable system.

JEL Classification: E42; G10; G20; D47;

https://doi.org/10.59576/sr.1177

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2026-01-01

Number: 1177