We develop a theory of liquidity transformation performed by market participants. An in-kind wrapper (e.g., a corporate bond ETF), issued by a fee-collecting sponsor, is a portfolio of illiquid OTC securities trading in the secondary market. Market makers clear the wrapper, dealers the OTC market, and authorised participants arbitrage between the two. The wrapper price is a public signal on which privately informed holders coordinate selling in stress. The informed sponsor values the wrapper off the same price, so a run affects its decision to close the wrapper and sell the portfolio at a fire-sale discount, leading to possibly self-fulfilling failure. We decompose failure into fundamental-driven and panic-driven components. We evaluate new stability instruments more relevant than deposit-era ones.
