Written by Pat LaVecchia, Founder and CEO of Oasis Pro Inc./Oasis Pro Markets.
Recently, Gary Gensler wrote in an op-ed regarding digital capital markets that addressed the current lack of regulation: “In the meantime, the SEC will serve as the cop on the beat.”
While he is referring to digital assets in general, the road map of digital asset securities remains murky. Currently, the ecosystem is akin to a Ferrari Roma—a masterpiece of engineering, encumbered by training wheels and a powerful engine stuck in neutral.
Stuck In Neutral?
The blockchain ecosystem for digital assets currently is managed by regulation through enforcement, which when SEC actions are publicized are open to various interpretations. Rather, the goal should be the implementation of policies and procedures with clear and implementable rules to replace the current approach.
As an example, a July 2022 announcement involved a recent insider trading action against a former Coinbase employee which included the statement that nine of the tokens identified were securities. The key point of “at least nine of which [tokens] were securities” was somewhat lost in the business reporting of the SEC action. This is a critical component as these tokens had previously been deemed by various exchanges as non-securities. Several exchanges have now delisted those nine tokens and Coinbase has filed a petition with the SEC requesting clarity. The ecosystem’s guessing game continues.
However, clarity may be forthcoming. A major step in this direction occurred on Sept. 8, 2022, when Chairman Gensler gave a speech to the Practising Law Institute. Although many would say there are significantly more than 10,000 tokens, he stated, “Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities.” From this, one can conclude that his primary message was that crypto activities are already covered by existing regulations and do not need new laws or rules of their own. In turn, investors deserve disclosure and deserve to be protected against fraud and manipulation.
Blockchain As A Compliant Technology Solution
Much of Wall Street’s current infrastructure is built on legacy technology, which has often been patchworked and remains inflexible. Blockchain by comparison is as important as the introduction of the internet was. Blockchain technology, when fully implemented, can reduce costs, significantly reduce counterparty risk/real-time settlement, enable real-time cap table management, streamline KYC/AML compliance and increase transparency for regulatory oversight utilizing an immutable ledger.
Blockchain technology has untapped potential to improve regulatory compliance and move regulations forward efficiently and successfully. Additionally, assets traded on the blockchain have a digitally pre-verified ability to settle a trade, reducing settlement times and eliminating counterparty risk.
The application of blockchain technology drastically reduces the time, cost and effort that registered broker-dealers spend on counterparty risk management and regulatory reporting, while protecting against financial and reputational losses. By using blockchain technology, there is an instantaneous audit trail that is immutable and a reliable record of transactions. This is an innovation that makes blockchain technology truly powerful.
Compliance-First Approach In Capital Markets
Given the Chairman’s messaging, companies would be well advised to implement a “compliance-first” approach to digital assets now, rather than wait for the SEC to determine what products qualify as securities and then subject that firm to enforcement action.
A compliance-first approach is a proactive strategy from a regulatory standpoint; combining know your customer (KYC), know your business (KYB) and anti-money laundering (AML), each meeting the required standards. This approach will require building out a team of experienced financial experts and integrating technology that enables the team to continuously assess actors and actions.
Blockchain has been proposed as a secure reporting mechanism for regulators; however, their reluctance to accept blockchain as an authoritative ledger has stalled adoption. The concerns of manipulation are outweighed by the fact that the blockchain is a transparent, real-time, instantaneous ledger with secure wallet-to-wallet transactions.
By effectively implementing blockchain technology into their ecosystem, financial institutions can reduce the time, cost and effort that it takes to achieve and maintain regulatory compliance while also seeing an improvement in the quality, accuracy and confidence in the process. The viewpoint toward blockchain as the authoritative ledger or “good control location” should start to shift as the SEC moves toward outlining its definition of securities and finalizing regulatory practices.
Regulation, ATSs And Capital Markets
New uses of blockchain, such as providing the foundation for alternative trading systems (ATSs), are emerging to help remove some of today’s regulatory challenges.
ATS platforms are emerging with new technology that allows digital securities to be traded on the blockchain directly. The technology allows instantaneous digital to digital wallet transactions, providing back-office savings to issuers such as major corporations and investors providing liquidity to historically illiquid asset classes.
Our recommendation is to search for a compliant-forward, FINRA-regulated and SEC-registered ATS. By partnering with a compliant-forward company, compliance requirements and regulatory compliance will be prioritized from day one. The best piece of advice for any financial or capital market organization is to begin to prepare compliance-forward practices, rather than await enforcement punishment from regulators. There are options available.
The Future Is Bright
A proposed road map includes a compliance-first approach in the capital markets, regulatory acceptance of the blockchain as an immutable record and authoritative ledger, a clear regulatory framework for new issuers, as well as a path for existing unregulated assets to become compliant digital securities.
Several decades from now, the acceptance and utilization of blockchain technology may be ubiquitous in the capital markets. Many crucial infrastructure institutions, such as DTCC, are making very large investments to integrate blockchain technology into their existing business functions. Blockchain technology and digital currencies are here to stay, and when full implementation occurs, it will be welcomed by the capital markets and its core participants.
In the near future, further regulatory clarity should occur and the benefits of blockchain can pave the road forward in the capital markets. But for now, the Ferrari sits idle in a garage, waiting to shift to first gear before roaring down the streets of a resurfaced Wall Street.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.