Tokenization: Our Dreamland? The Speech at the Crypto Assets Working Group Tokenization Roundtable.

Compiled: Vernacular Blockchain

Today's topic is very broad, perhaps the broadest subject discussed so far in the cryptocurrency task force roundtable: Tokenization. I understand that today's discussion will primarily focus on the potential regulatory efforts to promote Tokenization.

This topic reminds me of a famous quote from the movie "Field of Dreams" ( - "If you build it, they will come." You may remember that this movie stars Kevin Costner ), who plays the farmer Ray Kinsella (, inspired by a mysterious voice to plow his cornfield and build a baseball field, firmly believing that great things will happen.

I think this has some similarities to the current enthusiasm for Tokenization. Blockchain technology has been around for a long time. Although some limited use cases have been introduced recently, it has not yet been widely used for the issuance and trading of registered securities. Some believe that if we "build" - or more accurately, "rebuild" the financial system to adapt to blockchain, "they" various market participants will flock to embrace tokenized securities. Investors will benefit from increased participation and choice, and the market will thrive due to the improvements brought by blockchain.

In this regard, I would like to start by asking, what exactly are we trying to build? What is Tokenization?**Even if it is limited to the SEC's domain, it is difficult to give a simple definition of this term. Tokenization refers to the issuance of securities directly on the blockchain? Or does it refer to the creation of a digital representation of a security on the blockchain? This may seem like a subtle distinction, but from a regulatory perspective, it can have significant implications. In addition, should tokenization cover post-issuance distribution, trading, clearing, and settlement? In other words, will the entire life cycle of a security be "on-chain", or will it be just a subset of it?

No matter how we try to answer these defining questions, it is clear that the tokenized financial system is unlike any system we have seen before. It is not as well-known or easily understood as the baseball field built by Ray Kinsella. Many envision a completely tokenized system where any security, including high-volume liquidity products such as stocks of Fortune 500 companies, can be issued, traded, cleared, and settled on the blockchain.

Is this technically possible? If we're talking about public permissionless blockchains, the answer, at least as it stands, seems to be no. Trading volume limits and other scalability issues are well known. The whole concept of public permissionless blockchains – designed to provide trust without government oversight – seems like an inappropriate tool for a field as complex and heavily regulated by law as the securities market. **

If we are discussing private or permissioned Blockchains, does it improve the potential for scalability? Even if it does, what is the qualitative difference compared to other widely used database technologies? Does this require any regulatory adjustments?

It seems that no one opposes the SEC maintaining a "technologically neutral" regulatory stance. So, why should we evaluate specific forms of Blockchain as candidate technologies for industry adoption? Why should we pay special attention to Blockchain, rather than other types of distributed ledger technologies? The regulatory efforts to promote Blockchain—let alone its specific forms—appear to be the government picking winners and losers. Moreover, it seems we are doing this before the technology is proven to be fit for purpose.

Aside from the question of what we are trying to build, why are we building it? Supporters believe that tokenization can accelerate transaction settlement and make markets more efficient. The current settlement cycle is T+1) trading day after one day (, while tokenization could push us towards instant settlement or "T+0". There is also a viewpoint that instant settlement can reduce counterparty risk since transactions will be pre-funded. However, while the settlement cycle has shortened compared to the past, it is a design feature rather than a flaw. The intentional delay between trade execution and settlement supports core market functions and protective mechanisms.

For example, the settlement cycle facilitates netting )netting(. In simple terms, netting allows counterparties to settle a day's trades on a netting basis, rather than on a case-by-case basis. The complexity of multilateral netting in our national clearing and settlement system has dramatically reduced the volume of transactions that require final settlement. **On average, 98% of trading obligations are eliminated through netting. This allows the current system to handle huge transaction volumes. This is one of the key reasons why the market has been able to remain stable in the face of consistently record trading volumes recently. **

Net settlement also promotes liquidity. Because the vast majority of transactions are settled "net" without actual settlement, they do not require the exchange of funds. If A sells to B, B sells to C, and C sells to A, these transactions will be paired and offset. A, B, and C can all retain their funds, whereas in bilateral instantaneous settlement on the Blockchain, everyone must give up cash for at least a period of time.

Another important consideration is that instant settlement is often unfavorable for retail investors, as many retail investors currently rely on the ability to submit payment after placing an order.

We must also remember that key compliance activities will take place during the settlement period. These activities include checks aimed at identifying and preventing fraud and cybercrime. The ability to suspend transactions and conduct investigations when warning signs arise is crucial for protecting investors, as well as for broader issues like national security and counter-terrorism.

Whether it is desirable or feasible to shorten the existing settlement cycle based on these and other reasons is still unclear. Domestic and foreign regulatory agencies and major market participants have raised compelling objections to this.

I believe that, as a regulatory body, our statutory duty is to remain extremely cautious about potential changes of this magnitude, which historically occur only in response to genuine market crises. While there is indeed room for improvement in our markets, I am curious whether the changes discussed today will address any existing specific issues. In "Field of Dreams," Ray Kinsella's belief that "if you build it, they will come" ultimately led to good results for him. However, Ray's choices and risks were limited to his family and farm. The SEC is the regulator of the U.S. capital markets, and the systemic changes we are discussing may affect every market participant from Wall Street to the general public.

Let's make sure that the measures we consider are appropriately limited to the portion of the crypto market – recently estimated to represent less than 5% of U.S. households – and do not cause harm to the traditional financial )TradFi( markets that most Americans rely on for their financial well-being. **

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