Thank you and good afternoon. I am delighted to speak to this distinguished group at today’s roundtable on tokenization.[1] Thank you to the panelists for participating today.

The topic of this afternoon’s discussion is timely as securities are increasingly migrating from traditional (or “off-chain”) databases to blockchain-based (or “on-chain”) ledger systems.

This movement of securities from off-chain to on-chain systems is akin to the transition of audio recordings from analog vinyl records to cassette tapes to digital software decades ago. The ability to easily encode audio in a digital file format, which could readily be transferred, modified, and stored, unlocked tremendous innovation within the music industry.[2] Audio was freed from its boundaries as a static, fixed-format creation. It suddenly was compatible and interoperable across a wide range of devices and applications. It could be combined, broken apart, and programmed to form entirely new products. This also led to the development of novel hardware devices and streaming content business models, greatly benefiting consumers and the American economy.[3]

Just as the shift to digital audio revolutionized the music industry, the migration to on-chain securities has the potential to remodel aspects of the securities market by enabling entirely new methods of issuing, trading, owning, and using securities. For example, on-chain securities can utilize smart contracts to transparently distribute dividends to shareholders on a regular cadence. Tokenization can also enhance capital formation by transforming relatively illiquid assets into liquid investment opportunities. Blockchain technology holds the promise to allow for a broad swath of novel use cases for securities, fostering new kinds of market activities that many of the Commission’s legacy rules and regulations do not contemplate today.

In order for the United States to be the “crypto capital of the planet” as envisioned by President Trump,[4] the Commission must keep pace with innovation and consider whether regulatory changes are needed to accommodate on-chain securities and other crypto assets. Rules and regulations designed for off-chain securities may be incompatible with or unnecessary for on-chain assets and stifle the growth of blockchain technology.

A key priority of my Chairmanship will be to develop a rational regulatory framework for crypto asset markets that establishes clear rules of the road for the issuance, custody, and trading of crypto assets while continuing to discourage bad actors from violating the law. Clear rules of the road are necessary for investor protection against fraud – not the least to help them identify scams that do not comport with the law.

It is a new day at the SEC. Policymaking will no longer result from ad hoc enforcement actions. Instead, the Commission will utilize its existing rulemaking, interpretive, and exemptive authorities to set fit-for-purpose standards for market participants. The Commission’s enforcement approach will return to Congress’ original intent, which is to police violations of these established obligations, particularly as they relate to fraud and manipulation.

This undertaking requires coordination across multiple offices and divisions within the Commission, which is why I am pleased that Commissioner Uyeda and Commissioner Peirce have worked together to establish the Crypto Task Force. For too long, the Commission has been plagued by policymaking siloes. The Crypto Task Force exemplifies how our policy divisions can come together to expeditiously provide long-needed clarity and certainty to the American public.

Now, I mentioned three areas of focus for crypto asset policy – issuance, custody, and trading.

Issuance

First, I intend for the Commission to establish clear and sensible guidelines for distributions of crypto assets that are securities or subject to an investment contract. Only four crypto asset issuers have conducted registered offerings and offerings pursuant to Regulation A.[5] Issuers have largely avoided these types of offerings, in part, due to challenges in satisfying the associated disclosure requirements. In cases where the issuer does not intend to distribute ordinary securities, such as stock, bonds, or notes, issuers also struggle to determine whether a crypto asset constitutes a “security” or is subject to an investment contract.[6]

In the past few years, the SEC first pursued what I call the “head-in-the-sand” approach – perhaps hoping that crypto would go away. Then, it pivoted and pursued a shoot-first-and-ask-questions-later approach of regulation through enforcement. It claimed that it was willing to talk to prospective registrants, “Just come in to visit,” but this proved ephemeral at best and more often misleading because the SEC made no necessary adaptations to registration forms for this new technology. For example, Form S-1 continues to require detailed information regarding executive compensation and use of proceeds, which may not be relevant or material for investment decisions in crypto assets. While the SEC has previously adapted its forms for offerings of asset-backed securities and by real estate investment trusts, it has not done so for crypto assets despite increased investor interest in this space over the past few years. We cannot encourage innovation by trying to fit a square peg into a round hole.

I am committed to the Commission charting a new course. The Commission staff recently issued a staff statement on disclosure obligations for certain registrations and offerings.[7] The staff also clarified the view that certain distributions and crypto assets do not implicate the federal securities laws, and I expect the staff to continue to provide clarifications at my direction with regard to other types of distributions and assets.[8] However, existing registration exemptions and safe harbors may not be entirely fit-for-purpose for certain types of crypto asset offerings. I view this construct of staff pronouncements as extremely temporary – Commission action is both vital and necessary.  In the meantime, I have asked the Commission staff to consider whether additional guidance, registration exemptions, and safe harbors are needed to create pathways for crypto asset issuances within the United States. I believe that the Commission has broad discretion under the securities acts to accommodate the crypto industry, and I intend to get it done.

Custody

Second, I support providing registrants with greater optionality in determining how to custody crypto assets. Commission staff recently removed a significant impediment for companies seeking to provide crypto asset custodial services by rescinding Staff Accounting Bulletin No. 121.[9] That pronouncement was a grave error. The staff had no place to act so broadly in place of Commission action and without notice-and-comment rulemaking. The action created needless confusion and went far beyond the jurisdiction of the SEC in its effects. However, the SEC can do much more to enhance competition in the market for legally compliant custodial services than merely getting rid of SAB 121.

It is important to provide clarity on the types of custodians that qualify as a “qualified custodian” under the Advisers Act and Investment Company Act, as well as reasonable exceptions from the qualified custody requirements to accommodate certain common practices within crypto asset markets. Many advisers and funds have access to self-custodial solutions that incorporate more advanced technology to safeguard crypto assets as compared to some of the custodians in the market. Consequently, the custody rules may need to be updated to allow advisers and funds to engage in self-custody under certain circumstances.

Additionally, it may be necessary to repeal and replace the “special purpose broker-dealer” framework[10] with a more rational regime. Only two special purpose broker-dealer are in operation today due clearly to the significant limitations imposed on these entities. Broker-dealers are not and never were restricted from acting as a custodian for non-security crypto assets or crypto asset securities, but Commission action may be needed to clarify the application of the customer protection and net capital rules to this activity.

Trading

Third, I am in favor of allowing registrants to trade a broader variety of products on their platforms and in response to market demand, activities which previous Commissions had prevented. For example, some broker-dealers seek to go to market with a “super app” that offers trading in securities and non-securities and other financial services all under a single roof. Nothing in the federal securities laws prohibits registered broker-dealers with an alternative trading system from facilitating trading in non-securities, including via “pairs trading” between securities and non-securities. I have asked the staff to help us devise ways to modernize the ATS regulatory regime to better accommodate crypto assets. Additionally, I have asked the staff to explore whether further guidance or rulemaking may be helpful for enabling the listing and trading of crypto assets on national securities exchanges.

While the Commission and its staff work to develop a comprehensive regulatory framework for crypto assets, securities market participants should not be compelled to go offshore to innovate with blockchain technology. I would like to explore whether conditional exemptive relief would be appropriate for registrants and non-registrants that seek to bring new products and services to market that may otherwise not be compatible with current Commission rules and regulations.

I am eager to coordinate with colleagues in President Trump’s Administration and Congress to make the United States the best place in the world to participate in crypto asset markets.

Thank you for your attention. I look forward to the discussions to follow.

Source: SEC

Getting Smart – Tokenization and the Creation of Networks for Smart Assets: Opening Remarks for Tokenization Roundtable

Thank you, Chairman Atkins, Commissioner Uyeda, and Commissioner Crenshaw, and thank you all for joining us in person or online for the Crypto Task Force’s fourth roundtable. Thank you especially to our moderators, Jeff Dinwoodie and Tiffany Smith, and today’s panelists for helping us to get smart on tokenization.

Tokenization is rooted in the internet, which revolutionized our lives by enabling the creation of a range of networks. At the base of these networks are software protocols—a set of rules defining how computers and other devices communicate with each other. Protocols built on top of TCP/IP[1]—the protocol that governs the internet—enable applications that facilitate communication and easy access to information.[2]

Blockchain and other distributed ledger technology protocols are new internet-based protocols enabling the creation of new global networks, this time to facilitate the seamless transfer of assets and related data. These protocols commonly rely on cryptography for their operation and security. Novel crypto assets that would not exist but for the underlying protocols live on these networks. So do traditional assets when they get tokenized. Tokenization fits squarely within the Commission’s jurisdiction because it involves formatting traditional financial assets, like stocks and bonds, as crypto assets (or “tokens”) on a crypto network. Much as earlier internet-based protocols dramatically enhanced our lives by making it easier to communicate and access information, these cryptographic protocols have the potential to improve our lives through enhanced accessibility and efficiency of the markets for traditional financial assets.

Your “smartphone” makes you smarter and more efficient by serving as a portal to the internet and its networks of applications. Similarly, tokenizing traditional assets and putting them on crypto networks makes them smarter. Crypto networks are not only a new type of database or ledger for recording ownership of assets, but also a new type of computing platform that can support applications that allow you to do more with your assets. Smart contracts are self-executing software programs that define important properties of assets and applications running on crypto networks and serve as a portal to the networks of applications supported by these new internet-based protocols. A smart contract can define how and when securities may be purchased, sold, and transferred, as well as automate dividend and interest payments or other distributions. Further, because of the common protocols used to program these smart contracts and the related assets and applications, investors can use tokenized securities seamlessly on or within other smart contract-based applications, including DeFi applications.

Removing securities from siloed databases and tokenizing them on open, composable crypto networks mobilizes them and makes them usable in new and enhanced ways. Stablecoins, the first application of tokenization to achieve scale, demonstrate the efficiency and accessibility improvements that may arise from the use of crypto networks. Tokenization may provide similar benefits to the securities markets, such as increased operational efficiency, transactional transparency, liquidity, and accessibility; faster settlement; and greater investor opportunity. Several tokenized money market products are registered under the Investment Company Act of 1940, and tokenized private funds similarly issue securities designed to maintain a stable value and provide yield. Using crypto networks to maintain the record of ownership enables the securities to be used as collateral in derivatives transactions, rather than requiring investors to redeem the securities and then post cash as collateral. Tokenized securities also may serve as a means of settlement in the purchase and sale of other crypto assets, including other tokenized securities, in peer-to-peer or other types of onchain transactions. If these assets live on the same network, near-instant and simultaneous settlement is possible.

Tokenization cannot reach its full potential without legal clarity. Issuers and transfer agents continue to be unsure about whether a crypto network can be the master securityholder file or a component thereof for purposes of the Exchange Act’s transfer agent rules, even where the relevant state law expressly contemplates the use of a crypto network in connection with the maintenance of the securities ownership record. Further, the Commission’s Special Purpose Broker-Dealer statement, which defines “crypto asset security” to encompass any security that relies on cryptographic protocols, has created confusion regarding a broker-dealer’s ability to custody tokenized traditional securities, even when issuers and transfer agents retain control and can address erroneous or impermissible transactions. The Commission proposed to amend the Advisers Act custody rule to preclude traditional securities that are issued on a public, permissionless crypto network from eligibility for an exception from the qualified custodian requirement.

We are working on providing legal clarity to these and other questions in a sensible manner. Absent a compelling reason grounded in fact and law, the Commission should treat tokenized securities the same as traditionally issued securities. Under this approach, for example, the type of database used to record ownership of securities does not affect the substance of the securities issued, nor does the use of a crypto network give rise to a new or different type of security. A crypto network can constitute all or part of the issuer’s books maintained by its transfer agent. Tokenized mutual fund shares and tokenized privately issued securities should be eligible for the exceptions for such securities from the Advisers Act qualified custodian requirement. Tokenization may raise some legal challenges related, for example, to the integration with DeFi, application of the transfer agent rules and National Market System requirements, use of permissionless networks, and appropriate classification as certificated versus uncertificated securities. We can work through these and other issues with the expert help of today’s panelists and other interested members of the public. I look forward to the upcoming panels.

Source: SEC

Tokenization: Our Field of Dreams? Remarks at the Crypto Task Force Roundtable on Tokenization

Today’s topic is very broad, perhaps the broadest tackled so far in these Crypto Task Force roundtables: tokenization. I understand that much of the discussion will focus on potential regulatory efforts to facilitate tokenization.

This idea brings to mind a famous line from the movie Field of Dreams – “if you build it, they will come.”[1] As you may remember, this is a movie starring Kevin Costner as Ray Kinsella, a farmer who is inspired by a mysterious voice to plow under his corn field and build a baseball diamond, taking it on faith that great things will follow.

I see a parallel to the current enthusiasm around tokenization. Blockchain technology has been around for a long time.[2] And, although a number of limited use cases have recently been introduced,[3] it has not been widely adopted for issuance and trading of registered securities. There is an argument that if we “build” – or more accurately, “rebuild” – the financial system to accommodate blockchain, “they” – all manner of market participants – “will come” to embrace tokenized securities. Investors will benefit from increased participation and choice, and markets will flourish from blockchain-derived improvements.

To this, I would first ask, what exactly are we trying to build? What is tokenization? It is a term that, even limited to the SEC space, eludes a straightforward definition. Does tokenization mean issuing a security directly on a blockchain? Or does it refer to creating a digital representation of a security on a blockchain? This may seem a subtle distinction, but it likely carries significant consequences from a regulatory perspective. Beyond issuance, does or should tokenization encompass downstream distribution, trading, clearing and settlement? In other words, would the entire securities lifecycle move “on-chain,” or only a part of it?

However we might try to answer these definitional questions, it’s clear that a tokenized financial system is unlike anything we’ve seen before. It’s not something known and understood like the baseball field Ray Kinsella built. The vision many espouse seems to be a fully tokenized system, where any security, including high-volume liquid products like Fortune 500 stocks, can be issued, traded, cleared and settled on the blockchain.

• Is that even technologically possible? If we are talking about public permissionless blockchains, the answer at least as we sit here today seems to be no. The transaction volume limitations and other scalability problems are well understood.[4] The whole concept of public permissionless blockchains – which were designed to provide trust without the need for government oversight[5] – seems an awkward vehicle for something as complex and statutorily regulated as the securities markets.
• If we are talking about private or permissioned blockchains, does that improve the potential for scalability? Even if it does, is this qualitatively different from other types of database technologies already in widespread use?[6] Does it warrant any regulatory adjustments at all?
• No one seems to disagree that the SEC should remain a “tech neutral” regulator. So why is it our place to assess particular forms of blockchain as candidates for industry adoption? Why would we focus on blockchain in particular over other types of distributed ledger technologies? Regulatory efforts to facilitate adoption of blockchain, let alone specific forms of it, seem like the government picking winners and losers. And we seem to be doing so before the technology has even been demonstrated as fit for purpose.

Moving on from the questions around what we are trying to build, why are we trying to build it? Proponents argue tokenization can speed up the settlement of trades and make markets more efficient. Instead of our current settlement cycle of T+1, tokenization could potentially move us to instant settlement or “T+0.” There is also an argument that instant settlement could reduce counterparty risks because trades would be pre-funded. But the settlement cycle, while shorter than it used to be, is a design feature, not a bug. The intentional delay built in between trade execution and settlement provides for core market functionalities and protection mechanisms.

• For example, the settlement cycle facilitates netting. Roughly speaking, netting allows counterparties to settle a day’s worth of trades on a net basis rather than trade-by-trade. The sophisticated, multilateral netting that occurs in our national clearance and settlement system drastically reduces the volume of trades requiring final settlement. On average, 98% of trade obligations are eliminated through netting.[7] This allows the current system to handle tremendous volume. It’s a key reason why our markets withstood sustained, record-breaking trade volume in recent weeks without major failures.
• Netting also facilitates liquidity. Because the vast majority of trades are “netted” and don’t require settlement, they don’t require an exchange of money.[8] If A sells to B, B sells to C, and C sells to A, these trades are paired off and eliminated. A, B, and C can each retain their capital, as compared to a bilateral instant settlement over a blockchain, where each would have given up its cash for at least some period of time.[9]
• Another important consideration is that instant settlement would generally disfavor retail investors, many of whom currently rely on the ability to submit payment after placing orders.[10]
• We must also remember that critical compliance activities take place during the settlement cycle. These include checks designed to identify and prevent fraud and cybercrime.[11] When red flags go up, the ability to pause a transaction and investigate is essential for investor protection and broader concerns like national security and counterterrorism.

For these and other reasons, it is not at all clear that shortening the existing settlement cycle is desirable or feasible.[12] Regulators and major market participants, here and abroad, have persuasively argued otherwise.[13]

I think it is our statutory obligation as a regulator to exercise extreme caution with potential changes of this scale, which historically have been undertaken only to address true market crises. While there are certainly areas to improve in our markets, I am interested in whether the changes discussed today would fix any specific existing dysfunction. In Field of Dreams, putting faith in “if you build it, they will come” worked out pretty well in the end for Ray Kinsella. But Ray was making a choice, and taking a risk, limited to his family and his farm. The SEC is the steward of the U.S. capital markets, and the kinds of systemic changes we are talking about have the potential to affect every market participant from Wall Street to Main Street.

Let’s ensure that what we’re contemplating is appropriately scoped to the portion of the market that participates in crypto – recently estimated to be less than 5% of U.S. households[14] – and not detrimental to the “TradFi” markets on which most Americans depend for their financial well-being.[15]

Thank you all for your ongoing engagement with the Commission on these important issues. I look forward to today’s discussions.

Source: SEC