Davos Debate: Should Tokenization Follow the “Same Business, Same Rules” Approach?

I was hoping I could get through the week without mentioning Davos, since the conference has become increasingly boring over the years, not to mention irrelevant.

But, alas, this harsh judgment is largely unfair, since the agenda of the annual meeting of the world’s elites attempts to address major global issues by inviting quintessential “influencers” to have their say. We can mock the private jets used to travel to a venue to discuss the dangers of climate change, mock the privileged financiers who reject the tools for financial freedom, and laugh at the hypocrisy of wanting to do so. fight disinformation with censorship. However, we can also appreciate showcases, parades and parties for the networking opportunities they represent. And we can enjoy the pageantry of media coverage, which is increasingly what Davos is about.

Sometimes intriguing but overlooked debates emerge. This happened yesterday, on Tokenization Economy panel, which I really liked. It featured good dialogue and smart people, including Circle’s Jeremy Allaire, Stellar’s Denelle Dixon, Euroclear’s Lieve Mostrey and Skybridge’s Anthony Scaramucci.

Noelle Acheson is the former head of research at CoinDesk and Genesis Trading and host of the CoinDesk Markets Daily podcast. This article is excerpted from her Cryptocurrencies have gone macro now newsletter, which focuses on the overlap between the changing crypto and macro landscapes. These opinions are his and nothing he writes should be taken as investment advice.

The discussion covered use cases, regulation, jurisdictional differences – the usual stuff but eloquently said. Finally, though, just as I was concluding “nice, but nothing new,” an audience member asked the panel’s opinion on the “same business, same risk, same regulation” regulatory approach.

Ha ha! Finally, something potentially controversial.

Euroclear’s Mostrey spoke first, insisting on such regulation it must be independent of technology if we do not want to block progress. This has been Euroclear’s approach so far, issuing a short-term note on its proprietary blockchain and then switching it to mainstream binaries, fully compliant with existing laws.

Read all: Noelle Acheson – Bitcoin ETF and Wall Street: a double milestone

I understand this and, in principle, I agree: when it comes to protection, it is the result that counts, not the technology. But when it comes to blockchain and securities, technology it matters a lot. It confers not only new benefits but also new features that legacy binaries cannot contemplate. True, it is not exactly the “same activity”. But insisting that all blockchain-based securities comply with current regulations limits the potential at the starting gate. We will only ever get “more of the same”, but with a certain efficiency. We can certainly aim higher.

Same but different

Even if we agree to start with the “same” and work with regulators to create rules for the “different,” there are still regulatory issues that need to be addressed. For starters, the blockchain-based Euroclear banknote needed to be switched to legacy binaries to be fully compliant. This adds steps, layers and intermediaries, which doesn’t seem that efficient to me. Why can’t blockchain-based banknote meet regulatory requirements?

Because natively recognizing securities transactions on a blockchain is not as simple as it seems. For example, settlement finality is a key part of securities regulation: when does ownership transfer? In traditional securities, it occurs when the seller has accepted payment for the asset from the buyer. This involves many steps, involving clearing houses such as Euroclear. But on a blockchain, the “finality” of settlement is both atomic (payment and transfer in one step) and usually consensus-based. How much consent is sufficient for the purpose?

This is made even more complicated by the variety of blockchains used for tokenization: there are public, permissioned chains, proprietary networks, and sometimes a hybrid. Different blockchains work in different ways.

There is also currently a lack of clarity on what reporting is required for on-chain transactions and how it should be provided. Also, what kind of identity should be used?

And when the entire lifecycle of a title is embedded in code, who is responsible if something goes wrong? Depending on the platform you choose, blockchain “fixes” are not at all simple.

The Euroclear approach can work: use blockchain, but repeat everything on traditional tracks so that regulators are happy and traditional investors don’t feel left out. But is it optimal? Is inserting this new type of resource into an existing structure the most efficient approach? For now, it broadens the potential reach beyond gatekeepers, but ultimately, it’s nothing more than a very short-term solution.

Circle’s Allaire’s response sums it up succinctly: “Same business, same rules is still a backward-looking philosophy.”

Read all: Colin Butler – 2024 will be the year tokenization truly (finally) begins

He used the early days of the Internet as an example. If this philosophy had been applied then, she said, the world would look very different today. All websites should be registered with the Federal Communications Commission. If someone were to stream audio, they would have to get a radio license. For peer-to-peer communication, a platform should apply to become a telecom operator. With this maze of requirements, the primary use of the Internet would probably still be the exchange of research papers.

Cryptocurrencies are in a similar situation. I totally agree that regulation should care about outcomes, not technology. But to ignore technology’s ability to do things in a radically different way is to diminish its potential even as it takes its first steps.

It’s a difficult problem to solve. Financial assets have a totally different risk profile than publications or audio content. The layers of regulation aimed at protecting investors while constraining economies are orders of magnitude more complex, as they should be.

And waiting for new rules to be developed, which take into account the new features of blockchain-based asset transfer, could end up delaying progress for years.

A compromise

So, what is the solution? My preference is for “simple” tokenized securities to be covered by existing rules, to allow crypto-native and legacy market participants to begin to experience market processes and reactions. In the meantime, sandboxes should allow experimentation with regulators’ consent. Sandboxes must recognize that markets are changing and that ideas “out there” may end up becoming the norm of a more efficient tomorrow. It wasn’t that long ago that e-commerce was considered a radical departure from common sense throughout history.

Tokenization represents a similar step forward: just as electronic trading has unleashed a previously unimaginable range of new types of products and trading strategies, so will blockchain-based markets. Just as electronic trading has enabled increasingly sophisticated dashboards to improve both intelligence and reporting, blockchain transparency can reduce risk while enabling new market capabilities.

The potential is much greater than doing something more efficiently. It’s about what we will be able to do that we couldn’t do before. This will require new rules, but in the meantime we can work within the existing ones.

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