How Tokenised ETFs Work

What Are Tokenised ETFs?

A tokenised ETF is a blockchain token that represents ownership of — or economic exposure to — an exchange-traded fund. It brings the diversification and liquidity properties of ETFs into the on-chain world: 24/7 trading, fractional ownership, self-custody, and DeFi composability. The fastest-growing segment is tokenised money market and Treasury ETFs, which have attracted billions in AUM as institutions seek on-chain yield.

The traditional ETF is already one of the most efficient financial instruments ever created. Its creation/redemption mechanism keeps market price aligned with net asset value (NAV), its in-kind transfer mechanism makes it tax-efficient, and its exchange listing makes it liquid. Tokenisation adds a new distribution layer on top of this structure — but it does not replicate the full efficiency of the underlying ETF. Understanding what is preserved and what is lost in the tokenisation process is essential.

The market has evolved in two distinct directions. Institutional tokenised funds — BlackRock BUIDL, Franklin FOBXX, Ondo OUSG — are designed as on-chain cash management tools for institutions already familiar with money market funds. They are not ETFs in the SEC-registered sense; they are tokenised fund products that happen to hold ETF shares or equivalent instruments. Retail tokenised ETFs — Backed Finance's bCSPX, Dinari's dSPY — are tokens backed by actual ETF shares, designed to give non-US and retail investors access to equity index exposure on-chain.

How Traditional ETFs Work

To understand tokenised ETFs, you must first understand the authorised participant (AP) mechanism that makes traditional ETFs function. This mechanism — and its absence in tokenised ETF structures — explains most of the differences in efficiency, pricing, and liquidity between the two.

An ETF is a fund that holds a basket of assets (stocks, bonds, commodities) and issues shares that trade on a stock exchange. Unlike a mutual fund, which is priced once per day at NAV, an ETF's shares trade continuously throughout the day. The mechanism that keeps the market price aligned with the NAV of the underlying basket is the AP arbitrage loop.

Authorised Participants are large financial institutions — Goldman Sachs, Citadel, Jane Street, Virtu Financial — with contractual agreements to create and redeem ETF shares directly with the fund issuer. They can assemble baskets of the underlying securities and exchange them for newly created ETF shares (creation), or deliver ETF shares to the fund and receive the underlying basket back (redemption). This is the primary market — only APs have access to it.

The arbitrage works automatically. If the ETF market price rises above NAV (premium): APs buy the cheap underlying basket, deliver it to the ETF issuer, receive ETF shares, and sell those shares at the premium. Their selling pressure drives the market price back down toward NAV, and new ETF shares are created (supply increases). If the market price falls below NAV (discount): APs buy the cheap ETF shares on the market, redeem them for the more valuable underlying basket, and sell the basket. Their buying drives the market price back up. ETF shares outstanding decreases.

This mechanism is why large, liquid ETFs like SPY and QQQ typically trade within 0.01% of NAV throughout the trading day. It requires active, competitive APs with the capital and infrastructure to exploit tiny deviations instantly.

The Tokenisation Layer

Tokenisation wraps an existing ETF structure in an additional legal and technical layer. Understanding this wrapper — what it adds, what it costs, and where it introduces risk — is the key to evaluating any tokenised ETF product.

In the most common asset-backed model, the tokenised ETF issuer purchases actual ETF shares through a licensed broker, deposits them in a segregated account at a regulated custodian, wraps the position in a Special Purpose Vehicle (SPV), and mints ERC-20 tokens representing fractional beneficial interests in the SPV. The result is a two-layer structure: the underlying ETF (which holds stocks or bonds), and the SPV (which holds ETF shares and issues tokens).

This layering has consequences. Fees stack: you pay the underlying ETF's expense ratio plus the tokenised ETF issuer's fee. For equity ETF tokens this is manageable (iShares CSPX charges 0.07%; Backed charges a small additional fee). For money market products, issuers often absorb or pass through most of the underlying fund's yield, making fees more visible relative to returns.

The tokenisation layer also introduces its own primary market. To mint new tokens, an investor sends stablecoin to the issuer, who converts to fiat, buys ETF shares on the exchange, and mints tokens after T+2 settlement — a 1–3 day process. Redemption is the reverse. This is categorically slower than the underlying ETF's same-day in-kind AP mechanism. Tokenised ETF issuers are effectively retail-level participants in the underlying ETF market, not APs.

Money Market & Treasury Fund Tokenisation

The dominant use case for tokenised ETFs and fund products is not equity exposure — it is yield. Tokenised money market funds and short-duration Treasury products have attracted over $5 billion in AUM as of mid-2025, driven by institutions seeking to put idle on-chain capital to work at risk-free rates.

The demand comes from a structural gap in DeFi. DeFi protocols accumulate large treasury positions denominated in stablecoins — USDC, USDT, DAI — that earn zero yield while sitting idle. Traditional treasuries yield 4–5%. Tokenised Treasury products bridge this gap: a DAO treasury or market maker can hold BUIDL or OUSG instead of USDC and earn near risk-free rates, with the same on-chain composability.

BlackRock BUIDL — launched in March 2024 on Ethereum, issued through Securitize — became the largest tokenised fund by AUM within weeks, crossing $500 million in months and reaching $2.9 billion by mid-2025. BUIDL holds US Treasury bills and repo agreements and distributes yield daily as additional BUIDL tokens. The product requires a $5 million minimum and is restricted to accredited investors — it targets institutional treasuries, not retail.

Franklin Templeton's FOBXX (traded as BENJI tokens on Stellar and Polygon) is notable for a different reason: it is a registered US mutual fund that uses blockchain as the official book of record — meaning the on-chain token is the legal security, not a wrapper around it. Franklin also offers retail access via the Benji app with a $20 minimum, making it one of the only tokenised fund products accessible to US retail investors.

Ondo OUSG holds actual ETF shares — specifically BlackRock's SHV (iShares Short Treasury Bond ETF) — making it a true tokenised ETF rather than a direct fund. OUSG is available on multiple chains and has become a widely used collateral asset in DeFi protocols like Flux Finance, demonstrating the composability advantage of on-chain yield-bearing assets.

Equity & Bond ETF Tokens

Beyond money market products, a smaller but growing market for tokenised equity and bond ETF exposure is developing — primarily targeting non-US retail and professional investors seeking 24/7 access to global market indices without opening a traditional brokerage.

Backed Finance's bCSPX — backed by iShares Core S&P 500 UCITS ETF shares listed in London — is the most actively traded tokenised equity ETF. By using the London-listed UCITS version (CSPX) rather than the US-listed SPY, Backed sidesteps US securities regulation while still offering S&P 500 exposure. CSPX is anaccumulating ETF: it reinvests dividends rather than distributing them, so bCSPX holders receive price appreciation only — no dividend pass-through.

Tokenised bond ETFs are the natural fixed income complement. Short-duration Treasury ETF tokens (Backed's bIB01 holding iShares $ Treasury Bond 0-1yr UCITS ETF) offer on-chain yield with minimal duration risk. These products have found the strongest DeFi integration because their yield is predictable, their NAV is stable, and their duration means limited price volatility — making them safer collateral than equity ETF tokens.

The challenge for equity ETF tokens is clear: they do not yield. A holder bears equity market risk but receives no income stream to compensate for the issuer fee, custody cost, and DEX trading spread. The value proposition is entirely access — trading S&P 500 exposure 24/7 from a self-custody wallet, with potential DeFi utility. For investors who cannot access US markets through traditional brokers, this is genuinely valuable. For investors who can access them easily, the cost and counterparty overhead may not be worth it.

NAV Tracking & On-Chain Pricing

The central challenge in tokenised ETF pricing is that the underlying ETF only trades during exchange hours, while the token trades 24/7. The gap between NAV and on-chain price — the premium or discount — is the most important metric to watch when trading tokenised ETF tokens.

During market hours, sophisticated arbitrageurs monitor the spread between the token's DEX price and the underlying ETF's market price. If the token trades at a discount, they can buy cheap tokens and submit them for redemption at full NAV (with a 3–5 day delay). If the token trades at a premium, they can mint new tokens at NAV and sell at the premium. This arbitrage is less efficient than the AP mechanism — it requires 3–5 days for primary market round-trips rather than same-day settlement — but it does constrain deviation during market hours.

During after-hours, weekends, and market holidays, no arbitrage is possible because the primary market (mint/redeem with the issuer) is unavailable and the underlying ETF is not trading. Only secondary market DEX activity determines price. A major overnight event — a geopolitical shock, a central bank announcement, earnings from a large S&P 500 constituent — will cause the underlying to gap open when markets reopen, but the tokenised ETF's DEX price cannot adjust until either liquidity providers update their positions or trading volume forces the price to the new level. Sophisticated traders exploit these windows systematically.

On-chain NAV oracles are an emerging solution. If a reliable on-chain oracle updates the token's official NAV price (sourced from the ETF issuer or a data provider like Chainlink), DeFi protocols can use it for more accurate collateral valuation, and AMMs can be designed to reference NAV rather than just spot price. Several tokenised Treasury products have implemented this — BUIDL uses the Chainlink BUIDL/USD price feed — but equity ETF tokens generally lack reliable real-time oracles.

Major Products

The tokenised fund landscape spans four asset classes: money market / T-bill products (dominant by AUM), equity ETF tokens, bond ETF tokens, and commodity tokens (primarily gold). Each serves a different investor need and comes with a different regulatory and structural profile.

The AUM concentration in money market products reflects the DeFi demand for on-chain yield rather than retail demand for equity access. BUIDL, OUSG, and FOBXX collectively hold more than 80% of the tokenised fund market by AUM — all in near-cash instruments. Equity ETF tokens remain niche relative to the size of the underlying markets they reference.

A meaningful shift is underway with major traditional asset managers entering the space. BlackRock's BUIDL, Franklin Templeton's FOBXX, and WisdomTree's tokenised fund products signal that institutional capital is committed to on-chain asset management. The next phase — registered, SEC-approved tokenised equity ETFs trading on national securities exchanges — remains pending as of mid-2025, with several applications under review.

Regulatory Landscape

The regulatory status of tokenised ETFs varies dramatically by product structure and jurisdiction. Whether a token is a regulated security, an unregistered offering, or something in between determines who can access it, what disclosures are required, and what investor protections apply.

Registered fund products — Franklin Templeton's FOBXX — use existing US mutual fund regulation (1940 Act). The blockchain is the book of record, but the fund structure is fully regulated. This is the highest regulatory standard currently available for tokenised funds in the US and provides the strongest investor protections. The trade-off is access: only specific approved platforms can distribute FOBXX.

Exempt offerings — BlackRock BUIDL, Ondo OUSG, Superstate USTB — use Rule 506(c) of Regulation D (US private placement exemption) to issue to accredited investors without full SEC registration. This is faster to market but limits access to qualified institutional and accredited investors, with no retail distribution in the US. Most institutional tokenised fund products use this structure.

Non-US issuers — Backed Finance (FINMA Switzerland), Swarm Markets (BaFin Germany) — operate under their home jurisdiction's securities regulations and explicitly exclude US persons. European securities regulation (MiFID II, Prospectus Regulation) provides the legal framework, often with a prospectus exemption for professional investors. The EU's DLT Pilot Regime creates an additional sandbox for regulated DLT-based securities.

The SEC's position on tokenised securities is still evolving. Under the current administration (2025), the SEC has taken a more crypto-friendly stance and is actively reviewing applications for tokenised fund structures that go beyond private placement exemptions. An SEC-approved, publicly traded tokenised ETF would be a watershed moment for the market — but regulatory approval timelines remain uncertain.

Risks & Limitations

Tokenised ETFs carry the risks of the underlying fund plus additional layers introduced by the tokenisation structure. Some of these risks are shared with tokenised stocks; others are specific to the ETF wrapper.

Issuer and custodial risk are the foundational risks. The token's value depends on the issuer remaining solvent, maintaining its regulatory licence, and the custodian safekeeping the underlying ETF shares correctly. SPV structures protect holders from issuer insolvency in theory — but this protection depends on legal jurisdiction and has not been tested in a major failure. Regulated custodians (Interactive Brokers, Apex Clearing) add credibility; unregulated or offshore custodians should prompt heightened scrutiny.

NAV deviation and liquidity risk are more acute for tokenised ETFs than for the underlying funds. DEX liquidity for most tokenised ETF tokens is thin — TVL in the millions rather than the billions of the underlying ETF. A large exit during after-hours periods may require accepting a significant discount to NAV on the secondary market, or waiting days for primary market redemption. Investors who need to exit quickly in a stressed market may find neither option attractive.

After-hours price risk is unique to tokenised ETFs. The underlying ETF does not trade outside exchange hours, but the token does. A major macroeconomic event overnight can create significant divergence between the token's DEX price and the underlying ETF's fair value. Sophisticated participants exploit these dislocations systematically — retail investors who trade tokenised equity ETFs outside market hours are taking on this risk.

Fee stacking is a structural inefficiency that does not exist in the underlying ETF. Every tokenised ETF layer — the underlying fund's expense ratio, the issuer's management fee, DEX trading spreads, and stablecoin conversion costs — adds to the total cost. For equity ETF tokens, where there is no yield to offset fees, this meaningfully erodes returns relative to holding the underlying ETF directly. For money market tokens, the yield typically exceeds total fees comfortably, making the economics more favourable.

Smart contract risk applies to the token contracts and, increasingly, to the DeFi protocols that use tokenised ETF tokens as collateral. A bug in a lending protocol accepting OUSG as collateral could affect OUSG holders indirectly — composability risk compounds with each DeFi integration layer.

Regulatory discontinuity risk is real: a tokenised ETF issuer can lose its regulatory authorisation and be forced to wind down with limited notice. Investors in such a wind-down situation would typically receive redemption at NAV, but the process could take weeks and restrict trading in the interim. The lesson from FTX's tokenised stock programme — which disappeared instantly with no orderly wind-down — underscores the importance of holding tokens from regulated issuers with clear wind-down procedures disclosed in their offering documents.