Bridging the Gap: Bringing Institutional-Grade Investor Protections Onchain
From $0 to $1.6 billion in just over a year, the recent rise of tokenized government treasuries has brought this emerging tokenized asset class to the main stage of the digital asset space. Novel products introduce new factors across compliance, investor protection, transparency and a diversity of other considerations to ensure users are confident their assets are safe and secure.
As the first issuer to introduce tokenized government treasuries to the market in 2023, Ondo has developed a robust reputation for its institutional-grade products, with investor protection, safety, transparency, and legal frameworks at the forefront. As adoption of Ondo’s products has grown to over $530m in AUM—the largest of any tokenized treasuries protocol—these topics remain evermore important.
Who better to share insights on these important topics than Mark Janoff, the new General Counsel of Ondo Finance. We sat down with him to discuss his perspective on the real world asset tokenization space and to explore various facets of investor protections.
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You’re now the General Counsel at Ondo Finance, but how did you get into the crypto industry?
"I started my career as an engineer in the air and missile defense systems division of MIT Lincoln Laboratory. I felt some stagnation in the pace of that culture, so I pivoted to law to focus on IP and technology transactions – though I caught the bug of corporate deal work. I jumped fully down the crypto rabbit hole during DeFi summer and decided to pivot entirely to blockchain-related legal work. It’s the first time in my career that I’ve been able to combine a creative impulse with my skills and a technology whose capabilities I deeply believe in."
Describe your charter at Ondo. What is it about Ondo that excites you?
"As most GCs would tell you, a little bit of everything. But the core is strategic product legal work. I focus on how to design, launch and operate our products and services within the context of global regulatory change and ambiguity. An integral part of this is determining how our stakeholders (both institutions and individuals) will be affected by the intersection of our product design and regulation. Financial systems, and particularly blockchain-based financial systems, are highly interconnected. So it’s crucial to understand and address the security, transparency, legal and risk appetites of our stakeholders, including our investors. What excites me about Ondo is the vision and the people. We can unite the traditional and decentralized finance sectors in a manner that amplifies their best features."
S&P Global published stability assessment reports on Tether and USDC last December. In the reports, it pointed out specifically the lack of information regarding the bankruptcy remoteness of both stablecoins as a concern. Can you explain what is meant by bankruptcy remoteness and why it is important?
"Bankruptcy remoteness, also known as insolvency remoteness or insolvency protection in some countries, refers to the legal protection of one set of business assets from the bankruptcy of another business line. In short, the creditors of the bankrupt business cannot successfully pursue the assets of the bankruptcy-remote business.
This is typically accomplished by establishing a separate, limited-scope company known as a special purpose vehicle (SPV) to operate the bankruptcy-remote business and hold its assets – and truly run it as a separate business.
This approach is a rarity in crypto, however, including among stablecoin issuers.
By contrast, in the case of USDY, we have organized the underlying legal entity structure in such a way that if a parent or affiliate company like Ondo Finance were to go bankrupt, the creditors of the bankrupt company should find it impossible to get at the assets that are held by the fund that issues USDY tokens and holds its US treasuries and bank deposit collateral, Ondo USDY LLC.
As such, Ondo USDY LLC is said to be bankruptcy-remote. The assets of the tokenholders are protected in a bankruptcy and are very unlikely to be redirected by the bankruptcy court to the creditors of the LLC’s parent company or affiliates. I say “very unlikely” because bankruptcy courts have very wide latitude. It’s impossible to make assets in an affiliated group of companies “bankruptcy-proof,” but you can make the chances of loss very “remote"; hence the name."
What roles do collateral agents and security interests play? Can you use USDY as an example?
"Collateral agents and securities interests work together to give teeth to an investor or tokenholder’s rights to assets that are said to back its investment or tokens. A collateral agent is an independent third party who acts for the benefit of investors or token holders, to ensure that they can access the assets (collateral) that back their investment or tokens. And a security interest is a right that an investor, token holder or collateral agent has to take possession of the collateral that backs a company’s obligation to the investor, token holder or collateral agent
USDY embodies these robust investor protections. When someone purchases USDY tokens from the token issuer, Ondo USDY LLC , the LLC uses the purchase price to acquire collateral in the form of short-term US treasury bills and US dollar bank deposits. The LLC is required to hold this collateral for the ultimate benefit of the token holders.
The LLC has a contract with the tokenholders that lays out these obligations. But a contract is just table stakes when it comes to investor protections. Ondo USDY LLC goes farther in two respects.
First, it files a public notice of the security interest in the collateral with the State of Delaware. When a public notice is filed, the security interest is said to be “perfected” – or prioritized over a security interest where no public filing is made. This process helps ensure that the SPV isn’t promising the same collateral to different groups.
Second, the LLC engages a collateral agent to work for the benefit of the tokenholders if the LLC fails to meet its key obligations to the token holders, known as a default event. Default events include failures to sufficiently overcollateralize the LLC’s obligations to the token holders, or failures to timely redeem tokens. If a default event occurs, the collateral agent is obligated to seize and repossess the collateral – and distribute it to the token holders – when token holder approval is obtained. If anyone challenged the collateral agent’s right to do so, the collateral agent can point to the public notice of the security interest to prove its right to seize and repossess the collateral.
Without security interests and collateral agents protecting a token holder’s right to collateral, a token holder is doing little more than relying on a token issuer’s word and, perhaps, a court battle to recoup their collateral if a default occurs."
These are some of the most battle-tested practices in traditional finance to enhance investor protection and reduce operational risk. Ondo has gone beyond that by including an equity buffer in its Ondo USDY LLC structure. Can you explain why we made that decision?
"The Ondo USDY LLC equity buffer serves two functions. First, it overcollateralizes the obligations that Ondo USDY LLC has to the USDY token holders. Second, it aligns the interests of Ondo Finance with the USDY token holders because Ondo Finance is an equity investor in the LLC and naturally wants to protect that equity.
What that means, in practice, is that if the value of the LLC’s assets (the token holders’ collateral) goes down, the equity holders, which include Ondo Finance and the Ondo Foundation, absorb the loss first while supporting the tokenholders’ ability to redeem. Since the equity holders want to prevent and minimize these events, they have every interest in the best possible management of the LLC – from proper diversification of its treasuries and bank deposit holdings, to working with best-in-class bank, brokerage and custodian partners.
Investor protection is front and center of everything that we do here at Ondo. This equity buffer protects the investors in any distressed scenario because it protects the collateral from any extreme but temporary market dislocations.
In fact, we size our equity buffer so that the likelihood that the collateral would ever have to be liquidated is incredibly low, and based on the historic changes in value of US treasuries."
Any additional thoughts about investor protections?
"Investor protections aren’t just a legal issue. Security is also critical. Tokenizing assets is only interesting insofar as tokenization affords holders blockchain-based utility, and different types of utility – from transferability to bridging to interaction with blockchain applications – present unique investor protection questions that should be understood and addressed by investors and builders in this space."
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⚠️ NOTE: Neither USDY nor OUSG has been registered under the US Securities Act of 1933 ("Act") or pursuant to securities laws of any other jurisdiction, and neither may be offered, sold or otherwise transferred in the US or to US persons unless registered under the Act or an exemption or exclusion from the registration requirements thereof is available. Additional restrictions may apply. Neither Ondo USDY LLC nor Ondo I LP, the respective issuers of USDY and OUSG, is registered as an investment company under the US Investment Company Act of 1940, as amended. Nothing herein constitutes any offer to sell, or any solicitation of an offer to buy, USDY or OUSG. Acquiring tokens, including USDY and OUSG, involves risks. A holder of such tokens may incur losses, including total loss of their purchase price. Past performance is not an indication of future results.