Following on this morning's "BIS/New York Fed: Hell Yes We Can Run Monetary Policy In A Tokenized World".
note: this commissioner is very sharp and can probably run rings around most practitioners in the fields of securities regulation and market structure, she's worth listening to.
From the U.S. Securities and Exchange Commission, May 12:
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]
....MUCH MORE
It's all happening right now and as the kids used to say, ya snooze, ya lose.
Also at the SEC, May 12:
