Today, the Digital Assets, Financial Technology, and Inclusion Subcommittee, part of the House Financial Services Committee, held a hearing on the tokenization of real-world assets (RWAs) and the migration to digital securities. The hearing was entitled “Next Generation Infrastructure: How Tokenization of Real-World Assets Will Facilitate Efficient Markets.”
Testifying in front of the subcommittee were the following individuals:
- Carlos Domingo, Co-founder and CEO, Securitize
- Nadine Chakar, Global Head of DTCC Digital Assets, Depository Trust and Clearing Corporation
- Robert Morgan, Chief Executive Officer, USDF Consortium Lilya Tessler, Partner, Sidley Austin LLP
- Hilary Allen, Professor of Law, American University Washington College of Law
The hearing memo states that entities may be able to reduce reliance on intermediaries by using blockchain or tokenization to represent and facilitate the management of securities.
Tokenization may also provide the structure for payments and transfers as well as deposits. By reducing intrinsic friction in current financial services operations, all aspects of the tech stack managing financial assets may be improved. At the same time, novel assets may emerge as innovators see opportunity in the technology and previously exclusive assets become more atainable.
Subcommittee Chairman French Hill opened the hearing by saying that many markets may benefit from this new technology, but regulators in the US have blocked its development.
“We need to ensure our regulators are welcoming this kind of innovation to modernize our markets,” said Hill.
While Hill, and Republicans in general, have been supportive of Fintech innovation – most Democrats remain skeptical. The ranking member on the Subcommittee, Representative Stephen Lynch, voiced his skepticism of tokenizations, expressing concern about the risk to consumers and the financial services sector.
Domingo, well-known in the Fintech world and founder of a top tokenization platform, said in a prepared statement that “the tokenization of securities and the issuance of traditional asset classes in tokenized form can bring substantial efficiency improvements in the sale of securities, their issuance, trading, and post-trade processes, and everything related to the asset servicing of those securities.”
Domingo warned that existing regulation, which frequently has focused on crypto, has missed the mark as definitions and language regarding digital securities remain opaque. This has the potential to undermine innovation and competitiveness in the US as other jurisdictions push forward on bespoke digital securities rules.
“As a great example, the European Parliament has established a regulatory pilot regime for market infrastructures based on distributed ledger technology (DLT) for financial instruments that fall within existing regulations. The European Commission recognized years ago, in 2020, the many “provisions in existing EU financial services legislation that… preclude or limit the use of DLT in the issuance, trading, and settlement of… financial instruments” when utilizing blockchain technology. They also embraced “a policy interest in developing and promoting the uptake of transformative technologies in the financial sector, such as blockchain and distributed ledger technology.” In Europe, Securitize is a leader in participation in this Pilot regime. We are in the process of receiving a license for a Trading & Settlement System (TSS), one entity that operates both a trading system and a settlement system. Regardless of the regulatory environment in Europe, we continue to focus most of our efforts on the US because of the size and importance of the US capital markets.”
Domingo said a pragmatic step forward in the tokenization space would be to target private securities, issued under the various exemptions (Reg D, Reg A+, Reg S, and Reg CF), which could benefit from distributed ledger technology.
Domingo provided a list of recommendations for policymakers to pursue to enable digital security innovation. These include:
- Clarity in the definition of digital asset securities or tokenized securities.
- The SPBD framework is limited and time-bound and should be extended and expanded.
- Tokenized securities must be allowed to flourish on public, permissionless blockchains, in addition to private, permissioned chains, to realize the full benefits of blockchain technology.
- Digital Transfer Agents are critical to the tokenization ecosystem and must be recognized as such.
- ATSs must continue to be Eligible Trading Platforms for Tokenized Securities.
- Registered ATSs within SPBDs must be allowed to facilitate the settlement of transactions in tokenized securities.
Domingo encouraged the creation of legislation that provides a safe and compliant environment for digital securities to evolve.
Other witnesses echoed the advocacy of Domingo.
Chakar from DTCC said that tokenizing financial assets has the potential to address many limitations of the current post-trade process by modernizing, streamlining, and simplifying financial industry infrastructure. She described the technology as an attractive option to existing processes, including “standardized rules for financial transaction validation and replication and immutable transaction history.”
DTCC is developing a permissioned DLT ecosystem for the digital security sector.
Morgan said tokenization is “not crypto” and simply a shared database (or ledger) that enables parties to collaborate in real time from all over the world. He outlined the benefits of digital assets, describing tokenized deposits as the future of money. But as Domingo explained, regulatory clarity is needed to “bring this innovation to market.”
Attorney Tessler added that tokenization does not change the essential nature of an asset.
“A security represents the same bundle of rights, whether it is represented by a paper certificate, an entry on a centralized database, or a token on a decentralized blockchain ledger.”
She told the Subcommittee to learn about digital assets and support the US in becoming the leader in the tokenization world.
“The current market for tokenized real-world assets, at least in the securities space, cannot entirely develop until regulations treat these assets like any other traditional asset. The same may be true for other tokenized real-world assets, across many industries, that can take advantage of a blockchain’s capabilities, but may be challenged by outdated regulations providing for recordkeeping in paper form or transmitting data by mail couriers, which is not practical in a digital economy.”
The one witness who opposed tokenization, at least permissionless DLT, Professor Allen, claimed that “permissionless blockchain technology suffers from significant governance and operational fragilities.” Professor Allen is a regular suspect on Capitol Hill, having participated in past hearings where she has expressed her concerns about digital assets in general.
She is not a proponent of stablecoins and believes that CBDCs may be useful for wholesale (not retail) currency management. She stated:
“Regulators around the world have sounded the alarm that greater integration of crypto and traditional finance could undermine the stability of our financial system. Tokenization should not be used to facilitate this integration.”
While other global jurisdictions are progressing to the inevitable world of digital securities, the US has been slow to address the need for updated rules which were created prior to the Internet. A security should always be regulated as a security, but new ledger technology can provide improvements if rules are updated to accommodate the ecosystem and the ability of smart contracts. What is missing is a consensus within Congress to approve common-sense legislation that advances this type of Fintech innovation.