What is the outlook for tokenized securities? SEC Commissioner questions its feasibility.

Author: Commissioner Caroline A. Crens

Translated by: Blockchain in Plain Language

Today's topic is very broad, perhaps the broadest subject discussed so far in the crypto task force roundtable: Tokenization. I understand that today's discussion will primarily focus on potential regulatory efforts to promote tokenization.

This topic reminds me of a famous quote from the movie "Field of Dreams" — "If you build it, they will come." You may remember that this film stars Kevin Costner, who plays a farmer, Ray Kinsella, inspired by a mysterious voice to plow his cornfield and build a baseball field, believing that great things will happen.

I think this has some similarity to the current enthusiasm for tokenization. Blockchain technology has been around for a long time. Although some limited use cases have been introduced recently, it has not been widely used for the issuance and trading of registered securities. Some believe that if we "build" — or more accurately, "rebuild" the financial system to adapt to blockchain, "they" various market participants will flock to embrace tokenized securities. Investors will benefit from increased participation and choices, and the market will thrive due to the improvements brought by blockchain.

To this, I would like to first ask, what exactly are we trying to build? What is tokenization? Even limited to the SEC's domain, this term is difficult to define simply. Does tokenization refer to issuing securities directly on the blockchain? Or does it refer to creating a digital representation of securities on the blockchain? This seems to be a subtle distinction, but it could have significant implications from a regulatory perspective. Furthermore, should tokenization encompass post-issuance distribution, trading, clearing, and settlement? In other words, will the entire lifecycle of the securities be "on-chain," or just a part of it?

No matter how we try to answer these definitional questions, it is clear that the financial system of tokenization is unlike any system we have seen before. It is not as well-known or easily understood as the baseball field built by Ray Kinsella. Many envision a fully tokenized system where any security, including highly traded liquid products like stocks of Fortune 500 companies, can be issued, traded, cleared, and settled on the blockchain.

Is this technically feasible? If we are discussing public permissionless blockchains, at least based on the current state of affairs, the answer seems to be no. The volume limitations and other scalability issues are well-known. The entire concept of public permissionless blockchains — designed to provide trust without government oversight — seems to be an unsuitable tool for complex and legally regulated areas like the securities market.

If we are discussing private or permissioned blockchains, will there be potential improvements in scalability? Even if so, what is the qualitative difference compared to other database technologies that are already widely used? Does this require any regulatory adjustments?

It seems that no one opposes the SEC maintaining a "technology-neutral" regulatory stance. So why should we evaluate specific forms of blockchain as candidate technologies for industry adoption? Why should we focus specifically on blockchain rather than other types of distributed ledger technologies? Regulatory efforts to promote blockchain — not to mention its specific forms — seem like the government is picking winners and losers. Moreover, it appears we are doing this before the technology has proven suitable for its intended use.

Beyond the question of what we are trying to build, why are we building it? Proponents argue that tokenization can accelerate trade settlement and make markets more efficient. The current settlement cycle is T+1 (one day after the trade date), and tokenization could push us toward instant settlement or "T+0." There is also a viewpoint that instant settlement can reduce counterparty risk because trades would be pre-funded. However, while the settlement cycle has shortened compared to the past, it is a design feature rather than a flaw. The intentional delay between trade execution and settlement supports core market functions and protective mechanisms.

For example, the settlement cycle facilitates netting. Simply put, netting allows counterparties to settle a day's trades on a net basis rather than on a trade-by-trade basis. The complex multilateral netting in our country's clearing and settlement system significantly reduces the volume of trades that need to be finally settled. On average, 98% of trade obligations are eliminated through netting. This enables the current system to handle enormous trading volumes. It is also one of the key reasons why the market has remained stable despite record trading volumes recently.

Netting also promotes liquidity. Because the vast majority of trades are "net settled" without actual settlement, they do not require cash exchange. If A sells to B, B sells to C, and C sells to A, these trades can be paired and eliminated. A, B, and C can all retain their funds, whereas in bilateral instant settlement on the blockchain, everyone must at least part with cash for a period of time.

Another important consideration is that instant settlement is often disadvantageous to retail investors, many of whom currently rely on the ability to submit payment after placing an order.

We must also remember that critical compliance activities occur during the settlement cycle. These activities include checks aimed at identifying and preventing fraud and cybercrime. The ability to pause trading and conduct investigations when warning signs arise is crucial for protecting investors and addressing broader issues such as national security and counter-terrorism.

Based on these and other reasons, it is unclear whether shortening the existing settlement cycle is desirable or feasible. Regulatory agencies and major market participants both domestically and internationally have raised compelling objections to this.

I believe that as regulators, our statutory duty is to exercise extreme caution regarding potential changes of this magnitude, which historically have only occurred in response to genuine market crises. While there is indeed room for improvement in our markets, I am curious whether the changes discussed today will address any existing specific issues. In "Field of Dreams," Ray Kinsella's belief that "if you build it, they will come" ultimately led to a good outcome for him. But Ray's choices and risks were limited to his family and farm. The SEC is the overseer of the U.S. capital markets, and the systemic changes we are discussing could impact every market participant from Wall Street to the general public.

Let us ensure that the measures we consider are appropriately limited to the portion of the market participating in crypto — recently estimated to account for less than 5% of U.S. households — and do not harm the traditional financial (TradFi) markets that most Americans rely on for their financial well-being.

Link to the article: https://www.hellobtc.com/kp/du/05/5850.html

Source: https://s.c1ns.cn/El3td

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