Mark Wetjen, Managing Director, Head of Global Public Policy, DTCC and Chairman of the Board, DTCC Deriv/Serv LLC
The crypto-asset market is still relatively small compared with the global financial marketplace. The projections on its likely growth have been questioned and some industry participants are even describing the current state of affairs as a ‘crypto-winter’. The current question therefore needs to be, will the sector evolve towards growth and if so, how?
Policy makers have struggled to respond to the development of crypto-asset marketplaces, where these assets can be bought and sold. Up until now, the main investors in crypto assets have been individual investors, family offices and small hedge funds. With the retail investor’s interest in the market as significant as it has been, policy makers rightly have been focused on investor protection.
With these concerns in mind, in a recent white paper, we outlined post-trade responsibilities that should be undertaken by platforms providing the post-trade processing of these assets. We focused on tokenized securities, which are another form of a security, a capital-raising instrument that is subject to very developed policy and laws around the world.
Without the establishment of best practices, rules and regulations that provide levels of safety and risk mitigation that the public rightly expects for the processing of traditional securities, policy makers will not meet their objectives, and the market for tokenized securities will fail to broaden its current community of investors. This approach has applicability to the crypto-asset space more broadly, beyond just the subset of tokenized securities.
Blockchain technology can be used to support the trading and/or post-trade processing of crypto assets – including security tokens – on platforms that can be structured in various ways, including through utilization of a permissioned or permissionless blockchain network.
Existing regulations applicable to the post-trade processing of traditional securities should be applicable to the post-trade processing of tokenized securities. However, in some cases those existing regulations might not squarely apply. In such cases, and because platforms can be configured in a variety of ways, policy makers should consider a functional approach.
When looking at which post-trade responsibilities should apply to security-token platforms, policy makers might consider which existing post-trade responsibilities should not apply. From a policy point of view, this would be the best way to serve the public interest bearing in mind that the post-trade infrastructure for traditional assets has been developed over many years.
Also, this will ensure that a security-token platform operates in a way that is consistent with the public interest. Any platform that provides post-trade processing for tokenized securities should have a clear, transparent and enforceable legal basis for each aspect of its activities in all relevant jurisdictions. It should also have an identifiable governance structure and prove it can be operated safely with a high degree of resiliency and security.
“Without the establishment of best practices, rules and regulations that provide levels of safety and risk mitigation that the public rightly expects for the processing of traditional securities, policy makers will not meet their objectives, and the market for tokenized securities will fail to broaden its current community of investors.” – Mark Wetjen, DTCC
When it comes to procedures and systems, processing platforms need to have identifiable risk management procedures and systems as well as the ability to provide clear and certain final settlement. Ensuring final settlement is perhaps one of the key challenges facing the processing of tokenized securities because of the complexity of the technology itself, which often employs a consensus mechanism relying on multiple nodes and computer systems.
Other responsibilities related to the issuance, custody and asset servicing of tokenized securities are important. Again, custody – and the responsibilities surrounding that function – is another area where the complexity of the underlying technology can make it more challenging for policy makers to understand and agree to what best practices might be.
Finally, the platform should be able to demonstrate how it manages the privacy and confidentiality of records while maintaining their accessibility to regulators and appropriate third parties such as external auditors. Blockchain technology generally is regarded as especially equipped to ensure the confidentiality of its users – establishing policies and procedures so that regulators and auditors can check the technology’s work is equally important.
As the nascent crypto-asset space evolves, so does the need for an appropriate post-trade rules to serve it. To some this might run contrary to the ethos that created public blockchains. But to the investing public, it is a must, and the post-trade responsibilities applicable to securities processing more generally can be instructive.
This article first appeared in Global Investor/FOW on May 3, 2019.