Tokenized Fund BUIDL Represents the Use of Public Blockchain Technology by Traditional Institutions to Improve Operations and Capital Efficiency, Signaling a Wider Adoption of Blockchain Technology

By DigiFT

Abstract

• Introduction: On March 20, 2024, the well-known asset management company BlackRock issued the tokenized fund BUIDL (BlackRock USD Institutional Digital Liquidity Fund) in collaboration with the American tokenization platform Securitize, further expanding its influence in the Web3 field. This move closely followed the approval of its Bitcoin spot ETF, marking a significant advancement in mainstream cryptocurrency investment. The tokenized fund BUIDL represents the use of public blockchain technology by traditional institutions to improve operations and capital efficiency, signaling a wider adoption of blockchain technology.

• Problems Solved by Tokenized Funds: Traditional public offering funds, such as money market funds, involve operations by multiple institutions, leading to inefficiency and high costs due to independent databases. As tokens issued on public blockchains, tokenized funds eliminate the need for centralized registration, reducing costs by providing real-time, traceable transaction records. They achieve real-time atomic settlement and secondary market trading, improving capital utilization and providing higher returns. Tokenized funds also support various applications such as pledging and lending through smart contracts.

• Entry of Large Institutions into Public Chains: The DeFi sector has demonstrated the advantages of blockchain, but transferring traditional financial capital to Web3 faces significant resistance. Fund tokens with KYC and AML compliant whitelist control demonstrate mainstream institutions' efforts to explore DeFi. Examples include Franklin Templeton's FOBXX and WisdomTree's WTSYX, which initially used blockchain for auxiliary accounting. BlackRock's BUIDL, by using public blockchain as the primary accounting tool and partnering with Securitize as a regulated transfer agent, marks a breakthrough.

• Design and Performance of BUIDL: BUIDL is issued as an ERC20 token on Ethereum, supporting real-time on-chain transfers within the whitelist. It interacts with smart contracts and provides real-time USDC redemption through Circle. As of July 9, 2024, BUIDL's managed assets reached $502.8 million, held by 17 addresses, including significant participation from institutions such as Ondo Finance. BUIDL facilitates the integration of DeFi, channeling stable real-world returns into the DeFi sector.

• Challenges and Future Prospects: Despite BUIDL's success, it still faces significant regulatory and compliance challenges. The tokenization of assets faces conservative regulations globally, limiting issuance to qualified investors. However, initiatives by BlackRock and Franklin Templeton are drawing attention to the efficiency of on-chain interactions and driving the development of new laws and standards.

On March 20, 2024, the asset management giant BlackRock, following the issuance of the Bitcoin spot ETF, further expanded its presence in Web3 by collaborating with the US-based tokenization platform Securitize to issue the tokenized fund BUIDL (BlackRock USD Institutional Digital Liquidity Fund). While the approval of the Bitcoin spot ETF recognized cryptocurrency as a new asset class for mainstream compliant funds, the greater significance of tokenized funds lies in traditional institutions' efforts to utilize public blockchains as a new technology to improve operations and capital efficiency, signifying the recognition and adoption of blockchain technology.

What Problems Can Tokenized Funds Solve Compared to Traditional Funds?

The funds widely accessible to investors are generally public offering funds, such as money market funds, which are subject to strict regulation due to their low entry barriers, broad coverage, and large fund size. For example, the operation process of such funds involves collaboration among multiple institutions, with each institution responsible for a part of the fund's operations to improve efficiency through specialized operations and avoid excessive concentration of power by a single entity, preventing misconduct. The entire process typically includes fund distribution channels (banks, securities firms, financial advisors), fund administrative management, transfer agents, fund auditing, fund custody, and exchanges.

However, inconsistencies in the databases of the parties involved in the process result in significant friction and costs. Generally, each purchase and redemption of a fund involves various institutions in this chain. Orders are transmitted through manual or automated means, and fund settlement is completed through the settlement system, often taking several days to clear.

Through fund tokenization, fund shares are issued and traded in token form on public blockchains, with shares directly entering investors' wallets in token form. Share and net asset value can be publicly viewed on the chain, and all transaction records are accessible and queryable on the blockchain, eliminating the need for centralized registration and avoiding the costs of multiple verifications.

After tokenization, distribution platforms can use smart contracts to achieve real-time atomic settlement between fund share tokens and payment tokens (such as various stablecoins) to reduce the waiting time for investors. If fund tokens are traded on the chain's secondary market, investors can directly enter and exit in real time, reducing the redundant fund size reserved for redemptions within the fund, thereby improving fund capital utilization and creating higher returns. Investors can obtain efficient trading experiences through real-time settlement on the chain's secondary market, avoiding the waiting period for purchases and redemptions.

In addition, tokenized funds can integrate more application scenarios, such as supporting pledging and lending through smart contracts, to meet a wider range of user needs.

Institutional Attempts to Enter Public Chains - From Auxiliary Tools to Primary Ledgers

The DeFi scene has fully demonstrated the advantages of blockchain, but transferring vast traditional financial capital from the Web2's complete system to the entirely new system based on Web3 technology faces significant resistance and requires gradual progress and exploration of new practical solutions.

For compliance, especially the need for KYC and AML, unlike the cryptocurrencies we commonly see, fund tokens usually implement a whitelist mechanism, where each whitelist address corresponds to a user who has passed KYC on the fund platform, and transactions cannot be executed for non-whitelist addresses. The freedom of transfer between addresses gives rise to transfer risks, fund loss risks, and trade monitoring issues. Before risk control solutions emerge, these limitations will be difficult to overcome.

However, we have noticed that mainstream asset management institutions are also exploring the DeFi sector, attempting to transform their products by integrating the characteristics of blockchain technology, and we can see the evolution trajectory in their product designs.

In 2021, the US asset management giant Franklin Templeton issued the tokenized fund Franklin Onchain U.S. Government Money Fund - FOBXX. In the initial design, the tokens were actually maintained by the transfer agent in a private database system as the official record, with secondary records on Stella and Polygon. In the event of conflicts between centralized and public ledger records, the centralized ledger takes precedence. Investors trade fund share tokens through Franklin's app, with each user being allocated an on-chain address, but investors cannot transfer tokens within their wallets. In 2022, WisdomTree also issued a similar design of a tokenized fund investing in short-term US bonds on the Stella blockchain, WTSYX.

The designs of FOBXX and WTSYX essentially only use blockchain as an auxiliary accounting tool, making share records public, without actually reaping the benefits.

In March 2024, the BlackRock USD Institutional Digital Liquidity Fund (BUIDL) issued through the tokenization platform Securitize achieved a significant breakthrough, partly due to Securitize acting as a regulated transfer agent, using the public chain as the primary accounting tool to record the ownership and change of issued assets.

In-depth BUIDL Design - Obstacles and Improvements

According to the BUIDL issuance document, the basic issuance information is as follows:

Issuer: BlackRock USD Institutional Digital Liquidity Fund Ltd. (BlackRock's BVI entity, established in 2023)

Registration Exemption: SEC Reg D Rule 506(c), Section 3(c)(7) (Reg D is an exemption clause for securities issuance, allowing fundraising from qualified investors without limits on the number of people and the amount raised)

Registered Security Type: Pooled investment fund

Investment Threshold: Qualified Purchaser

Minimum Investment Amount: Individual investors $5 million USD; institutional investors $25 million USD

Issuance Scale and Investor Scale: Unlimited

At the time of issuance, the only distribution channel was Securitize Markets, LLC, a SEC-registered securities broker. Additionally, the related entity of Securitize, LLC, is a SEC-registered transfer agent, capable of registering and recording securities ownership on the blockchain.

It is worth noting that the fund's issuance used a newly registered BVI entity of BlackRock, rather than its conventional fund issuance entity, possibly out of risk considerations to minimize impact on compliant entities. Additionally, the SEC registration documents involve four related individuals, namely Ian Pilgrim in Bermuda, Jennifer Collins in the Cayman Islands, W. William Woods in Canada, and Noëlle L’Heureux in California, USA. Of these, only Noëlle L’Heureux is a Managing Director at BlackRock, with 32 years of experience at the company. The other three are likely from third-party institutions.

Source of information link

BUIDL Product Design

Trading Currency: USD

Subscription and Redemption: Daily subscription and redemption

Strategy: Mainly invest in short-term government bonds

Net Asset Value: 1 BUIDL = 1 USD

Token Standard: Specially designed ERC20 with a whitelist mechanism, tokens can only circulate in whitelist addresses, and transfers and transactions to non-whitelist addresses will fail

Earnings Calculation: Record earnings based on the address's share holdings every weekday at 3:00 PM Eastern Time, with earnings distributed through additional issuance of BUIDL tokens and airdrops on the first weekday of each month.

Redemption Rules: Daily redemption, with same-day redemption based on the quantity of BUIDL tokens held at a rate of 1 BUIDL = 1 USD; direct redemption through Securitize requires sending the tokens to a specified address, followed by the destruction of BUIDL tokens and completion of off-chain USD redemption at 3:00 PM on each weekday, generally T+0. Complete redemption is required for accumulated earnings between the last distribution and the transfer to be initiated after interest distribution (on the first weekday of each month), completed within 2-3 working days.

BUIDL is an ERC20 token issued on the Ethereum blockchain, allowing free circulation within the whitelist and interaction with whitelisted smart contracts, with interactions with non-whitelist addresses failing. For DeFi users, this seemingly simple step represents a significant breakthrough in traditional finance, indicating that large institutions are beginning to recognize public chains as accounting tools for registering asset ownership transfers, changes, and a series of ownership rights recorded on the public chain ledger, enjoying its openness, transparency, efficiency, and traceability.

Through open transfer functionality, BUIDL to some extent benefits from the advantages of blockchain settlement systems. One use case is provided by Circle, which, after the release of BUIDL, announced a contract allowing real-time exchange of BUIDL for USDC and prepared a reserve of 100 million USDC to enable real-time redemption of 1 BUIDL = 1 USDC for BUIDL holders.

This redemption option is provided by Circle and is essentially an OTC transaction: Circle provides the exchange contract (see Redemption address), and users transfer funds to the exchange contract, triggering the contract to transfer USDC from another EOA account (see holder address) to the user's address. These steps are all on-chain transactions, with atomic settlement.

Figure 1: Circle's USDC redemption contract process diagram for BUIDL

At the outset, this EOA account has a balance of 100 million USDC. Here, since the daily interest on BUIDL tokens is implemented through centralized accounting, if USDC is exchanged through the Circle contract, from the issuer BlackRock's perspective, it is a transfer, so the daily interest recorded between the last distribution and the transfer will be distributed at the next distribution time. After the BUIDL exchange, Circle will hold BUIDL and decide on subsequent operations. From the current on-chain information, Circle will periodically redeem BUIDL through Securitize for USD, then mint USDC and replenish the fund pool.

Three Months After Issuance, How is BUIDL Doing?

On May 15, 2024, BUIDL's AUM (Asset Under Management) exceeded Franklin Templeton's tokenized government bond fund FOBXX, becoming the largest tokenized fund project. As of July 9, 2024, the total AUM reached $502.8 million USD. However, compared to the trillion-dollar scale of the traditional market, the overall scale of tokenized government bond fund products is only $1.81 billion USD, indicating significant room for growth. (Source: RWA.XYZ, July 9, 2024)

Currently, BUIDL is held by 17 addresses, with the distribution of holdings as shown below:

Figure 2: Distribution chart of BlackRock BUIDL token holders (data as of July 9, 2024)

Securitize allows each client to bind up to 10 on-chain whitelist addresses. Among the 17 addresses mentioned, 2 addresses belong to Ondo Finance, the largest holder, with a total of 223 million BUIDL, worth 223 million USD. The two addresses are 0x72, holding approximately 173 million BUIDL, and 0x28, holding 50 million BUIDL, serving as the underlying assets for OUSG, Ondo Finance's tokenized government bond fund product (AUM 223 million USD). Previously, the underlying assets were short-term government bond ETFs from BlackRock iShares, which were all converted to BUIDL after the BUIDL issuance. Currently, OUSG's redemption operations are carried out through Circle's redemption contract, enabling real-time USDC redemption.

Additionally, due to collaborations between BUIDL and several crypto custodians, multiple addresses on the chain appear as EOA addresses with no transaction history, or are held in accounts of these custodians invited by BlackRock and Securitize to attempt tokenized fund purchases.

The USDC redemption pool provided by Circle currently has a balance of 80.6 million USDC, with Ondo Finance being the main redeemer. The Circle address (0xcf) also holds approximately 19.6 million BUIDL.

Figure 3: USDC amount held by the BUIDL USDC redemption contract, data as of July 9, 2024. Source: BlackRock BUIDL (Dune)

The Financial Institution's Path to DeFi

Due to the investment threshold set by BUIDL, it is difficult for ordinary users to directly obtain BUIDL. However, by issuing stable and secure money market funds on the chain, BlackRock can allow other institutions to introduce real-world stable returns into the DeFi world by using BUIDL as the underlying material.

A typical example is Ondo Finance. As mentioned earlier, Ondo is the largest holder of BUIDL. Through BUIDL and the redemption contract provided by Circle, Ondo Finance has enabled rapid subscription and redemption of the money market fund product OUSG through USDC, while lowering the user acquisition threshold from a minimum investment of $5 million USD to $100,000 USD. Additionally, Ondo can further collaborate with other DeFi protocols to pass on returns to the DeFi world, such as through DeFi lending platforms like Flux Finance, allowing anonymous DeFi users to also obtain real-world returns. This layered structure can direct real-world returns provided by traditional large institutions into the DeFi world.

Institutions Fully Entering? Facing Multiple Obstacles

Products like BUIDL, through a combination of on-chain and off-chain design, have improved the liquidity management efficiency of money market funds and provided a channel for on-chain investors to obtain real-world returns. By tokenizing funds, BlackRock, in collaboration with related Web3 institutions such as Securitize, Circle, and Ondo Finance, allows Web3 institutions to obtain real-world returns in the form of tokens on the public chain, avoiding complex fund inflow and outflow processes, and increasing application scenarios and fund utilization efficiency through smart contracts.

In fact, what BUIDL has done here is to allow tokens to be transferred on-chain without the need for centralized institution operations. Behind the simple transfer function, compliance and legal costs are very high. It is difficult to achieve transfers between different accounts in traditional financial platforms, and even transfers between accounts with the same name are very challenging. Generally, financial institutions only allow transactions, subscriptions, and redemptions on the platform. One month after BlackRock implemented the transfer function, Franklin Templeton's FOBXX also implemented the same function, indicating institutional recognition of the public chain as a ledger and a breakthrough at the product level. (The difference is that FOBXX holders do not have control over the private keys of the addresses, so they can only carry out transfers within the platform and cannot truly operate on-chain.)

Looking at the regulation of asset tokenization in different countries and regions, the current regulations are conservative. The United States has no specific legislation, so asset issuers only use various exemption clauses. BlackRock also avoids affecting its compliant entities by establishing an SPV in BVI for issuance. In other regions, such as Singapore, asset tokens have whitelist restrictions and can only be offered to qualified investors. These various restrictions and uncertainties hinder further entry of users and institutions into the Web3 field.

On the bright side, explorations into tokenization by institutions such as BlackRock and Franklin Templeton have attracted significant attention from the financial industry, demonstrating the high efficiency of on-chain interactions with real-world examples, while also driving regulation to promote the development of new laws and standards.

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