Creation and redemption arbitrage is the mechanism that holds a fund token's traded price near its net asset value. When the token trades rich, an eligible participant delivers the underlying and mints new units to sell. When it trades cheap, the participant buys units and redeems them for the underlying. The SEC describes this as the reason exchange traded fund prices stay at or close to NAV, and the same structure is what a tokenized fund is borrowing.
The mechanism is not a property of the token. It is a property of the redemption channel, and if that channel is closed, slow, or open to nobody with capital, the price stops tracking NAV no matter what the contract says.
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The trade, in the order somebody actually does it
Suppose the token trades at 100.4 and NAV strikes at 100.0. A participant buys the underlying basket in the market for 100.0, delivers it to the fund, receives newly minted units at NAV, and sells them at 100.4. Forty basis points of gross spread, against the participant's costs of doing all of it. Supply rises, the premium compresses, and the trade stops being worth doing before the gap fully closes.
Run it the other way when the token trades at 99.6. The participant buys units cheap, files a redemption, receives the underlying at NAV, and sells the underlying. Supply falls and the discount compresses. Both directions are ordinary risk arbitrage, and both are only available to whoever is allowed through the primary channel.
What the ETF rule requires for the mechanism to exist
Rule 6c-11 puts three obligations on a covered exchange traded fund, and each one is load bearing. Issue and redeem creation units only to and from authorised participants, in exchange for a basket plus any cash balancing amount. Publish the portfolio holdings daily. Transact at net asset value.1 The daily holdings requirement is easy to skip past and it is the one that lets an arbitrageur price the basket at all.
The Commission's own adopting release states the point plainly: "The combination of the creation and redemption process with secondary market trading in ETF shares and underlying securities provides arbitrage opportunities that are designed to help keep the market price of ETF shares at or close to the NAV per share of the ETF."2 Note the word designed. The alignment is engineered, not emergent, and it can be engineered badly.
In a tokenized fund the authorised participant is a whitelist
The tokenized version keeps the shape and swaps the gatekeeper. Instead of a handful of designated broker dealers, the primary channel opens to whoever the transfer agent has verified and whitelisted. BlackRock's BUIDL runs it this way: an investor completes checks through Securitize, wires funds by a 2:30 PM ET cutoff, and receives tokens minted to a whitelisted wallet. Redemption reverses the path, with tokens due in the redemption wallet by 3:00 PM ET before the wire and burn.3
That is a wider door than the ETF model in principle and often a narrower one in practice, because the eligible set is whoever passed onboarding rather than whoever has the balance sheet to arbitrage. Two questions decide whether the mechanism is real. How many verified wallets could execute a round trip today. And how much capital do they have parked and ready. If the honest answers are three and not much, the peg is a document, not a market.
The mechanism prices forward, which caps how fast it works
Creation and redemption settle at the NAV next computed after the order, not at the NAV the arbitrageur saw when the trade looked attractive.4 That means the participant carries market risk between placing the order and the strike, and prices that risk into how wide a deviation has to get before they act.
Add the cutoff windows and the picture sharpens. An arbitrageur who spots a premium at 4:00 PM cannot act on it until the next window. The token keeps trading in the meantime. Deviation that appears after the cutoff has to survive until the next one, which is why intraday gaps in tokenized funds are routinely wider than the fee schedule alone would suggest.
Three ways the loop breaks
First, no eligible participant with capital. The contract permits creation and redemption, nobody is positioned to use it, and the price wanders on secondary flow. Second, a redemption channel that is asymmetric or shut. A vehicle that can create but not redeem has only an upper enforcement path, so a premium can persist without limit while a discount gets corrected. That asymmetry is a structural feature of the design, not a market accident.
Third, an opaque basket. If holdings are not published on the cadence the arbitrage needs, nobody can price the delivery leg, and the trade becomes a bet rather than an arbitrage. Rule 6c-11 makes daily publication a condition for exactly this reason.1 In our view this is the most commonly under specified item in tokenized fund documentation we review.
What to specify before the contract is written
Five lines, and they belong in the offering documents rather than the repository. Who may create and redeem, and how somebody joins that set. The minimum creation unit, because a unit too large excludes everyone who would otherwise enforce the band. Both fee legs, creation and redemption, stated separately. The cutoff and settlement windows on each leg. And the conditions under which redemption can be suspended, along with who decides.
That last line is the one nobody wants to write and the one that gets read first when things go wrong. A suspension power discovered during a stress event reads as a gate improvised under pressure. The same power, written down in advance with a named trigger, reads as a design. What the mechanism leaves uncorrected after all of this is the arbitrage band, and the width of that band is a cost the holder pays.
Common questions
How does creation and redemption arbitrage keep a token near NAV?
Eligible participants profit from any gap. When the token trades above NAV they deliver the underlying, mint units and sell them, which adds supply and compresses the premium. When it trades below NAV they buy units and redeem for the underlying, which cuts supply and compresses the discount. The SEC describes this combination as designed to keep market price at or close to NAV per share.2
What is an authorised participant?
In the ETF structure it is a designated institution with the contractual right to create and redeem shares directly with the fund at NAV, in creation unit sized blocks.1 Tokenized funds replace the designated firm with a whitelist maintained by the transfer agent, so eligibility follows onboarding rather than a dealer agreement. The practical question stays the same: who can actually execute the round trip, and with how much capital.
Why does a tokenized fund still trade away from NAV?
Because arbitrage is not free. The participant pays both fee legs, gas, custody friction and the cost of capital, and carries market risk from the order until the next NAV strike, since orders price forward.4 Any deviation smaller than that round trip cost is not worth correcting. What remains is the arbitrage band, and it widens when the underlying is slow or illiquid.
Does automating creation and redemption in a smart contract fix the problem?
No. Automation removes latency and the dealer intermediary, and it changes nothing about the two constraints that actually bind. Someone eligible still needs capital in position, and the underlying still settles at whatever speed it settles at. A contract that mints instantly against an asset that liquidates in two days has moved the mismatch, not removed it.
See RWA Tokenomics Design for how this applies in practice.
Sources
- 17 CFR 270.6c-11, Exchange-traded funds
Electronic Code of Federal Regulations, current
Codified conditions for a covered ETF: issue and redeem creation units to and from authorised participants against a basket, and publish portfolio holdings daily. - Exchange-Traded Funds, Release Nos. 33-10695; IC-33646 (Rule 6c-11 adopting release)
U.S. Securities and Exchange Commission, 2019
The Commission's statement that combining creation and redemption with secondary market trading provides arbitrage opportunities designed to keep market price at or close to NAV per share. - BUIDL: BlackRock USD Institutional Digital Liquidity Fund, asset page
RWA.xyz, 2026
Documented issuance and redemption lifecycle: transfer agent onboarding, 2:30 PM ET funding cutoff, mint to whitelisted wallet, 3:00 PM ET redemption cutoff, burn and wire. - 17 CFR 270.22c-1, Pricing of redeemable securities for distribution, redemption and repurchase
Cornell Law School Legal Information Institute, current
Forward pricing: primary market orders execute at the net asset value next computed after receipt, which is what leaves an arbitrageur carrying risk into the strike.
Last reviewed 2026-08
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