Token Taxonomy Q&A: Lori Jo Underhill, LJU & Associates
While digital currencies and crypto-assets continue to go through their version of the Cambrian explosion, classifying and naming these new assets remains a major challenge for the industry. Markets Media caught up with Lori Jo Underhill, a principal at consultancy LJU & Associates, to discuss how firms can approach these tasks.
How would you grade Wall Street’s approach to building sustainable taxonomies for digital assets?
My grade for Wall Street is F-.
Wall Street is quite capable of embracing and adopting a digital asset taxonomy. The issue is not that the players don’t have the capacity, the matter is that there is a lack of interest and commitment to understanding the nature of digital assets, and to consider their inclusion as legitimate assets in the financial ecosystem. I suspect the reason for this is a lack of guidance from regulatory bodies for the same reasons.
Standard & Poor’s and Morgan Stanley developed the Global Industry Classification Standard (GICS) in 1999. This taxonomy now serves as the basis for ETFs worldwide and is a multi-billion-dollar SKU for S&P Global. If you put this into perspective, this taxonomy was created more than 200 years after the alleged and legendary first stock equity trade executed by a group of investors beneath a buttonwood tree on the sidewalk in the vicinity of where the NYSE now stands. The difference now is that digital asset technology is accelerating so much more quickly than equities ever did, and these assets impact all sectors of the economy.
The use case for a properly designed digital asset taxonomy is primary. Its adoption is critical for the full integration of digital assets into the world’s financial infrastructure. All market participants, including regulators, traders, investors, and product designers, could benefit and utilize it to forward a path of integration, not segregation of these asset classes.
Are most firms developing proprietary taxonomies or adopting a broader industry framework?
Most firms are lingering on the sidelines waiting for guidance from somewhere, and I suspect waiting for enlightenment endorsed through regulatory guidance. The taxonomies I have seen circling in the ecosystem, other than my own, have all been produced by industry trade organizations, lobbying and communication arms, or media companies supported by many firms. In contrast, my research was self-funded, objective, and without any sponsor.
Digital assets are comprised of multiple asset classes, not just one. My research identified four identifiers as well as a non-financial identifier, which are successfully framed against traditional asset classes.
This fact that digital assets are not just one asset class is lost on the majority of market participants. Key participants in the financial ecosystem use the language of traditional asset classes to refer to the nature of these assets (ie, security tokens or digital currencies).
My work is unique and identified the language for granular definitions for these asset classes, which was missing, and the phenomena are interesting to observe.
Other broad industry frameworks fail to consider the foundational attributes of digital assets when classifying and categorizing them, and that is why they all fail. Failure is defined by the framework producing outliers (uncharacterized assets).
The law is rooted in definition, classifications, and characterizations. A proprietary taxonomy is not useful for common definitions and understanding between jurisdictions and market participants. When the words commodity, currency, and equity are used, there is a common understanding of what those asset classes are, and they are well defined and understood across jurisdictions around the world.
The primary purpose of a taxonomy is to create a set of common definitions and/or attributes to categorize and classify. If there are disjointed approaches, there will never be a cohesive functional or regulatory ecosystem.
To which industry frameworks should issuers and financial institutions pay attention?
I designed a digital asset taxonomy framework, so I must suggest the Digital Asset Sector Hierarchy (DASH) is the one to consider and is the only integrative solution for digital assets into the world’s existing financial infrastructure. Most, if not all, other proposed frameworks consider the wrong attributes such as technology, use case, or function to classify assets. For example, many frameworks, including regulatory working group frameworks, consider the following classifications:
- security tokens,
- utility tokens,
- digital currency,
- and exchange tokens.
These four categorizations are not all based on the same fundamental attributes, and they cannot perform without experiencing attributive crossover.
For example, security tokens as the common understanding throughout the ecosystem, are not all securities. This distinction is not useful to categorized ownership assets. Utility tokens, which are described by many who lobby for lack of regulation because of their primary functional use cases, should not have any financial value at all. Digital currencies are not all created equally, especially when compared to what the industry now terms as “stablecoins.” Exchange tokens refer to digital assets traded on external exchanges.
This approach is wildly disjointed and applies technology, use case, and function to create a framework.
These frameworks produce outliers, which is the primary reason why everyone is entirely confused as to how to treat digital assets in a regulatory environment. When you hear participants refer to “hybrid” assets, this is because the attributes they are analyzing are not foundational enough to align them or separate them between buckets.
When applying the proper sets of distinct attributes to the assets there is an ability to classify them distinctly, and the result is a framework that produces distinct classifications without outliers.
My research identified:
- digital commodities,
- digital currencies,
- digital certificates of value,
- digital equities,
- and a digital unit which has no financial value.
When do you expect the various industry initiatives to deliver production-quality offerings?
I continue to be dismayed at the lack of understanding of the fundamental nature of digital assets. It took an in-depth study of over 2,500 digital assets over 14 months to realize the issue that is causing this confusion.
I studied financial and scientific taxonomies as a part of my research. The improper application of less than foundational attributes of technology, use case, and function are the reasons for industry confusion. Until industry participants and regulators realize the fundamental nature of digital assets in the ecosystem, this problem will continue to thwart worldwide adoption and shared understanding.
Regulatory clarity will unleash industry participation. Then interesting and innovative products will emerge.
What should firms expect to do between now and then, and how painful do you expect it to be?
The pain could stop immediately if the industry and regulators consider an academic perspective in designing and analyzing digital assets, rather than considering the agendas of parties who are lobbying for self-interests regarding regulation. These projects are trying to skirt regulation, claiming that they should not be regulated at all. As we have seen with the Libra project, that is not likely to happen.
My research uncovered that when digital asset attributes are aligned with existing traditional asset classes, and existing law, it results in three digital asset classes and some sub-asset classes of the fourth digital asset class that will likely require regulatory oversight.
Digital units and some digital equity ownership assets are currently unregulated when framed and compared to the existing regulation of current traditional asset classes.
If digital asset product designers and the financial industry begin to understand that what they are designing or trading is similar to one of the traditional asset classes, or doesn’t require regulation because it is aligned with an asset that is not currently regulated, then there will be no need to wait for future rules or regulations.
The pain points lie in trying to fit a square peg in a round hole when the peg is already round. Trying to re-create a new regulatory construct doesn’t make sense, and that is why there is no clear answer when applying other proposed frameworks. There is no reason to re-invent this.
The new market provides a regulated and transparent trading environment for crypto assets.
AAX offers over-the-counter, spot, and futures trading across a variety of digital assets.
DLT networks or tokenisation platforms have the potential to transform post-trade.
Cryptoassets are tradable property and smart contracts are enforceable agreements under English law.
Uncertainty for market participants limits innovation.