Tokenized index funds: A blockchain-based concept and a multidisciplinary research framework

Abstract

In response to the bleak prospects of today’s financial markets, a wave of financial and technological innovations emerges, bringing about potential benefits but also new challenges. For instance, tokenized securities are a new kind of blockchain-based asset enabling price stability, programmability, pseudonymity, and transaction efficiency, while also introducing new regulatory challenges and uncertainties. Conversely, index funds are an established investment device enabling broad diversification in a cost-effective, tax-efficient, and transparent way, while potentially also contributing to concentration of market power, intermediation cost, access barriers for underbanked or impoverished investors, increased market volatility, and human behavioral challenges. This paper conceptually develops Tokenized Index Funds as a hybrid approach that combines the benefits of tokenized securities and index funds while alleviating some of their drawbacks. Based thereupon, a corresponding multidisciplinary research framework is presented, with sample research questions along the activities of design and features, business and economics, management and organization, and law and regulation.

Full text

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Tokenized Index Funds: A Blockchain-based Concept and a
Multidisciplinary Research Framework
Raffaele F Ciriello, University of Sydney, raffaele.ciriello@sydney.edu.au
This is a preprint of an article published in the International Journal of Information
Management at https://doi.org/10.1016/j.ijinfomgt.2021.102400
Abstract: In response to the bleak prospects of today’s financial markets, a wave
of financial and technological innovations emerges, bringing about potential
benefits but also new challenges. For instance, tokenized securities are a new kind
of blockchain-based asset enabling price stability, programmability,
pseudonymity, and transaction efficiency, while also introducing new regulatory
challenges and uncertainties. Conversely, index funds are an established
investment device enabling broad diversification in a cost-effective, tax-efficient,
and transparent way, while potentially also contributing to concentration of
market power, intermediation cost, access barriers for underbanked or
impoverished investors, increased market volatility, and human behavioral
challenges. This paper conceptually develops Tokenized Index Funds as a hybrid
approach that combines the benefits of tokenized securities and index funds while
alleviating some of their drawbacks. Based thereupon, a corresponding
multidisciplinary research framework is presented, with sample research
questions along the activities of design and features, business and economics,
management and organization, and law and regulation.
Keywords: Blockchain, Index Funds, Tokenized Securities, Stablecoins, Finance,
Investing

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1. Introduction
Young people face grim financial prospects, as many currently live through their second
‘once-in-a-lifetime’ economic downturn: The aftermath of the Global Financial Crisis still
affects most economies while the long-term socioeconomic consequences of the COVID-19
pandemic remain to be seen (Dwivedi et al. 2020; He et al. 2020; Pandey & Pal 2020). As ever
more people live paycheck to paycheck, with millions of households under- or unbanked,
very few can accumulate savings, let alone invest for retirement (FDIC 2017; Friedman 2020).
Further challenges of these generations include soaring housing prices, stagnating wage
growth, rising inequality, a demographic transition towards an ageing population,
automation-induced job displacement, as well as record-high individual, corporate, and
government debt (Bernstein & Raman 2015; CreditSuisse 2021; IMF 2021; WEF 2020). Even
those lucky enough to have the means to save and invest face diminishing expected returns
for conventional assets such as stocks and bonds, for which earnings decrease constantly – in
the case of bonds even into negative returns (Economist 2021).
In response to this bleak outlook, financial and technological innovations have sprawled in
recent decades, enabling new opportunities but also introducing unresolved challenges. Such
innovations include index funds, which emerged in the 1970’s, enabling broad diversification
in a cost-effective, tax-efficient, and transparent way (Cremers et al. 2016; Fernando 2020; Ferri
2006; Lim 2019). Index funds have grown massively to one of the dominant investment
instruments, especially after the widespread adoption of Exchange-Traded Funds (ETFs) (Sun
2021). Despite the general scientific consensus on the relative advantage of index funds and
ETFs over actively managed funds and hedge funds, index funds also face several challenges
(Cremers et al. 2016; Dichev & Yu 2011; Fama & French 2010; Sharpe 1991). Chiefly among
these challenges are a concentration of market power to the few largest providers;
intermediation cost charged by stockbrokers, exchanges, trading platforms, fund managers,
financial advisors, and others; access barriers for underbanked or impoverished individuals;
and human psychology leading to suboptimal trading, asset allocation, and fund selection
behavior (Ben-David et al. 2018; Boldin & Cici 2010; Choi et al. 2010; Sherrill et al. 2020).
More recently, blockchain-based assets emerge along with great public attention,
controversy, and speculation (Frizzo-Barker et al. 2020; Hughes et al. 2019; Upadhyay 2020).

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The ongoing public discourse on blockchain generally tends to fall into two polarized camps
of enthusiasts and sceptics fiercely disagreeing over what blockchain-based assets may or may
not be or become (Torbensen & Ciriello 2019). Compared to conventional assets, such as stocks
and bonds, blockchain-based assets have only existed for little over a decade, during which
extreme volatility was the norm, especially considering the spectacular rollercoaster rides that
accompanied first-mover cryptocurrencies like Bitcoin or Ether in the last five years
(CoinMarketCap 2021a). At the same time, staggering market capitalizations in excess of two
trillion USD and increased adoption by large institutional investors and corporations make it
hard to dismiss blockchain-based assets altogether (Kovach 2021; Pirus 2021).
Against this backdrop, the most recent innovations in blockchain-based assets include
tokenized securities (Eichengreen 2019; Kranz et al. 2019; Smith et al. 2019). Contrary to
conventional cryptocurrencies, such as Bitcoin, whose value derives largely from artificial
scarcity and expected future demand (i.e., speculation), tokenized securities use blockchain
for the issuance, representation, and trading of an underlying asset, hence deriving their value
from a collateral. First applications of tokenized securities include tokenized real estate,
commodities, and fiat currency (Eichengreen 2019; EuropeanCommission 2020; Smith et al.
2019). Notably, so-called stablecoins (i.e., tokenized fiat currency) are increasingly adopted to
counter the rampant volatility of cryptocurrencies by offering price stability while also
enabling the benefits of a blockchain-based asset, such as decentralization, transparency,
security, and programmability. However, due to being pegged to fiat currency, stablecoins
are unattractive as an investment, difficult to sustain economically, and subject to
counterparty risk due to recentralization (Eichengreen 2019).
In a nutshell, index funds and tokenized securities are promising financial and
technological innovations offering potential benefits for individual investors while also
introducing new challenges. Prior finance research has not yet explored the potentials of using
blockchain technology to tokenize index funds; neither has prior blockchain research drawn
attention to the tokenization of index funds. Sometimes two things can be improved by
putting them together. As synergies between index funds and tokenized securities are not yet
understood, this paper explores how blockchain technology enables the tokenization of index funds.
This research question is answered by conceptually developing the Tokenized Index Fund
(TIF) as a hybrid, blockchain-based approach that combines the benefits of tokenized

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securities and index funds while alleviating some of their drawbacks, which are summarized
in sections 2 and 3. Next, Section 4 shows how TIFs can be implemented via ETF-backed
collateralization and demand-side arbitrage, enabling peer-to-peer transactions,
fractionalization, customizability, access, liquidity, automation, transparency, and secure
record-keeping – all of which could significantly benefit investors, intermediaries, firms, and
technology providers. Section 5 presents a corresponding multidisciplinary research
framework with sample research questions along the activities of design and features,
business and economics, management and organization, and law and regulation. Section 6
discusses theoretical and practical implications and Section 7 sums up key takeaways.
2. Tokenized Securities
Cryptocurrencies, such as Bitcoin or Ether, are contested. Enthusiasts propagate their value as
peer-to-peer payment system and digital store of value (Salcedo & Gupta 2021). Nobel Prize-
winning economists such as Joseph Stiglitz and Paul Krugman condemn them as bubble,
Ponzi scheme, and environmental disaster (Panisch 2018). Legendary investor Warren Buffet
called Bitcoin “rat poison squared” (Kim 2018). For many, cryptocurrency remains a solution
in search for a problem (Frizzo-Barker et al. 2020; Lodha 2020).
Volatility is a major roadblock to cryptocurrency adoption. Bitcoin’s volatility relative to
the US Dollar is ten times higher than between conventional currencies (Yermack 2013).
People are unlikely to pay for a coffee in Bitcoin if this sets them back five dollars today and
fifty dollars tomorrow. Coffee baristas would not be entirely happy either to receive their pay
in something that could lose over 90% of its worth over night. Due to this extreme volatility,
cryptocurrency trading is viewed to be largely driven by short-term speculation (Georg &
Dube 2017), rather than long-term investment (Ervin 2020). Generally, a speculator hopes to
profit from short-term price fluctuations, whereas an investor acquires an asset with the
expectation that the invested capital appreciates and generates earnings over the long-term
(Nguyen 2020).
Compared to conventional assets (such as stocks, bonds, or commodities), cryptocurrencies
have only been around for little over a decade. Hence, their suitability as a long-term
investment vehicle is uncertain. Complicating matters, the adoption of blockchain-based
assets is a complex and multidimensional phenomenon that needs to account not only for

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market factors (such as volatility, liquidity, and other aspects of market structure) and
technical factors (such as the design of the blockchain technology), but also institutional
factors (such as legislation and governance) (Janssen et al. 2020; Upadhyay 2020). Hence, first-
generation cryptocurrencies, such as Bitcoin or Ether, are often viewed as an object of
speculation, unsuitable for prudent long-term investors (Georg & Dube 2017; Nguyen 2020).
Tokenized securities can curtail the rampant volatility of cryptocurrencies by pegging their
value to a collateral, typically fiat money (such as US Dollars or Euros), commodities (such as
gold or silver), real estate, or other cryptos (Eichengreen 2019; Smith et al. 2019). For instance,
Tether is the most widely used, fully collateralized stablecoin with a one-to-one peg to the US
Dollar. In this case, a corporation (Tether Limited) maintains this peg by issuing or redeeming
Tethers (tokenized US dollars) for the respective deposit or withdrawal of US dollars to or
from a regularly audited bank account. Tether’s trading volume now exceeds that of all other
cryptocurrencies, including Bitcoin (CoinMarketCap 2021c).
Contrary to central banks, which usually maintain a peg by controlling the supply of a
currency (such as the Danish Kroner peg to the Euro), demand-side arbitrage between Tether
users and Tether Limited leads to a stabilization of the peg. Demand-side arbitrage has
effectively maintained the Tether peg to the US dollar, even throughout the Coronavirus-
induced economic downturn in 2020 (Lyons & Viswanath-Natraj 2020). By extension,
tokenization of securities could offer similar advantages to other kinds of assets, such as real
estate or stocks (EuropeanCommission 2020; Smith et al. 2019).
2.1. Benefits of Tokenized Securities
Due to their novelty, the expected benefits of tokenized securities are uncertain, but
somewhat better understood in the special case of stablecoins (EuropeanCommission 2020).
Stablecoins are seen as favorable to their more speculative counterparts even by
cryptocurrency critics, as they offer price stability and predictability (Eichengreen 2019). This
makes stablecoins suited for payment, though less so as an investment that is expected to
grow in value over time. Compared to the conventional US Dollar, stablecoins offer the
pseudonymity, accessibility, speed, and security of peer-to-peer transactions offered by other
cryptocurrencies (Ali et al. 2020).

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If widely adopted, government and public institutions could use stablecoins to create a
digital currency that would facilitate new modes of fiscal policy. For instance, in economic
downturns, central banks could simply drop digital currency into the wallets of eligible
citizens, as an efficient way to distribute stimulus checks. Central banks around the world are
exploring the potentials of digital currency (Eichengreen 2019), as are corporations. Notably,
PayPal currently rolls out support to pay in various cryptocurrencies (BBC 2020b), and
Facebook plans to roll out its native cryptocurrency Libra which, very similar to stablecoins,
would be pegged to fiat currency (BBC 2020a).
2.2. Drawbacks of Tokenized Securities
Tokenized securities and stablecoins like Tether are very much in their infancy, facing
many known and unknown drawbacks (Tething problems, if you will). These include:
Recentralization. An issuer needs to act as central entity to issue and redeem tokens, as is the
case with the Tether Limited corporation for Tether. This contradicts the principles of
decentralization, on which the many cryptocurrencies are built, questioning the desirability
of such a solution (Eichengreen 2019; Lyons & Viswanath-Natraj 2020).
Counterparty risk. As a result of recentralization, tokenized securities introduce a counterparty
risk: users need to trust the issuer and its auditors to maintain the peg through sufficient
collateralization and appropriate issuance and redemption of tokens. Notably, Tether has
been suspected to maintain insufficient reserves of its collateral (Eichengreen 2019).
Declining purchasing power. Even assuming widespread adoption, the very characteristic of
being pegged to fiat currency makes stablecoins unsuitable as a store of value or investment.
Like fiat currency, stablecoins are almost guaranteed to decline in real purchasing power over
time due to inflation (Eichengreen 2019). In times of ongoing expansive monetary policy and
low interest rates, which have dominated modern economies throughout more than a decade,
stablecoins are equally unsuitable as cash for investing.
Questionable economic sustainability. Declining purchasing power is not only a nuisance for
investors, but also a threat to the sustainability of stablecoins. Because the collateral must be
committed in low-yielding currency (in the case of Tether Limited, in US Dollars), the only
way by which the issuer can generate earnings (and thus cover the expenses of maintaining
the peg), is to charge transaction fees. Whether or not these fees make stablecoins an attractive

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alternative to simple bank transactions remains to be seen. At the time of writing, only 24
stablecoins are operational at the international level, all of which are expected to incur higher
long-term cost than other crypto-assets (EuropeanCommission 2020).
The following section shows that some of these disadvantages can be overcome by
tokenizing index funds, rather than fiat currency.
3. Index Funds
An index fund follows a rule-based investing strategy to hold a representative collection
of stocks in the same ratio as an underlying stock index, modifying holdings only as
companies enter or leave the index (Fernando 2020; Ferri 2006; SEC 2020). Index funds may
not only hold stocks but also bonds, commodities, or other assets. For simplicity, the focus is
here on stock market index funds – the dominant form of index funds – but the key concepts
apply to other kinds of index funds. A stock market index is a statistical tool that tracks the
performance of a basket of company stocks (Feuerriegel & Gordon 2018). The most widely
observed stock market index today is the S&P500, which tracks the performance of 500 large
US stocks. Its counterparts in other countries include the German DAX, British FTSE100,
Japanese Nikkei255, or Australian S&P/ASX200. Global stock market indices (such as the
MSCI World or FTSE All-World) or industry-specific stock indices (such as the NASDAQ-
100), are also commonly observed (ETFdb 2020).
Index funds have grown massively since the mid-1970s, particularly since the authorization
of exchange-traded funds (ETFs) in the US in 1992 and in Europe in 1999. Initially frowned
upon and ridiculed by competitors for the underwhelming ambition to receive just average
market returns, legendary investor John Bogle founded the Vanguard 500 Index Fund, which
tracks the S&P500 index, with relatively modest assets of $11 million in 1975 (Ferri 2006). The
fund passed the $100 billion milestone in 1999 and the Vanguard Group is one of the largest
fund providers in the world today alongside its competitor Blackrock Inc., both of manager
over US$7 trillion in assets as of 2020. Index funds now constitute nearly 14% of the US stock
market, up from 7% in 2010, and nearly half of all US equity fund assets are now passively
managed via index funds (Cox 2019; Feuerriegel & Gordon 2018; Lim 2019). From 2007
through 2017, index funds received $1 trillion in new net cash while actively managed funds
experienced a net outflow of $659 billion over the same period (ICI 2017; Lim 2019).

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3.1. Benefits of Index Funds
Investing in index funds has many advantages over other investment strategies (Fernando
2020; Lim 2019; Lin 2015):
Broad diversification. Compared to actively managed mutual funds or individual stock picking
strategies, where an investor actively selects and allocates capital to a usually small number
of stocks, index investing allows the investor to passively participate in the performance of
thousands of stocks by buying and holding just one position.
Cost-efficiency. An index investor can simply buy and hold an index fund and thereby gain
exposure to the entire index, rather than screening large numbers of stocks to evaluate
whether an individual stock is worth buying, holding, or selling, and then paying commission
on each individual trade. Since an index fund uses a rule-based approach rather than picking
individual stocks, the cost of active management can be reduced. The largest index ETFs have
annual fees of 0.03% of the amount invested or even lower, whereas actively managed mutual
funds usually charge upwards of 1% annually in fees (Lin 2015). Over long periods of time,
fees can diminish returns substantially.
Tax-efficiency. Because only one index fund is held in lieu of many individual stocks, index
funds are tax efficient and can even provide a tax advantage, particularly if they are held in a
taxable account.
Liquidity. Unlike hedge funds or mutual funds, index ETFs can be traded throughout the day
on stock exchanges, just like individual stocks.
Transparency. Compared to mutual funds, which do not always disclose their up-to-date
constituents, index ETF providers must publish their constituents daily (SEC 2019).
These benefits appeal to a broad range of investors. Notably, Nobel-prize laurate Eugene
Fama and co-author Kenneth French have shown that actively managed funds will either
underperform their benchmark index or the excess return will be consumed by fees, salaries,
and other cost (Fama & French 2010). If some active fund managers outperform the market, it
is dollar for dollar at the expense of other active fund managers – a zero sum game, in fact a
negative one after expenses (Sharpe 1991). Some active fund managers have also begun to
seize the benefits of ETFs. A recent study by Sherill et al. (2020) has shown that mutual funds’
transition to their benchmark ETF reduces their potential for downturn and performance lag.

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A related study by Cremers et al. (2016) has shown that competitive pressure from index funds
improves mutual fund performance, but only if these adjust fees and holdings accordingly.
Simply put, most investors would be better advised to buy low-cost index funds. To illustrate
this point, Warren Buffet famously bet in 2007 against hedge fund managers that most funds
will underperform the S&P500 index over a 10-year period after fees – he won the bet by a
huge margin (Buffett 2017; Floyd 2019). This should not come as a surprise to anyone remotely
familiar with the academic literature on mutual fund performance since Jensen’s (1968)
seminal paper, after which studies upon studies have shown that hedge funds reliably
underperform index funds, in many cases so badly that they barely outperform the risk-free
rate of government bonds, with the worst-performing hedge funds often charging the highest
fees (Amin & Kat 2003; Baks et al. 2001; Chen et al. 2004; Cumby & Glen 1990; Dichev & Yu
2011; Gil-Bazo & Ruiz-Verdú 2009).
In short, the empirical evidence clearly suggests that hedge funds should be avoided, and that
passively managed index funds should be preferred over actively managed mutual funds.
3.2. Drawbacks of Index Funds
As with every financial instrument, some drawbacks need to be considered with index funds.
Tracking error. It is impossible to track an index with perfect accuracy, as the statistical models
for sampling an index cannot be 100 percent accurate. Tracking error refers to the difference
between the performance of an index fund and its underlying index. Well-run S&P500 index
funds have tracking errors of 5 basis points (5-hundreths of one percent) or less, however
larger tracking errors are possible, particularly for smaller and more specialized index funds
(Rudolf et al. 1999; Strub & Baumann 2018; Tergesen & Young 2004).
Intermediation cost. Investors need to purchase index fund shares from a stock exchange via a
stockbroker who may charge trading fees, brokerage commission, and other fees. Other
intermediaries incurring additional costs may include banks, financial advisors, or tax
advisors.
Concentration of market power. As the index fund industry continues to grow, the three largest
index fund providers (BlackRock, Vanguard, and State Street) each manage trillions of US
dollars in assets. As these intermediaries can potentially hold very high stakes and therewith
associated voting rights in indexed companies (Fichtner et al. 2017), investors need to trust

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them to act in their best interest. Such intermediation typically prompts blockchain
proponents to argue for disintermediation (Ali et al. 2020; Frizzo-Barker et al. 2020; Janssen et
al. 2020; Upadhyay 2020).
Barriers to access. Investors need access to capital markets to purchase index fund shares. Such
access is not granted in countries without a stock exchange, which include many developing
nations (Wikipedia 2020). Even in countries with a stock exchange, many people cannot invest
in index funds because they are underbanked or impoverished. For instance, the Federal
Deposit Insurance Corporation (FDIC) estimated in 2017 that 6.5% of US households (around
14 million adults) were unbanked, meaning no one in the household has a bank account and
hence cannot access stock exchanges either (FDIC 2017). Even those who might in principle
have access to capital markets might not be able to afford investing in them, as index fund
shares can only be traded in one piece. With about half of Americans living paycheck to
paycheck (Friedman 2020), one can reasonably assume that a large part of the population
cannot afford the sometimes hundreds of dollars per piece at which index funds are traded.
Moreover, many otherwise qualified investors might simply not know about index funds.
Increased volatility: Early findings from recent studies suggest that ETF ownership and index
membership may increase the negative autocorrelation in stock prices and hence increase
volatility of stocks (Ben-David et al. 2018). In times of market downturns, selling hysteria
among ETF holders may put further downward pressure on financial markets.
Behavioral challenges: Even assuming that index funds are a rational investment, behavioral
studies have shown that people often behave in unexpected and irrational ways. For instance,
the so-called index fund paradox – people’s tendency to select suboptimal index funds based
on past performance rather than more effective criteria such as fees – has been empirically
documented for over two decades (Boldin & Cici 2010; Choi et al. 2010; Elton et al. 2002).
Further, studies suggest that investor demand for advice is inelastic: people prefer to pay
higher fees for advisors that recommend suboptimal products. This explains why index funds
have not brought down fees substantially several decades after their invention (Sun 2021).
Complicating matters, investors often trade ETFs frequently due to their high liquidity and
ease of trade, thereby diminishing potential returns and creating information inefficiencies
(Glosten et al. 2021). Lastly, the advent of highly specialized ETFs (such as leveraged ETFs,
sector ETFs, smart beta ETFs, etc.) has made index fund choice more complex.

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The following section shows that Tokenized Index Funds - a combination of tokenized securities
and index funds - can help to overcome some of these disadvantages.
4. Tokenized Index Funds: A Blockchain-Based Concept
Tokenized Index Funds (TIFs) are a special case of tokenized security that uses blockchain
technology to tokenize an index fund. Much in the same way that a stablecoin such as Tether
matches the price of the US dollar by pegging its value to a collateralized reserve of US dollars,
a TIF token matches the price of a stock index such as the S&P500 by pegging its value to a
collateralized reserve of ETF shares. Figure 1 illustrates the concept, and the key mechanisms
are explained below.
Figure 1. Tokenized Index Funds: A Blockchain-Based Concept
1) ETF-backed collateralization: To effectively maintain a peg to a stock market index, an issuer
acting as a central legal entity (such as a limited liability corporation, a foundation, or a
consortium of organizations) must verifiably hold ETF reserves tracking the index matched by
the exact same number of TIF tokens to be pegged to the index. As an illustration, an issuer
could hold equal amounts of shares in an S&P500 ETF (or similar) and TIFs as a reserve. This
issuer may use a blockchain token sale (Kranz et al. 2019) to raise funding for ETF shares.
TIF Foundation
ETF
Reserve
TIF
Reserve
1:1
TIF User
ETF
in
TIF
issued
TIF
redeemed
ETF
out
+
-
TIF User
TIF User
TIF
received
TIF
sent
Foreign Exchange TIF/Fiat exchange Cryptocurrency
Exchange
TIF/Crypto exchange
1) ETF-backed
collateralization
2) Demand-side arbitrage
4) Trade
3) P2P
payment

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2) Demand-side arbitrage: Whenever the price of one TIF token deviates from that of one ETF
share, TIF users are incentivized to trade TIF tokens for ETF shares (or vice versa) with the
issuer. Rather than the issuer acting like a central bank that controls the supply of TIF tokens,
TIF users have an incentive to maintain the peg through a demand-side arbitrage mechanism
(Lyons & Viswanath-Natraj 2020).
When the TIF token trades at a premium (one TIF token is more expensive than one ETF share),
TIF users have an incentive to sell ETF shares to the issuer in exchange for TIF tokens (Lyons
& Viswanath-Natraj 2020). The issuer then needs to match the resulting imbalance between its
TIF and ETF reserves by issuing new TIF tokens, hence increasing the amount of TIF tokens in
circulation through which their price will decrease. Conversely, when the TIF trades at a
discount (one TIF token is cheaper than one ETF share), users have an incentive to exchange
TIF tokens for ETF shares with the issuer, who will then redeem the received TIF tokens to
match the resulting decrease of ETF reserves it now holds, thereby reducing the circulating
supply of TIF tokens and increasing their price.
Studies have shown that this demand-side arbitrage mechanism is effective and robust in the
case of Tether, provided that the issuer is trusted, regularly audited, and that there is a
sufficiently large pool of accredited users who can trade tokens for collateral with the issuer
in a sufficiently efficient manner (Lyons & Viswanath-Natraj 2020). The crux is that the issuer
and TIF users, who wish to act as arbitrageurs, would need to be accredited by the financial
regulator to trade equities in exchange for cryptocurrency.
3) Peer-to-peer payment: Like any other cryptocurrency, TIF tokens could be sent to and received
from users via a digital wallet. This would enable a range of use cases that are not possible
with conventional ETF shares. For instance, private individuals could send each other TIF
tokens across national boundaries at very low cost and at very high speed, providing access to
index investing instruments for people who would otherwise not have access to capital
markets or investment services.
Using TIF tokens as a form of payment is also conceivable, since TIF tokens can be expected to
be relatively stable compared to conventional cryptocurrencies. Also, employees could choose
to receive employer contributions into their government-regulated pension accounts (such as
401k in the US or Superannuation in Australia) in the form of TIF tokens, thereby reducing

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fees and cost of operation. This would also reduce the need for financial intermediaries, such
as stockbrokers.
4) Trade: The same mechanism enabling peer-to-peer payment would also facilitate
corporations to act as exchanges that trade TIF tokens. For instance, a cryptocurrency
exchange, such as Coinbase or Binance, could facilitate trade between TIF tokens and other
cryptocurrencies such as Bitcoin or Ether. Similarly, foreign exchange markets could facilitate
trade between TIF tokens and fiat currency such as US Dollar or Euro. If widely adopted and
pegged against a major global stock index such as the MSCI World, or FTSE All-World, this
would effectively introduce TIF tokens as a global reserve currency that is backed by the world
economy, rather than by the promise of governments and central banks.
4.1. Potential Benefits of Tokenized Index Funds
Fractionalization and access. Contrary to ETF shares that can only be bought in one piece, TIFs
can be broken down into fractions with very small digital units (such as six or more decimal
places), allowing impoverished investors to participate with only few dollars or even cents. In
addition, TIFs would allow people without access to capital markets to participate in the
returns of major stock indices (Roth et al. 2019; Smith et al. 2019). Hence, TIFs could be a way
to increase financial inclusion in emerging markets (Schuetz & Venkatesh 2020).
Disintermediation, cost-efficiency, and premiums. Contrary to index fund shares, which can only
be bought on stock exchanges via stockbrokers from index fund issuers, TIFs provide
investors with the possibility to buy and sell an index-tracking financial instrument directly
from each other, from the central issuing entity, or from cryptocurrency exchanges and foreign
exchanges. This could result in increased price competition and lower fees, especially in the
case of cross-border transfers. Anecdotal evidence suggests transaction cost via stablecoins
tend to be less than one percent of the transferred amount, compared to upwards of two to
four percent for traditional cross-border payments (EuropeanCommission 2020). Moreover,
as with stablecoins, arbitrageurs can profit from premiums (Lyons & Viswanath-Natraj 2020).
Customizability and automation. Due to their digital representation, TIFs are programmable and
extensible, allowing for automation of payments and other generative innovations (Ciriello et
al. 2018b). For instance, TIFs could make pension funds, employer pension schemes, and
government pensions more efficient via smart contracts. This could also reduce the cost of

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firm operations, such as dividend payments or share splits (EuropeanCommission 2020).
Additionally, once a wide range of stock market indices would be tokenized, various TIFs
could be combined to allow for fine-grained customized portfolio allocations (Roth et al. 2019;
Smith et al. 2019), enabling market engineering innovations (Notheisen et al. 2017).
Transparency and secure recordkeeping. Due to their representation on a blockchain, ownership
of TIFs can be transparently represented on a distributed network (Ali et al. 2020). This could
also reduce vulnerability of cyberattacks, increase resilience in times of crises (Dwivedi et al.
2020), enhance transparency of investors, accelerate due diligence processes, and lower the
costs of business continuity plans, compared to the common practice of running a parallel
recovery system (EuropeanCommission 2020).
Predictable volatility. TIFs will by nature be as volatile as their underlying index. Compared to
conventional cryptocurrency, the price of TIFs is pegged to a collateral and thus predictable.
While short- and mid-term price fluctuations are impossible to anticipate in any market, TIFs
can be expected to grow in value alongside index ETFs over the long term. The principles of
index investing apply equally to TIFs.
Liquidity. As a result of lowered barriers to entry, publicly traded corporations that are listed
on an index tracked by a TIF will have more access to capital to grow their business, since new
categories of investors can be reached (EuropeanCommission 2020).
Digital nudging: Due to their programmability, TIFs can be designed to nudge people towards
desirable investing behavior (Weinmann et al. 2016). For instance, considering the above
drawbacks of index funds, TIFs could use smart contracts to enforce a minimum holding
period, to encourage long-term investing and prevent excessive trading activity that could
exacerbate market volatility, especially in turbulent times.
4.2. Potential Challenges of Tokenized Index Funds
Regulatory uncertainties. Regulatory frameworks for blockchain-based assets are in their
infancy (Pandey & Pal 2020; Sandner 2020), and hence the regulatory compliance criteria for
issuers and traders would have to be determined. TIFs represent a special category of
tokenized securities, which have seen very little regulatory progress so far. Whereas initial
studies have focused on tokenized securities in the real estate sector (EuropeanCommission
2020; Kumar et al. 2019; Smith et al. 2019), studies on TIFs are inexistent. Existing legal

- 15 -
frameworks in most jurisdictions do not fit well with the use of blockchain in existing financial
market infrastructures (Smith et al. 2019), and a recent study shows that 77 percent of
respondents think regulatory uncertainty will hinder the development of tokenized securities
(EuropeanCommission 2020). From a technical viewpoint, the interoperability of blockchain-
based systems with existing financial markets infrastructure poses a challenge (Ali et al. 2020;
He et al. 2020). Hence, appropriate regulation will be crucial to realize the benefits of TIFs.
Taxation issues. The taxation of capital gains from TIFs depends on whether the financial
regulator regards TIFs as securities, financial derivatives, or commodities. Securities and
derivatives are both strictly regulated, and it is highly uncertain whether TIFs would meet
these regulatory criteria. Over-the-counter traded derivatives are less strictly regulated but
this usually comes at the cost of very complex taxation. Some countries, such as Germany,
regard cryptocurrencies as commodities, which means capital gains are tax-free if the asset has
been held more than one year. Hence, appropriate taxation laws are crucial for TIFs.
Threat of illegal activity and fraud. As with other cryptocurrencies, the pseudonymity of peer-to-
peer payments with TIFs might be used for illegal activities such as tax evasion, money
laundering, drug trade, and so on. Fraud is also very common in the issuance of blockchain-
based assets and hence new guidelines for investor and consumer protection are necessary
(EuropeanCommission 2020).
Threat to market integrity. In the event of extreme market downturns, the issuer might not be
able to settle all transactions without running out of index fund reserves, particularly if the
issuer engages in securities lending or total return swaps with the collateral. Moreover,
assuming TIFs would become systemic at a global scale, their interconnectedness with existing
financial markets could be increased, potentially introducing new forms of systemic risk.
Notably, panic-selling might exacerbate downward pressure during a market downtown
(Ben-David et al. 2018; EuropeanCommission 2020). This adds to the need for appropriate
regulation and legislation to support the development of TIFs.
Uncertain economic viability. It will be challenging for the issuer to maintain the peg in an
economically viable way – especially considering the potentially high cost of meeting
regulatory compliance criteria and transaction fees for trading index fund shares for TIFs, as
well as the potentially complex tax implications of such trades. For many investors

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(particularly those with access to high quality stock markets, financial services, sufficient
funds, and trust in the existing infrastructure) index funds will likely remain the preferred
choice. As such, TIFs are likely to digitally enhance and complement index funds, rather than
substitute them. Developing appropriate business models will be crucial for success of TIFs.
Counterparty risk. TIFs introduce a counterparty risk in that the issuer is contractually obliged
to maintain the peg. Notably, a moral hazard emerges if a malicious issuer could profit by
selling off all its index ETF and TIF reserves at once and thereby render the TIF worthless in
an instant. Regular audits by independent, trusted accounting firms could help mitigate that
risk. Alternatively, the peg could also be maintained by a decentralized autonomous
organization. By analogy, the USD Coin is a stablecoin pegged to the US Dollar, yet unlike
Tether, a consortium maintains the peg, rather than a single company (Kharif 2018).
Tracking error. Just as index funds can never track an index with perfect accuracy, TIFs can
never track an index fund with perfect accuracy. Hence, to avoid negative feedback loops, one
challenge is to curtail the tracking error, for which sufficient collateralization and a sufficiently
large pool of trustworthy, accredited arbitrageurs are necessary.
Behavioral challenges: As with every technology, people might use TIFs in unanticipated and
unintended ways. In particular, there is still much to learn about the paradoxical effects of
blockchain technology on user behavior (Ciriello et al. 2018a).
5. Tokenized Index Funds: A Multidisciplinary Research Framework
This paper conceptualizes Tokenized Index Funds as a hybrid approach to combine the
benefits of tokenized securities and index funds while alleviating some of their drawbacks.
Rational long-term investors would be well-advised to be skeptical of both stablecoins and
conventional cryptocurrencies. Whereas stablecoins promise to offer lower price volatility
than non-pegged cryptocurrencies, their near-guaranteed declining purchasing power
basically eliminates their attractiveness as an investment. On the other hands, while index
funds introduce a low-cost, broadly diversified, tax efficient, liquid, and transparent
investment vehicle, there are also barriers to access and intermediation cost that limit their
widespread adoption, particularly for underbanked and impoverished investors. Table 1
summarizes and compares the potential benefits and drawbacks of stablecoins, index funds,
and Tokenized Index Funds.

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Table 1. Comparison of Stablecoins, Index ETFs, and Tokenized Index Funds
Examples
Benefits
Drawbacks / Challenges
Stablecoins
Tether (USDT), USD
Coin (USDC)
Price stability, pseudonymity,
accessibility, speed, security.
Recentralization, counterparty risk,
declining purchasing power,
questionable economic sustainability.
Index ETFs
SPDR S&P500 ETF
(SPY), iShares Core
S&P500 ETF (IVV),
Vanguard S&P500 ETF
(VOO)
Broad diversification, cost-
efficiency, tax-efficiency,
liquidity, transparency.
Tracking error, intermediation cost,
concentration of market power, access
barriers, behavioral challenges.
Tokenized
Index Funds
None
(Conceptually: this
article)
Fractionalization, access,
disintermediation, cost-
efficiency, premiums,
customizability, automation,
transparency, secure record-
keeping, predictable volatility,
liquidity, digital nudging.
Regulatory uncertainties, taxation
issues, threat of illegal activity and
fraud, threat to market integrity,
uncertain economic sustainability,
counterparty risk, tracking error,
behavioral challenges.
As there is much to be learned about TIFs, Table 2 presents a multidisciplinary research
framework. Building upon dimensions suggested by earlier IS research frameworks (Aral et
al. 2013; Kranz et al. 2019; Risius & Spohrer 2017), researchers should examine the implications
of TIFs at the level of investors, intermediaries, technologies, and firms. Each level of analysis
contains research questions related to the areas of design and features, business and
economics, management and organization, and law and regulation. While by no means
exhaustive, this could inspire and guide further research on TIFs.

- 18 -
Table 2. Tokenized Index Funds: A Multidisciplinary Research Framework with Sample Research Questions.
Design and Features
Business and Economics
Management and
Organization
Law and Regulation
Level of
Analysis
How TIFs are designed and
their effects.
How TIFs create value and
how value is appropriated.
How TIFs are governed
and what strategies actors
employ.
How regulators create and enact
legal frameworks for TIFs.
Investors
(Retail and
institutional)
How can affordances such as
fractionalization,
customizability, automation,
transparency, and security
impact TIF adoption?
How do TIF design features
impact investment decisions?
How do TIF design features
impact investor confidence?
How do design features
impact TIF values and stock
valuations over time?
Which factors drive expected
returns from TIFs? What is the
role of the issuer’s reputation?
How can TIF risk be assessed
to optimize portfolios? What
interdependencies emerge
between stablecoins, index
ETFs, and TIFs?
How do volatility, liquidity,
and extreme market
downturns impact TIFs?
How can economic
sustainability of TIFs be
assessed?
How does issuer
governance impact stock
markets and TIFs?
What motivates private and
institutional investors to
participate in TIFs?
How will TIFs impact their
underlying collateral?
What systemic
interdependencies with
financial markets arise from
TIFs?
Which indices will be most
attractive to investors?
How to strengthen investor
protection in the face of
regulatory uncertainty for TIFs?
What information and reporting
requirements to impose?
How to identify and prevent
fraudulent TIFs? How to
facilitate criminal investigations?
How should financial regulators
regard TIFs (commodity, e-
money, security, or property)?
How to regulate TIF
arbitrageurs? How to regulate
insolvency and complaints?
Inter-
mediaries
(Exchanges,
auditors, service
providers)
How can intermediaries
enable trade, custody, and
transfer of TIFs?
How to design smart
contracts for TIFs to integrate
with existing financial
markets and institutions?
How can intermediaries
effectively design the peg to
an index fund collateral?
How can intermediaries create
value and be economically
sustainable?
What kinds of intermediaries
will emerge? Which ones are
at risk of disappearing?
To which degree will TIFs
lead to re- or decentralization
of index fund issuance?
How can emerging or
established intermediaries
organize in an TIF context?
How will existing and
emerging regulations
impact governance of
intermediaries?
How can intermediaries
increase confidence and
trust in TIFs?
How can intermediaries protect
and create value for investors?
How can market power be
distributed among TIF issuers?
How can TIF issuers and smart
contracts be audited?
How to regulate reporting
requirements?
Techno-
logies
(Blockchain,
middleware,
interfaces,
other systems)
How can blockchains be
designed to minimize
tracking error and maximize
security, scalability, and
efficiency of transactions?
Which blockchain
configuration and consensus
mechanism best balances
demands for security,
scalability, and energy-
efficiency?
How to establish
interoperability and
tradability of TIFs across
different platforms?
How do different blockchain
protocols impact the economic
viability of TIFs?
How do different
configurations of ETF-backed
collateralization and demand-
side arbitrage impact the
valuation of TIFs?
How do the valuations of TIFs
and collateral interact?
How can business continuity
be achieved?
How does the smart
contract and blockchain
configuration impact TIF
adoption?
How can TIF smart
contracts be evaluated?
What is the impact of the
issuer’s governance,
ownership, and control on
TIF adoption and success?
How does the TIF’s smart
contract impact the issuer’s
reputation and
trustworthiness?
How can TIF smart contracts
become a legal form of
settlement, transaction, and
investment?
How to identify and prevent
illegal activities with TIFs?
What technical requirements,
boundaries, and standards
should regulators set on TIF
smart contracts?
How should regulators regard
TIFs for different types of assets
(securities, bonds, commodities,
currencies)?
Firms
(Issuers,
publicly listed
companies,
financial firms)
How can TIFs be designed to
meet governance,
compliance, and risk
requirements of financial
firms?
How should sensitive
investor and transaction data
be handled to meet reporting
and privacy requirements of
financial firms?
How will the stock price of
firms listed in a collateralized
index be impacted by TIFs?
Which other use cases exist for
collateralized TIFs? What
other forms of collateral could
be used?
What role do established
financial institutions play for
TIFs (particularly index fund
issuers)? What opportunities
and challenges arise for them?
Will TIFs be more successful
than index ETFs?
What impact will TIFs have
on stock market
capitalization?
Under which conditions
will financial firms use TIFs
alongside or instead of
traditional index funds?
What new business models
will emerge from TIFs?
How will systemic global
TIFs impact the wider
economy?
How can TIFs be taxed
efficiently? How to detect and
prevent tax evasion?
How can cross-border TIF
transactions be taxed and
regulated?
What existing and emerging
financial regulations apply or
need to be adapted to TIFs (e.g.
KYC, AML)?
What capital and information
requirements should be
imposed?

- 19 -
6. Contributions and Implications
6.1. Research Contributions
The main contribution of this paper is to conceptually develop Tokenized Index Funds and a
corresponding multidisciplinary research framework. Whereas prior research has explored
the potential of tokenized securities for real estate, commodities, and fiat currency
(Eichengreen 2019; EuropeanCommission 2020; Smith et al. 2019), this paper is the first to
propose that TIFs could combine the benefits of tokenized securities and index funds.
Blockchain is a foundational technology enabling exciting opportunities for behavioral IS
research, design science research, and research on the economics of IS (Rossi et al. 2019). Given
the interdisciplinary nature of TIFs at the intersection of blockchain and finance, the IS
research community is ideally positioned to examine this emerging phenomenon from social,
technical, economic, and regulatory perspectives (Beck et al. 2017; Kranz et al. 2019). The
idiosyncratic potential benefits and threats of TIFs represent exciting research opportunities
that researchers should approach in a forward-looking way to design for desirable futures
and to avoid undesirable ones (Frizzo-Barker et al. 2020).
To that end, IS researchers should engage in interdisciplinary research collaborations with
experts in finance, law, regulation, market design, (behavioral) economics, and other related
areas to address the proposed research questions in Table 2. Within this framework,
researchers should explore TIFs through the lens of multiple IS theories and methodologies,
including technology adoption (Dwivedi et al. 2019), cultural values influencing usage
(Salcedo & Gupta 2021), appropriate IT governance arrangements (Riemer et al. 2020), socio-
technical perspectives (Sarker et al. 2019), design science research approaches (Hevner et al.
2004), and digital nudging (Weinmann et al. 2016).
6.2. Implications for Practice
Index funds and blockchain-based assets are on the rise. Both are economically and socially
impactful financial innovations. Index funds have grown steadily over the last decades to one
of the most important investment vehicles (Cox 2019; ICI 2017; Lim 2019). Blockchain-based
assets are increasingly adopted and gain economic significance (Kovach 2021; Pirus 2021).

- 20 -
This paper proposes that TIFs could lower the barriers to access and intermediation cost of
index funds while also offering more predictable volatility than conventional
cryptocurrencies and higher expected long-term growth in value compared to other
blockchain-based assets. In addition, TIFs could enable generative innovations by means of
their programmability. At the same time, unresolved challenges related to design, features,
business models, economics, management, organization, and governance need to be
addressed. Private and institutional investors, financial services firms, tech companies,
pension funds, governments, and legislators would all be well-advised to proactively embrace
change and shape desirable futures with the help of TIFs while also being mindful of the
social, economic, technological, and ethical challenges involved.
Private and institutional investors should take stock of their investment portfolios and be
mindful of the rapid pace at which novel financial and technological innovations emerge.
Index funds are and will most likely continue to be a proven way for broadly diversified long-
term investing. Blockchain-based assets are still in a discovery phase, and many of them will
not survive the early hype, but tokenized securities and TIFs are worth keeping an eye on.
Financial services firms should brace for the impact of blockchain that stands to transform the
finance industry in many ways (Ali et al. 2020). TIFs present huge opportunities but also
threats to large index fund providers, notably BlackRock or Vanguard, but also stockbrokers,
trading platforms, banks, and financial advisors, who would be well-advised to evaluate TIFs
as both an opportunity and threat to their business model. It would not be the first time for a
digital technology to disproportionately benefit early adopters while wiping out laggards.
Tech companies seeking to disrupt the finance industry through blockchain could find
inspiration in the TIF concept. Decisive questions include: how to create economically
sustainable business models, how to accredit a sufficient pool of qualified arbitrageurs, and
how to establish a trustworthy organization to act as TIF issuer.
Pension funds should consider the potential of TIFs and related blockchain technologies to
automate their operations and make pension schemes more cost-efficient and flexible due to
the programmability of blockchain-based assets.
Governments and legislators should put TIFs on top of their blockchain regulation agenda to
develop regulatory frameworks that enable financial and technological innovation through

- 21 -
blockchain and TIFs for social good. Pressing issues of taxation, market integrity, consumer
protection, as well as cybercrime prevention need to be addressed. Funding research on these
issues is vital.
6.3. Limitations and Future Research Direction
Readers should be mindful not to equate a concept with a business plan. Although TIFs are
conceptually conceivable and potentially beneficial, there are numerous possible futures for
TIFs. Whether these futures are desirable or undesirable depends largely on well-founded
design, business models, governance, and regulation. This paper makes a first conceptual step
in that direction and outlines many paths for future studies, but much further research is
required to answer the many open research question within and beyond the provided
multidisciplinary framework (Table 2).
7. Conclusions
As new financial and technological innovations emerge rapidly in response to the troubled
economic waters of recent years, IS researchers face exciting new opportunities to study their
benefits and threats in a forward-looking way to guide design for desirable futures.
This paper conceptualizes the Tokenized Index Fund (TIF) as a hybrid approach to index
funds and blockchain-based assets. It outlines numerous potential benefits (fractionalization,
access, disintermediation, cost-efficiency, premiums, customizability, automation,
transparency, secure record-keeping, predictable volatility, liquidity, digital nudging) and
challenges (regulatory uncertainties, taxation issues, threat of illegal activity and fraud, threat
to market integrity, uncertain economic sustainability, counterparty risk, tracking error,
behavioral challenges).
There is much to be learned about the design, features, business models, economics,
management, organization, legislation, and regulation of TIFs. IS researchers should engage
in multidisciplinary research collaborations with experts in these fields to explore how TIFs
can be designed, commercialized, governed, and regulated, and how TIFs would impact retail
and institutional investors, intermediaries (such as exchanges, auditors, and service
providers), technologies (blockchain, middleware, interfaces, and other systems), and firms
(issuers, publicly listed companies, and financial firms).

- 22 -
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