Tokenized US T-Bond Fund Seeks Foothold in $17T Market

The crypto industry is taking aim at one of Wall Street’s oldest redoubts: investing in the $17 trillion market for U.S. Treasury bonds. 

Arca Funds, a Los Angeles-based money manager specializing in cryptocurrencies, wants to create a fund to buy U.S. Treasury bonds and then use them to back a digital token created atop the ethereum blockchain network. Those tokens will then be distributed to investors.

The plan, refiled earlier this month after more than a year of back-and-forth with the U.S. Securities and Exchange Commission, still awaits the regulator’s approval. Executives with the project say they’re hopeful for the go-ahead in the next few months, and they recently started touting the effort on Arca’s website while hiring a new public-relations firm to help with publicity.   

The proposed “ArCoin” would provide a modern alternative to the current methods of investing in Treasurys, namely buying bonds from a broker or acquiring shares in a fund that holds them. Morningstar, which tracks the money management industry, lists more than $330 billion of funds devoted to investing in government bonds, dominated by U.S. Treasurys. 

A Securities and Exchange Commission (SEC) spokesman declined to comment on the status of the filing, but Arca says its new project would be the first tokenized fund to be fully authorized under the Investment Company Act of 1940, making it easily available to most U.S. traders in the fast-growing digital-asset markets.  

According to Arca executives, the ease of transferring cryptocurrencies over blockchain networks means an investor could even pay for goods or services using the Treasury-fund tokens. 

 “It’s collapsing the space between payments and investment vehicles,” Arca CEO Rayne Steinberg said in a phone interview. 

Cryptocurrency markets have been criticized by some lawmakers, regulators and mainstream investors over their reputation as a hunting ground for fraudsters and scammers, not to mention a popular payments channel for criminals, money launderers and foreign actors looking to skirt financial sanctions. 

But entrepreneurs say innovations in blockchain technology create the potential for faster transactions than on Wall Street’s current market systems, with lower costs and fewer middlemen.

Facebook’s proposal last year to launch a payments token known as Libra prompted a rush by central bankers globally to study digital currencies — potentially a sign of how vulnerable traditional financial firms and monetary systems are to fresh competition from emerging technologies. 

The rise of the ‘blockchain-traded fund’?

The ultimate prize for crypto-focused entrants like Arca is that a new market for digital token-based funds might spring up to compete with exchange-traded funds, or ETFs, which can be traded like shares on venues such as the New York Stock Exchange and Nasdaq. Invented less than three decades ago, ETFs have grown to become a $4 trillion asset category, enriching big purveyors including BlackRock and State Street. 

Steinberg, 42, is the son of the New York socialite Gayfryd Steinberg and adopted son of the late corporate raider and financier Saul Steinberg. During the 2000s, the younger Steinberg worked for the ETF-focused investment firm WisdomTree, led by his stepbrother Jonathan Steinberg. WisdomTree announced in January it wants to start offering clients digital assets, including a so-called stablecoin linked to the U.S. dollar. 

In materials on closely held Arca’s website, executives describe the proposed ArCoin as a “blockchain-traded fund,” or BTF. 

Rayne Steinberg says Arca plans to target big institutional investors as the first potential customers for its tokenized Treasury fund, if approved. The SEC’s blessing would help to build trust in the product, and investors might warm to the income that would come from a Treasury fund, even with interest rates at historically low levels. 

Arca Chief Investment Officer Jeff Dorman, a former bond trader at Merrill Lynch and Citadel and who is also a CoinDesk contributor, will manage the proposed fund, according to the filing.

“When you talk about why there’s not more institutional adoption in crypto, it’s because there aren’t institutional-grade products as they would think of them,” Steinberg said. 

The SEC has thus far refused to approve a bitcoin ETF, which would allow investors to bet on the cryptocurrency with the ease of buying a stock using a brokerage account. The regulator has cited concerns that the price of the underlying 11-year-old cryptocurrency is prone to manipulation.

The ArCoin’s underlying investments, however, are Treasury bonds — considered among the world’s safest and most reliable assets. The U.S. government’s triple-A ratings from Moody’s and Fitch make the securities heavily sought after by foreign central banks as reserves, and by investors as a safe haven from volatile stock and corporate-bond markets in times of geopolitical or economic turmoil. But it’s the blockchain-based issuance and distribution technology that’s new and, as yet, untested for a regulated investment fund. 

A ‘new and untested’ market

According to a Feb. 7 filing with the SEC, the project would consist of issuing digital securities whose ownership and transfer would be authenticated on the ethereum blockchain under a compatibility standard known as ERC-1404. According to Arca’s website, the coins could be redeemed for cash on a quarterly basis. 

“The ERC-1404 standard allows shareholders to interoperate with the entire ethereum ecosystem with added functionality that allows the fund to enforce transfer restrictions within the ArCoin smart contract,” the filing reads. A smart contract is a computer programming script that stipulates how the tokens work and gets embedded into the blockchain network.  

One risk for investors, according to the filing, is that digital-asset markets might lack the deep liquidity U.S. Treasury investors currently enjoy in traditional markets. 

“Use of the blockchain in this fashion is relatively new and is untested,” the filing reads. “Investors should therefore initially expect greater price volatility in the secondary market than would be the case if the shares had greater liquidity.”

There’s also the potential for congestion on the ethereum blockchain and “the possibility of breakdowns and trading halts as a result of undiscovered technology flaws,” according to the filing.

Arca plans to use Fifth Third Bank, a big regional bank based in Ohio, as its custodian and DTAC LLC as its transfer agent. DTAC was registered as a new subsidiary in December by the San Francisco-based crypto-focused startup TokenSoft. Mason Borda, TokenSoft’s CEO, told CoinDesk in an interview that month his firm was creating “an automated investment bank,” allowing issuers to bypass Wall Street underwriters.

The Arca project looks like a “plain-vanilla fund that uses blockchain technology,” says Jay Baris, a New York-based partner in the investment practice at the white-shoe law firm of Shearman & Sterling, which caters to big U.S. banks such as Citigroup. 

“It’s inevitable that this is going to happen, and if it works it could take off,” according to Baris, who isn’t involved in the Arca project. “It’s just that nobody’s done it yet.”