Authors: Michael Junho Lee
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The New York Innovation Center bridges the worlds of finance, technology, and innovation and generates insights into high-value central bank-related opportunities.
The growing role of nonbank financial institutions, or NBFIs, in U.S. financial markets is a transformational trend with implications for monetary policy and financial stability.
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Staff Reports
Composable Finance
Number 1177
January 2026
January 2026
JEL classification: E42, G10, G20, D47
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.
Author Disclosure Statement(s)
Michael Junho Lee
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Suggested Citation:
Lee, Michael Junho. 2026. “Composable Finance.” Federal Reserve Bank of New York Staff Reports, no. 1177, January. https://doi.org/10.59576/sr.1177
Lee, Michael Junho. 2026. “Composable Finance.” Federal Reserve Bank of New York Staff Reports, no. 1177, January. https://doi.org/10.59576/sr.1177
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