Institutional Involvement in DeFi: What is BlackRock's BUIDL Status?

Author: DigiFT

• Introduction: On March 20, 2024, the renowned asset management company BlackRock, in collaboration with the U.S. tokenization platform Securitize, launched the tokenized fund BUIDL (BlackRock USD Institutional Digital Liquidity Fund), further expanding its influence in the Web3 space. This move follows the approval of its Bitcoin spot ETF, marking a significant advancement in mainstream cryptocurrency investment. The tokenized fund BUIDL represents traditional institutions leveraging public blockchain technology to enhance operational and capital efficiency, signaling broader adoption of blockchain technology.

• Problems Addressed by Tokenized Funds: Traditional publicly offered funds, such as money market funds, involve operations across multiple institutions, leading to inefficiencies 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 enable real-time atomic settlement and secondary market trading, improving capital utilization and offering higher returns. Tokenized funds also support various applications such as staking and lending through smart contracts.

• Large Institutions Entering Public Chains: The DeFi space showcases the advantages of blockchain, but transferring traditional financial capital to Web3 faces significant resistance. Fund tokens with KYC and AML compliant whitelist controls demonstrate mainstream institutions' efforts to explore DeFi. Examples include Franklin Templeton's FOBXX and WisdomTree's WTSYX, which initially utilized blockchain for auxiliary bookkeeping. BlackRock's BUIDL marks a breakthrough by using public blockchain as the primary bookkeeping tool in partnership with Securitize, a regulated transfer agent.

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

• Challenges and Future Outlook: Despite BUIDL's success, it faces significant regulatory and compliance challenges. Asset tokenization encounters conservative regulations globally, limiting issuance to qualified investors. However, the 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, asset management giant BlackRock further positioned itself in Web3 by issuing the tokenized fund BUIDL (BlackRock USD Institutional Digital Liquidity Fund) in collaboration with the U.S.-based tokenization platform Securitize, following the issuance of its Bitcoin spot ETF. If the approval of the Bitcoin spot ETF recognizes cryptocurrency as a new asset class within the investment realm of compliant funds, the greater significance of the tokenized fund lies in traditional institutions attempting to enhance operational and capital efficiency using public blockchain technology, acknowledging and adopting this technology.

What problems can tokenized funds solve compared to traditional funds?

The funds that investors commonly encounter are generally public funds, which, due to low thresholds, wide coverage, and large capital volumes, are subject to strict regulation. For instance, money market funds are heavily regulated. In the absence of special provisions, the operation of funds typically involves coordination among multiple institutions, with each responsible for a part of the fund's operational process, enhancing efficiency through specialization and avoiding the concentration of power in a single entity that could lead to malfeasance. The entire process generally includes: fund distribution channels (banks, brokers, financial advisors), fund administration, transfer agency, fund auditing, fund custody, exchanges, etc.

However, inconsistencies in databases among parties create significant friction and costs. Generally, each subscription and redemption of a fund involves various institutions along this chain. Orders are transmitted through manual or automated means, and funds are settled through a clearing system, often taking several days to complete a fund subscription.

Through fund tokenization, fund shares are issued and traded as tokens on public chains, with shares directly entering investors' wallets. Shares and net asset values can be publicly viewed on-chain, and all transaction records are accessible and queryable on the blockchain, recorded in real-time and automatically, eliminating the need for centralized registration and avoiding the costs of multiple parties verifying information.

After tokenization, distribution platforms can achieve real-time atomic settlement between fund share tokens and payment tokens (such as various stablecoins) through smart contracts, reducing the waiting time for investors. If fund tokens achieve a secondary market on-chain, investors can enter and exit the secondary market in real-time, reducing the redundant capital reserves that funds need to maintain for redemptions, thereby improving capital efficiency and generating higher returns; investors can enjoy an efficient trading experience through real-time settlement in the secondary market, avoiding the waiting periods for subscriptions and redemptions.

Additionally, tokenized funds can integrate more application scenarios, such as supporting staking, lending, and other business scenarios through smart contracts, thereby meeting a richer array of user needs.

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

The DeFi landscape fully showcases the advantages of blockchain, but transferring vast traditional financial capital from a complete Web2 system to a new system based on Web3 technology faces enormous resistance and requires gradual advancement and overcoming challenges, as well as exploring new practical solutions.

Due to compliance needs, particularly KYC and AML, unlike the cryptocurrencies we commonly see, fund tokens typically implement a whitelist mechanism, where each whitelisted address corresponds to a user who has passed KYC through the fund platform, and transactions from non-whitelisted addresses cannot be executed. For example, the free transfer function between addresses introduces risks such as transfer risks, fund loss risks, and transaction monitoring issues, which will be difficult to overcome until risk control solutions are in place.

However, we note that mainstream asset management institutions are also exploring the DeFi space, attempting to adapt their products to incorporate the characteristics of blockchain technology, and we can see the trajectory of evolution in their product designs.

In 2021, U.S. asset management giant Franklin Templeton launched the tokenized fund Franklin Onchain U.S. Government Money Fund - FOBXX. In the initial design, the tokens were actually maintained by a transfer agent in a private database system, with secondary records on Stella and Polygon. If there were conflicts between centralized bookkeeping and public chain records, the centralized records would prevail. Investors traded fund share tokens through Franklin's app, with each user assigned an on-chain address, but investors could not transfer the tokens in their wallets. In 2022, WisdomTree also issued a similarly designed tokenized fund WTSYX, investing in short-term U.S. Treasury bonds on the Stella blockchain.

The designs of FOBXX and WTSYX essentially only used blockchain as an auxiliary bookkeeping tool, making share records public without gaining actual benefits.

In March 2024, BlackRock's issuance of the BlackRock USD Institutional Digital Liquidity Fund (BUIDL) through the tokenization platform Securitize marked a significant breakthrough, partly because Securitize, as a regulatory-approved transfer agent, can use public chains as the primary bookkeeping tool to record ownership and changes of issued assets.

In-depth BUIDL Design - Obstacles and Improvements

According to the BUIDL issuance documents, the basic 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 that allows fundraising from qualified investors without limits on the number of investors or the amount raised)

Type of Registered Securities: Pooled investment fund

Investment Threshold: Qualified Purchaser.

Minimum Investment Amount: $5 million for individual investors; $25 million for institutional investors.

Issuance Scale and Investor Scale: No upper limit.

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

It is noteworthy that the fund's issuance utilized a newly registered BVI entity by BlackRock, rather than its usual fund issuance entity, which may have been a risk consideration to avoid impacting its compliant entities. Furthermore, the four related personnel mentioned in the SEC registration documents are Ian Pilgrim located in Bermuda, Jennifer Collins in the Cayman Islands, W. William Woods in Canada, and Noëlle L'Heureux in California, USA. Only Noëlle L'Heureux is a Managing Director at BlackRock, having worked there for 32 years. The other three appear to belong to third-party institutions.

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BUIDL Product Design

Trading Currency: USD

Subscription and Redemption: Daily subscription and redemption

Strategy: Primarily investing in short-term government bonds

Share Net Value: 1 BUIDL = 1 USD

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

Yield Calculation: Each business day at 3:00 PM Eastern Time, yield is recorded based on the shares held by the address, and on the first business day of each month, yield is distributed by issuing additional BUIDL tokens and airdropping them.

Redemption Rules: Daily redemptions, with redemptions based solely on the number of BUIDL tokens held at a rate of 1 BUIDL = 1 USD; direct redemptions through Securitize require sending tokens to a designated address, after which BUIDL will be destroyed at 3 PM each business day, completing the off-chain USD redemption operation, generally redeeming on T+0. Accumulated yield between the last distribution and redemption requires initiating a "full redemption" operation, which will be completed 2-3 business days after the interest distribution (on the first business day of each month).

BUIDL is an ERC20 token issued on the Ethereum blockchain, allowing free circulation within the whitelist and can enter smart contracts that are whitelisted, while interactions with addresses outside the whitelist will fail. For DeFi users, this simple step represents a significant breakthrough for traditional finance, indicating that large institutions are beginning to recognize public chains as tools for recording the transfer and changes of asset ownership, with a series of rights based on ownership also recorded on the public chain ledger, enjoying its characteristics of openness, transparency, efficiency, and traceability.

By enabling the transfer function, BUIDL benefits to some extent from the advantages of a blockchain settlement system. One use case is provided by Circle, which launched a contract allowing real-time BUIDL to USDC conversions after BUIDL's issuance, preparing a redemption reserve of $100 million USDC to enable real-time 1 BUIDL = 1 USDC redemptions for BUIDL holders.

This redemption option is provided by Circle and is essentially an OTC transaction: Circle offers a conversion contract (Redemption address in the image below), users transfer funds into the conversion contract, triggering the contract to transfer USDC from another EOA account (holder address in the image below) to the user's address. All these steps are on-chain transactions with atomic settlement.

Figure 1: Flowchart of Circle's USDC redemption contract for BUIDL

At the outset, this EOA account had a balance of $100 million USDC. Here, since the daily interest of BUIDL tokens is recorded through centralized bookkeeping, if USDC is exchanged through Circle's contract, from the perspective of the issuer BlackRock, it is a transfer. Therefore, the interest recorded daily between the last distribution and the transfer will still be distributed at the next distribution time. After BUIDL is exchanged, Circle will hold BUIDL, and subsequent operations will be decided by Circle. Based on current on-chain information, Circle will periodically redeem BUIDL for USD through Securitize, then mint USDC and replenish the liquidity pool.

What is the status of BUIDL three months after issuance?

As of May 15, 2024, BUIDL's AUM (Assets Under Management) surpassed Franklin Templeton's tokenized government bond fund FOBXX, becoming the largest tokenized fund project. By July 9, 2024, the total AUM reached $502 million. However, compared to the trillion-dollar scale of the traditional market, the overall scale of tokenized government bond products is only $1.81 billion, indicating significant growth potential. (Data source: RWA.XYZ, July 9, 2024)

Currently, BUIDL is held by 17 addresses, with the following distribution:

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

Securitize allows each client to bind up to 10 on-chain whitelisted addresses. Among the 17 addresses mentioned above, 2 belong to Ondo Finance, making it the largest holder with 223 million BUIDL, valued at $223 million. The two addresses are 0x72, holding approximately 173 million BUIDL, and 0x28, holding 50 million BUIDL, serving as the underlying assets for its tokenized government bond fund product OUSG (AUM of $223 million). Previously, the underlying assets were BlackRock iShares' short-term government bond ETF, which was fully converted to BUIDL after its issuance. Currently, OUSG's redemption operations are realized through Circle's redemption contract for real-time USDC redemptions.

Additionally, due to partnerships between BUIDL and several crypto custody institutions, multiple on-chain addresses appear as EOA addresses with no historical transaction records, or they may belong to traditional institutions invited by BlackRock and Securitize to attempt to purchase and custody the tokenized fund within these custody accounts.

Circle's USDC redemption pool currently has a balance of $80.6 million USDC, with Ondo Finance being the primary redemption party. Circle's address (0xcf) also holds approximately $19.6 million BUIDL.

Figure 3: Number of USDC held by BUIDL USDC redemption contract, data as of July 9, 2024. Data source: BlackRock BUIDL (Dune)

The Path of Financial Institutions Towards DeFi

Due to the investment threshold set by BUIDL, ordinary users find it challenging to access BUIDL directly. However, BlackRock's issuance of stable, secure money market funds on-chain allows other institutions to introduce real-world stable returns into the DeFi world by using BUIDL as an underlying asset.

A typical example here is Ondo Finance. As mentioned earlier, Ondo is the largest holder of BUIDL, and through BUIDL and the redemption contract provided by Circle, Ondo Finance has achieved rapid subscriptions and redemptions of its money market fund product OUSG via USDC, while lowering the entry threshold for users from $5 million to $100,000. Additionally, Ondo can collaborate with other DeFi protocols to further channel returns into the DeFi world, such as through DeFi lending platforms like Flux Finance, allowing anonymous DeFi users to also access real-world returns. This layered structure can direct the real-world returns provided by large traditional institutions into the DeFi space.

Are Institutions Fully Entering? Facing Numerous Obstacles

Products like BUIDL enhance the liquidity management efficiency of money market funds through a combination of on-chain and off-chain designs, providing on-chain investors with channels to access real-world returns. BlackRock, through fund tokenization in conjunction with related Web3 institutions like Securitize, Circle, and Ondo Finance, enables Web3 institutions to obtain real-world returns in the form of tokens on public chains, avoiding complex deposit and withdrawal processes, and increasing application scenarios and capital efficiency through smart contracts.

In fact, what BUIDL does here is allow tokens to achieve on-chain transfers directly without the intervention of centralized institutions. Behind this simple transfer function lies a very high compliance and legal cost. It is challenging to achieve transfers between different accounts on traditional financial platforms, and even transferring between accounts with the same name is very difficult; generally, financial institutions only allow transactions, subscriptions, and redemptions within the platform. After BlackRock implemented the transfer function, within a month, Franklin Templeton's FOBXX also achieved this function, indicating institutional recognition of public chains as ledgers, marking a breakthrough at the product level. (In contrast, FOBXX holders do not have control over the address private keys, so they can only perform transfer operations within the platform and cannot execute true on-chain operations).

From the perspective of asset tokenization regulation across different countries and regions, the current regulatory stance is conservative: the U.S. has no clear legislation, so asset issuers only utilize various exemption clauses. BlackRock also established a BVI SPV for issuance to avoid impacting its compliant entities. In other regions, such as Singapore, asset tokens have whitelist restrictions and can only be offered to qualified investors. These various limitations and uncertainties hinder users and institutions from further entering the Web3 space.

Optimistically, the exploration of tokenization by entities like BlackRock and Franklin Templeton has significantly attracted attention from the financial sector, showcasing the high efficiency of on-chain interactions through real-world case studies while promoting regulation to advance the development of new laws and standards.

About DigiFT

DigiFT is the world's first licensed on-chain real-world asset exchange, licensed by the Monetary Authority of Singapore and certified as a recognized market operator.

DigiFT issues blockchain-based security tokens for asset owners, allowing investors to achieve continuous liquidity trading through an automated market maker (AMM) mechanism.

Founded in 2021 and headquartered in Singapore, DigiFT is committed to meeting the regulatory requirements of Singapore's capital market operations while responsibly providing innovative financial solutions that push the boundaries of financial services. The founding team of DigiFT consists of executives with significant experience in financial and fintech institutions such as Citibank, Standard Chartered, Morgan Stanley, and the Shenzhen Stock Exchange, possessing deep blockchain technology knowledge and having successfully developed digital asset exchanges and products.

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