Why Tokenisation On Blockchain Is A BUIDL (‘bissel’ 🗣️/ˈbɪsəl/) Difficult
While blockchain promises transformative capabilities, the tokenization of financial assets like the BlackRock USD Digital Liquidity Fund reveals critical challenges and unresolved potential pitfalls.
What is there to say about BUIDL or the tokenized BlackRock USD Institutional Digital Liquidity Fund Ltd?
Let’s hear from the creators. According to Robert Mitchnick, BlackRock’s Head of Digital Assets:
“We are focused on developing solutions in the digital assets space that help solve real problems for our clients, and we are excited to work with Securitize.”
This is followed by this background info:
“Tokenization remains a key focus of BlackRock’s digital asset strategy. Through the tokenization of the Fund, BUIDL will offer investors important benefits by enabling the issuance and trading of ownership on a blockchain, expanding investor access to on-chain offerings, providing instantaneous and transparent settlement, and allowing for transfers across platforms. BNY Mellon will enable interoperability for the Fund between digital and traditional markets.”
And here are some more technical details:
The Fund invests 100% of its total assets in cash, U.S. Treasury bills, and repurchase agreements held at Bank of New York Mellon, allowing investors to earn yield while holding the token on the blockchain. Investors can transfer their tokens 24/7/365 to other pre-approved investors.
Fund participants will also have flexible custody options allowing them to choose how to hold their tokens at Anchorage Digital Bank NA, BitGo, Coinbase, and Fireblocks.
Securitize will act as a transfer agent and tokenization platform, managing the tokenized shares and reporting on Fund subscriptions, redemptions, and distributions.
The Fund’s initial investment minimum is 5 million USD.
The name "BUIDL” reminds me of the Yiddish "bissel” meaning "a little,” and it is perhaps not a bad name because it suggests that despite the grand promises, we might be left with only a little actual progress and stuck with a lot of the existing issues.
The SEC filing says that the Fund is registered in the British Virgin Islands. They intriguingly named the islands after St. Ursula and her companions. She was a British princess with a legendary story rooted in Cologne, Germany, on her way to Rome as part of a pilgrimage she declared necessary before her scheduled marriage. She was martyred along with no fewer than eleven thousand virgins by the Huns for refusing to renounce their faith and for preserving their virginity sometime around 400 AD. Principles come with a price!
Just in case you are interested, the Huns played a pivotal role in the foundational myths of Germany. They were a tribal group presumably from present-day Mongolia, Kazakhstan, and surrounding areas who invaded the peace-loving German tribes. The Huns feature prominently in the most German epos called the "Nibelungenlied." Here we have Attila the Hun, known as Etzel, who marries Kriemhild after the death of her first husband, the hero Siegfried. Kriemhild then invites her brothers and the Burgundians to the court of the Huns. She uses her position to seek revenge for Siegfried's murder, leading to a catastrophic and bloody conflict. So, Huns in Germany at the time should not come as a surprise to you
It is peculiar how BlackRock managed to find a suitable fund director meeting not only formal requirements but also offering a last name suitable as an homage to this history. His name is Mr Pilgrim (!), based in Hamilton, Bermuda. What a curious blend of history and modern finance, don’t you think? Sometimes, reality feels stranger than fiction.
This piqued my interest in examining the other fund’s directors:
Mrs Collins, based in the Caymans, who according to LinkedIn, became a chartered accountant through the Canadian Institute of Chartered Accountants in the 1990s, held sales roles for most of her career, and now serves as an independent director.
Mr Woods, based in Toronto, who says he is the former CEO of the Bermuda Stock Exchange, with a law degree from Manchester and work experience in Hong Kong.
Mrs L'Heureux from San Francisco, who claims on LinkedIn to have joined BlackRock in 1992 and remained in the same position ever since—possible, although not necessarily plausible, as BlackRock was formed in 1988.
And of course, Mr Pilgrim, who on LinkedIn states he worked for the last 18 years at Mayflower Management Services, despite the company being established in 2012. A curious detail, but LinkedIn profiles are not always perfectly reliable. But his efforts to stay on subject should be honoured since the Mayflower was an English sailing ship that transported a group of English families, known as the Pilgrims, from England to the New World in 1620.
Despite their diverse locations, this state-of-the-art governance team is expected to exercise due care and skill in supervising the fund’s affairs and thus stay fully informed about what’s going on. There are 965 sea miles between the Virgin Islands and the closest director in Bermuda. A quick check reveals zero daily flights between Bermuda and the British Virgin Islands—so much for in-person board meetings being easy peasy, but it’s all digital these days anyway!
What else:
The issuer is not registered as an investment company under the Investment Company Act of 1940, so no federal protection for your investments.
It claims Regulation D exemption under Rule 506(c). This means the securities are sold without registration as a private placement to accredited investors only, requiring that the issuer has taken reasonable steps to verify purchasers’ accredited investor status. So a walled garden set up.
Minimum investment size: 100,000 USD. Fractional ownership, but in reverse.
Sales compensation due to Securitize Markets, LLC, working from the WeWork office at Brickell City Center. This is a mall in downtown Miami which describes itself as follows: ‘Four levels of luxury, premium, and world-class dining and entertainment seamlessly interconnected across three city blocks and anchored by a 107,000 square foot Saks Fifth Avenue and luxury VIP Cinema Experience from CMX.’ Love it!
They expect to pay 525,000 USD in sales commission. I don’t know if there are formal requirements for how such a number is calculated, but if you happen to know, please ping me.
Signed by Mrs L’Heureux, which by the way, is French and means "the happy one" or "the fortunate one.” Happy Tokenization Days indeed!
Another important reference is from Consenys:
“BUIDL | bidl | verb
Building useful blockchain-based products and services that utilize smart contracts and have the ability to democratize technology for people of all races, genders, and cultures.
Developing blockchain projects on every layer of the Ethereum network, from protocols and infrastructure to dapps and design.”
So people of all races, genders, and cultures with 5 million USD spare cash might find this fund useful, or so the hope is. Don’t get me wrong, I am a big supporter of these ideas. But I am also not easily fooled by clever words. Simply put: is this a good example of delivering on those objectives?
A few comments, since I have written a few times about how questionable the idea is that tokenisation could improve money market funds:
What is the issue today? Money market funds have a daily investment cycle. An investor can get in and get out on a daily basis as long as the order is submitted before a daily cut-off time, which for USD-denominated products tends to be in the afternoon in NY. Why? Because that is where the underlying investments, be it securities or repurchase agreements, are traded. The fund has a need, often enshrined in the fund’s articles and definitely closely monitored by the custodians (because they don’t want to end up with large chunks of uninvested cash either), to invest the cash that comes in overnight. This means that interest is earned on a daily basis whether you place your order at 8 am in the morning or at 2:30 pm, let’s say 30 minutes before the cut-off time. All real-time settlement a blockchain system could theoretically enable before or after the cut-off time makes, economically speaking, absolutely no difference.
What is interesting is that they say the tokens can be transferred to other accredited investors. How exactly one investor knows that, other than through trial and error, is not clear to me, but it suggests to me that this model only works by removing competition where the current arrangements are fiercely competitive, which is in the distribution. The only way to redeem funds is through Securitize, hence why they are indifferent to who owns a token as long as the owner is from a pool of accredited investors, and they would still earn their fee. Assume you had two distributors, and all of a sudden, you could not easily establish who should earn their distribution fee.
So, all in all: is this a useful arrangement? That is a very good question.
And another question is whether lofty ideas such as “enabling the issuance and trading of ownership on a blockchain” are grounded in reality or simply uninformed wishful thinking. And here is why.
The size of an average smart contract on Ethereum can vary widely, but simple contracts might be as small as a few kilobytes (KB), while more complex contracts can be larger. On average, many smart contracts are between 2 KB and 50 KB. And there is a size limitation related to the allowable gas paid per transaction. As a result, many complex applications use a layered approach where the smart contract handles only the critical components, while the heavy lifting is done off-chain. In particular, business logic and computationally intensive tasks are often handled off-chain in traditional applications or side chains. The point is: this does not mean whatever genius processing they come up with is subject to the validation mechanism. It is the illusion of on-chain settlement.
One additional comment: To give you a feel for what 50 KB means, the original Tamagotchi software was about 30-60 KB, so roughly the size of a simple smart contract on Ethereum. In contrast, Microsoft Word can be hundreds of megabytes, illustrating how modern software has become much larger. This increase in size reflects the added complexity, features, and functionality of modern applications and a lot of things that would not be relevant here e.g. high-resolution pictures. But it gives you a sense for the scale of smart contracts: just think Tamagotchi and how annoying that was.
The technology does not solve per se critical issues. Instead, an assumption is made that the challenge does not exist or is not relevant for some unexplained reason. Take, for example, the efficient settlement achieved by using a one-sided settlement approach. When sending funds using Ethereum, but also permissioned chains such as Hyperledger Besu, the transaction process is typically one-sided, meaning that you only need to send a transaction and do not need a matching receipt instruction from the recipient. Transactions are created and sent using methods like
eth_sendRawTransactionfor public networks such as Ethereum orpriv_distributeRawTransactionfor private transactions eg. Besu. These methods broadcast the transaction to the network, and the transaction is then included in a block if valid. That creates perfect error-free settlement assuming that the sender has perfect error-free information and generally makes no mistakes.
The German language has a beautiful word to describe such an approach: ‘Schönfärberei’.
It literally means dye works to make something look beautiful; I guess you could describe it as whitewashing in English.
And one last example, though I have plenty if interested, is the recognition of the token. If somebody creates a token, there is no mechanism by which the market could recognize the token and what it represents. This means sending a newly minted token in proper peer-to-peer fashion to a wallet address without the receiver expecting exactly this token would typically render the token inaccessible, as the receiver's internal systems would simply ignore it like other ‘dust.’
The title of this blog is "Tokenization is Difficult," meaning it is difficult to make it work. My original idea for the title was "Why Tokenization Will Fail." What I mean here is to say tokenization will fail by doing more BUIDL and less solving for the foundational requirements.
But I may have some ideas, of course, so stay tuned.
P.S. 1: Somebody posted some interesting comments on LinkedIn regarding the article, suggesting I may be too critical and referencing the Matrix Movies—which totally rocks! The point of writing these things is to foster discussion and be open to arguments. I acknowledge that my perspective is not the only way to interpret things, and I can relate to the emotions of seeing something criticized due to possible shortsightedness on my part. But, of course, there is a "but." Let's do a quick Etherscan check. It reveals there are 13 investors in total, 5 of whom made the minimum investment of 5 million USD, and Ondo holds about 47%. The Gini coefficient for the token distribution among these 13 investors is approximately 0.547, indicating a moderate to high level of inequality in the distribution of tokens. One shareholder holding 47% of the tokens signifies a significant concentration of ownership. This level of concentration risk is not permitted in a 40' Act fund for good reason; the decision of one investor to redeem could trigger something akin to a fire sale, posing significant risk to other shareholders. Additionally, transparency issues arise: Does the blockchain record prices? No. All transactions are valued at 0 ETH. So why is this useful?
P.S. 2: One comment I forgot to make, which is so obvious that it should not be necessary to mention, but perhaps it is needed: A liquidity fund earns returns that offer very little upside over the risk-free short-term interest rates. The fund structure aims to preserve high liquidity and low risk at the expense of return. Now, a private placement such as Reg D is interesting for the opposite scenario. Liquidity is not of concern, and thus high returns (alpha) should be expected. A normal stablecoin gives flexibility to earn something in terms of DeFi, but this is not the case here since at this moment there are only 12 other investors to whom you could transfer these tokens. But they would not be able to generate a higher return from it as is the case in crypto. So, why is it a good idea to lock yourself into all the restrictions that come along with such a product when you could probably find a normal bank account that would not be too far off the return? That's another question.
