The Digitisation of Traditional Finance

Traditional Finance Made Digital

In the past few years we have witnessed an increased interest for blockchain technology by financial institutions, and a push towards the digitisation of financial products. As an example, Goldman Sachs planned three digitisation projects this year, while Fidelity International recently partnered with JPMorgan to fully expand their digital products to be included as collateral on JP Morgan’s Tokenised Collateral Network (see JP Fidelity).

“Digitisation” is not a new concept in traditional finance. For instance, when trading equities, traders rarely own the physical share certificate of a stock. Instead, they trade a “digital” representation of the asset that identifies their ownership. Now, companies are taking this a step further with “tokenisation”, creating digital tokens on blockchain technology that represent ownership or rights to an asset. The efforts of banks and asset managers to adopt blockchain solutions can be seen as the natural evolution of digitisation, aiming to enhance transparency, flexibility, and access in asset ownership.

Real-World Assets (RWAs) are commonly brought on-chain by minting tokens collateralized by their physical counterparts. The most widely recognized examples in decentralised finance (DeFi) are stablecoins, cryptocurrency tokens pegged to fiat currencies like the US dollar. For instance, USDT and USDC are digital currencies designed to maintain a stable $1 value, functioning as tokenised representations of the actual dollar.

Beyond fiat currency, asset tokenisation extends to commodities, such as gold. Digital gold tokens, like those issued by HSBC in Hong Kong, allow investors to gain fractional exposure to the gold reserves of the bank in London. This approach has broadened to include other commodities, such as precious metals, oil and natural gas, and even real estate, redefining ownership and accessibility for a diverse range of assets.

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What is the promise of bringing RWA onchain?

Owning a RWA-backed token holds the promise of giving an investor exposure to the real value and price of a offchain asset. Traditional assets can become more easily accessible than in the traditional finance environment: the process of tokenisation seeks to enable fractional ownership and improve access to high-value assets for a broader audience by dividing them into smaller, more affordable units, i.e. the tokens. Through blockchain technology, digitised assets attempt to allow for broader availability, 24/7 trading, and faster transactions. If tokenisation is performed on public blockchains, e.g. Ethereum or Solana, information regarding a tokenised asset becomes visible to everyone, increasing the transparency associated with the tokenised assets, providing a transparent and immutable ledger that anyone can audit to verify the asset’s ownership and transaction history.

Recently, major banks have been delving into the tokenisation paradigm with various solutions that attempt to combine the advantages of traditional finance products with the flexibility of the blockchain. In this article, we will focus on the tokenisation of fixed-income products, which attempt at combining the generation of onchain yields with the stability and familiarity of traditional bonds all within a decentralised framework. By focusing on their implementation, a few natural questions arise: Do these products actually deliver the promised benefits that blockchain technology offers? Is an investor actually better off just investing in conventional bonds?

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Digitising Bonds

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Prime targets for digitisation using blockchain technology are fixed-income products, which allow for the generation of steady yields with relatively low risk. For example, JPMorgan launched “Onyx digital assets” as a tokenisation platform, while HSBC’s Orion blockchain has been used by the European Investment Bank for the first ever £50 million digital bond, which used a combination of private and public blockchains. While these attempts have been successful and prove the interest of financial institutions for blockchain technology, these examples rely on private distributed ledgers – antithetical to the philosophy behind decentralised finance.

Alternative issuers of digital fixed-income products have therefore emerged, which make use of public blockchains. Key players in this field have been Ondo Finance (OUSG and USDY),  HashNote (Hashnote) and OpenEden (T-BILL). But the most notable examples of tokenisation on public distributed ledgers are Franklin Templeton’s FOBXX and BlackRock’s tokenised fund BUIDL. The fact that major asset managers have fully delved in these technologies is representative of the growing interest for the digitisation of traditional financial bills. These products are available on most major public blockchains, e.g. Ethereum, Solana and Stellar, and for a complete overview of the availability list we refer the reader to RWA.xyz.

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The Most Common Implementation of Tokenised Bonds

Currently, the implementation of tokenised bonds is similar across the different platforms that offer fixed-income digital products. The process can be visualised in Figure 1, where we have illustrated the relationship between the investor and digital bond provider and how the token issuance unfolds.

• Firstly, investors need to pass an onboarding procedure and security checks in order to gain access and to trade to tokenised bonds. These are generally Know Your Customer (KYC) and Anti-Money Laundering (AML) checks.
• Investors can then exchange either stablecoins or fiat currency, depending on the issuer, for newly minted tokens representing exposure to the bonds, which are then transferred to the investor's personal wallet onchain.
• These funds are then used to buy US treasury bonds and bills from a brokerage which are then stored in a secure Vault. The Vault is generally under custody in the hands of a qualified organisation, as is the case of OpenEden’s TBILL with StoneX, or Bank of New York Mellon for BlackRock’s BUIDL.

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When tokenised bonds are issued to KYC-compliant investors, they are accompanied by legal agreements that define the rights of token holders, such as access to interest payments and redemption. Smart contracts automate key processes, including compliance checks, by making sure that only approved investors own tokens, and payment execution, while ensuring that token ownership represents a stake in the underlying bonds or their cash flows. Compliance mechanisms, such as whitelisting, limit participation to eligible investors in approved jurisdictions, aligning with regulatory requirements.

Assets and securities purchased using investors’ funding form an aggregate portfolio of fixed-income products, and the pool of them is set to obtain a combined target yield on the users’ initial investment. As an example, BlackRock’s BUIDL is fully backed by cash and US Treasury bills, whose proceeds are reinvested once expired.

A standalone and unique example of how exposure to Treasury Bills can be achieved is Ondo finance OUSG’s Vault, which is composed of BUIDL tokens, BlackRock’s FedFund (TFDXX), bank deposits, and USDC. The unique implementation achieves the exposure to Bills and Treasuries through already digitised assets, and by leveraging some of the capabilities and the features related to BlackRock’s product, OUSG allows for flexible solutions which we will explore later.

Differences in Yields Generation

The mechanism under which the fund is managed and yields are actually generated and distributed to the token holders differs with each implementation. For example, OpenEdens’ TBILL token price is set to grow slowly in time to reflect the yield generated by the underlying portfolio of securities, which is embedded in the Net Asset Value of the portfolio. An investor earns returns by holding these tokens which appreciate in value.

Another example is implemented by BlackRock: the BUIDL token’s value is set fixed to $1. Once an investor buys into the fund, new bills are purchased and token holders are paid a daily accrued dividend of new BUIDL tokens each month to their onchain wallet, which is reflective of the yield the purchased bills have generated. In this way the token price is maintained constant, as the NAV of the portfolio remains constant. Upon meeting certain criteria, investors can then decide to either sell the tokens to other investors or to redeem them: this last process involves burning the tokens in exchange for currency.

Most of the issuers of tokenised bonds use one of these two frameworks for generating yields. Users therefore obtain a yield on their tokens which represents a share in a rolling fund composed of conventional bonds and/or other securities with different expiries, carefully managed in order to ensure the promised returns and yields. The issuer therefore handles the selection, management and the purchase of the yield bearing securities. Bonds and assets are held in third-party custodial accounts, separate from the provider's operational funds. This separation helps ensure that bondholders retain rights even if the issuer faces financial trouble.

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Are Tokenised Bonds useful?

The idea of tokenising bonds represents an effort to solve some of the problems related to these securities, while also unlocking safe returns on-chain for an otherwise untapped pool of investors.

Currently, unless one is an US citizen or resides within the US, there is no direct access to the purchase of US treasury bonds. Instead, one must rely on banks and brokerage firms to gain exposure to these products, which require the payment of fees and can span several business days. Not only this, but the unwinding of a position or the sale of the contract takes time, and can only be processed during market hours. As an example, conventional bond issuances in Hong Kong typically settle within a five-day cycle (T+5), which is much longer than the 1 business day (T+1) required for the HSBC digital version onto HSBC Orion's private permissioned blockchain. This is achieved thanks to the unique implementation offered by HSBC, by which the bonds are directly issued onto HSBC Orion's private permissioned blockchain and not tokenised after they have been issued. This solution represents an outlier given the specific implementation.

Among the products examined, we highlight that Hashnote USYC and BlackRock’s BUIDL, as they hold the record for highest market cap, with a total of $879M and $560M respectively. The success of USYC can be attributed to the recent partnership with Deribit, which allows to deposit USYC as a cross-margin collateral. On the other hand, the high market cap of BUIDL can be linked to Ondo Finance OUSG, which is backed for the majority by BlackRock’s tokenised bill. The fourth in order of highest market cap, USDY, holds the record for highest number of investors, due to the very few requirements needed for holding the tokens.

The case for Ondo finance USDY is fascinating as, while being one of the most popular product among the ones examined, it is one of the most limiting in terms of liquidity and accessibility. In fact, users are severely restricted to their geographical location, as the product is not available for US investors and many other locations, but it is unclear how these checks are performed on the secondary markets. In addition to this, once an investor sends their initial investment, users only receive a certificate of investment, and tokens are only minted after a lengthy period of around 40-50 days, only after which tokens can be redeemed or transferred, severely limiting users. As stated on the documentation, due to legal restrictions, “the note that USDY represents has heightened transfer restrictions for at least 40 days”.

Despite this, USDY product is one of the few to allow composability with third-party smart contracts, enabling onchain lending and trading of the product on the secondary market without the need for background checks. In fact, this product does not require users to be KYC’ed in order to possess the token in one’s wallet, allowing users to trade the products on a secondary market, but background checks need to be performed in order to mint and redeem tokens.

We now focus on the different caveats and essential features that make these products an interesting investment.

Fees

As the on-chain token is necessarily linked to off-chain securities, the token issuer must handle the conventional processes of trading government bonds, mainly the settlement of the treasury bonds, while also having to account for the storage of the contracts.

This results in management fees that are passed onto the investor, which are 0.30% for T-BILL, but can get as high as 0.5% for BlackRock’s BUIDL. Ondo’s OUSG currently does not have management fees, as they have been waived until January 2025, but still present a 0.35% third party fund expenses fee. Among the biggest competitors in the tokenised bonds sector, Ondo finance USDY is the only product that offers no management or performance fees. However, users will be charged fees for redemption of tokens and the interest rate investors earn is set by Ondo to be lower than the interest the banks and Treasuries pay.

In general, issuers require relatively low fees, but they can still be beaten by other brokerage firms for conventional bonds, e.g. 0.002% for investments up to $1M on Interactive Brokers. Hence, the way fixed-income products are brought on-chain still relies on off-chain securities and transactions, making the whole product still centralised.

Fractional Ownership

One of the main goals of digitising bonds is to make them more accessible to investors by allowing fractional ownership. This is generally permitted on secondary markets for all the platforms we have explored with one caveat: users need to have passed the background security checks in order to gain ownership of the tokens, and hence transfers are only limited to whitelisted and approved wallets and not fully decentralised. While this is true for most products, USDY proves once again to be more flexible, allowing ownership of the tokens without background checks and without passing KYC checks.

Accessibility

The minimum amount required to mint tokens is generally very high, for example $100K USDC for OpenEden’s TBILL and $5K for Ondo finance OUSG, to the staggering $5M for BlackRock’s BUIDL. Franklin Templeton’s FOBXX requires only $20 as initial investment but only for the Stellar blockchain, and quickly ramps up for other blockchains. In addition to this, different criteria need to be met in order to be able to redeem the tokens: for example OpenEden’s TBILL requires a minimum value of 1000 USDC while for OUSG one needs at least $10K for an instant redemption. Hence, small investors who do not buy larger amounts of shares of these funds are confined to the secondary market to earn yields on their stable coins, provided they pass the background checks and their wallets are whitelisted.

Time Constraints

The time constraints related to the minting process and redemption is something to take into account when investing into these products. The fact that most products rely on traditional bills and bonds implies that minting and redemption might be limited to market hours but it’s not generally the case for some products.

For minting, most products require one to a couple of business days in order to fulfil the orders. For example, Franklin’s templeton FOBXX allows for same day investments via their app if the order is received and approved prior to 1p.m. Pacific time, otherwise it will roll to the next business day. Other platforms offer more flexible solutions for instant minting, e.g. OpenEden’s TBILL and Ondo Finance’s OUSG, for which minting is atomic and instantaneous.

The same applies for the redemption procedure, requiring two to three business days to receive the original investment back for most products. However, some products implement different solutions, with BUIDL offering instant redemption thanks to a partnership with Circle on the secondary market to allow deep, 24/7, liquidity between BUIDL and USDC. If a whitelisted and KYC’ed investor decides to redeem their BUIDL tokens against USDC, Circle has set aside $100M USDC to buy BUIDL tokens at any time, allowing for an instant redemption process and liquidity, hence taking on the redemption process. Ondo Finance’s OUSG has allocated the vast majority of its reserves into BUIDL, allowing the product to achieve deep liquidity with both instant minting and redemption, subject to daily limits (global limit is $50M, and individual limit is $25M).

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Transparency

Another key feature of these products is the promise of transparency. All the platforms and issuers of the digital bonds release reports, generally written by third party agencies, on NAV and details on the portfolio that backs the digital securities daily, allowing investors to check accounts statements daily. The Vault itself is administered by external authorities, generally investment banks and authorised custodians, and platforms provide details on the results of periodic fund audits conducted by leading firms in the industry, reporting on the status of the reserves. For example, Franklin Templeton’s reports are audited by PricewaterhouseCoopers LLP, whereas Ankura Trust is providing reports for Ondo Finance. The transactions for the mentioned products live on the digitised token’s native public blockchains and so are easily verifiable, but the characteristics of the off-chain information can only be recovered from the issuers’ statements.

Is It Worth It?

While digital bonds represent an alternative opportunity for stablecoins holders to earn yields on otherwise idle capital, ultimately the implementation is wrought with limitations. The fees that one needs to pay in order to access this product can be quite high, but at the same time some implementations allow for (near) 24/7 trading on a limited secondary market. Only in a few cases do they offer instant redemption and issuance, otherwise requiring a couple of business days.

The most accessible product that we have discussed, Ondo’s USDY, still suffers from several limitations and complicated terms, restricting its usage but still representing the most popular choice among investors. This is probably motivated by the fact that users are not required to be KYC’ed in order to hold the tokens, hence broadening the secondary market to a bigger audience, whereas the other mentioned products require users to have passed the required checks. Users therefore need to carefully decide whether these features are worth the added costs and fees above those offered by brokerages.

At the same time, the legality and rules around these products is a critical cornerstone of tokenised fixed-income products. Bonds and securities fall under securities regulation, requiring issuers to comply with laws governing issuance, disclosure, and investor protection, often enforced by agencies like the SEC in the U.S. or the FCA in the U.K. In this evolving space, regulatory clarity and contractual precision in offering documents or smart contracts are crucial in defining investor rights.

For instance, within the OpenEden TBILL Vault, token holders have a contractual right to a proportional share of the redemption value of the assets, aligned with their investment, providing protective assurances as outlined in official documentation. While tokenised bonds are recognized as legal securities under frameworks like Switzerland’s DLT law and similar regulations in other jurisdictions, they are typically regulated under existing securities laws rather than newer frameworks like the EU’s Markets in Crypto-Assets Regulation (MiCA), e.g. tokenised securities remain subject to regulations like the Markets in Financial Instruments Directive II (MiFID II).

To ensure enforceability and regulatory compliance, mechanisms like whitelisting restrict participation to approved jurisdictions, aligning with the requirements of securities regulators. For example, token issuance and redemption on platforms like those used by BlackRock are typically confined to jurisdictions where legal contracts governing the tokens are enforceable, preventing unauthorized ownership.

The solutions offered by most of these products represent a first attempt at solving some of the issues highlighted with traditional finance fixed income products, but still suffer from limitations as they are linked with these off-chain assets. OUSG, which is backed by the tokenised bill by Blackrock, is a product that stands out for allowing fast redemption and issuance. In any case, the adoption of blockchain technology is a clear step forward towards digitisation that does not seem to be stopping, as proved by the ever growing market cap of digitised bonds that has almost reached $3B and by the attempts of expanding the offerings and features of their products.

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