Background
In the rapidly evolving landscape of financial innovation, cryptocurrencies have emerged as a disruptive force, captivating innovators and investors alike. With their potential to unlock new possibilities for decentralized peer-to-peer transactions, it is no surprise that they have also drawn significant attention from governments and regulators. In recent years, policymakers have invested significant resources in their attempts to understand and navigate the complex and ever-changing domain of “crypto,” and to put in place effective regulatory frameworks (with varying degrees of success across different jurisdictions).
However, it is always worth emphasizing that cryptocurrencies only account for a small portion of the overall transformational potential of the underlying distributed ledger technologies (DLT), such as blockchain. These systems could fundamentally transform our financial system and capital markets via processes like tokenization. As a way of further illustration, the current cryptocurrency market capitalization stands today at $2.42 trillion, while a recent BCG report estimates that tokenization alone could unlock a $16 trillion opportunity by 2030 – focused solely on illiquid assets. Furthermore, if we take BlackRock’s Chair and CEO Larry Fink at his word, the broader use cases and potential of these technologies could far exceed even these estimates over time.
Given these figures, it is reasonable to ask if policymakers and regulators have been and continue to miss the forest for the trees – a focus on one aspect of the underlying technology (i.e., crypto) while overlooking the broader potential of the underlying technology to transform our capital markets and enhance U.S. financial competitiveness globally. In addition, is it also fair to question whether the very real difficulties just in nomenclature have contributed to a broader malaise across the “digital assets” space that has stunted the potential of the underlying technology to transform our capital markets?
Terminology as a Barrier
Delving deeper, the Global Financial Markets Association (GFMA) together, with Boston Consulting Group, Clifford Chance, and Cravath, Swaine & Moore LLP published an in-depth report covering the potential of DLT for capital markets. The report highlighted several key calls to action for industry participants and regulators, such as harmonizing legal and regulatory frameworks and building consensus on common standards to enable interoperability. However, as you read through the report, it becomes evident that a significant barrier to progress is the ongoing confusion surrounding terminology – especially the lack of consensus around what exactly we mean when we say “digital assets”.
Consider the Association for Financial Markets in Europe (AFME) August 2024 report, Digital Finance in the EU. In this report, AFME expends a good amount of effort into distinguishing between “DLT-based forms of traditional securities” with other commonly used terminology.
Failure to differentiate between various assets, products, and services, or the assumption that everything “digital” is synonymous with “crypto”, or that everything “blockchain” is crypto, has significantly impaired important and necessary discussions around how blockchain-based infrastructures can transform today’s siloed, highly fragmented, costly and inaccessible capital markets. This is analogous to past discussions around “FinTech,” where firms or providers associated with the term were often unfairly labeled as “unregulated” or “inherently risky”. Unfortunately, while this makes for good political soundbites it also acts as a deterrent to looking under the hood to understand and differentiate the actual risks from the very real potential of the various components.
Carla L. Reyes, Associate Professor of Law at SMU Dedman School of Law reiterated this broader point around a need for a greater understanding of the technology during last year’s House Energy and Commerce Committee Innovation, Data, and Commerce Subcommittee hearing. In her research, she considered linguistic evidence of misunderstandings about the differences among types of cryptocurrencies, applications of blockchain technology and its impact on the law and policy-making sphere. She found that “stakeholders in the legal field — legal academics, lawmakers, judges, and lawyers — tend to use cryptocurrency-related terms interchangeably, and often hold a specific example out for use in building the applicable legal framework.” In so doing, she stated that “law and policy risk ignoring the important variations in cryptocurrencies and their technical attributes. That failure, in turn, can lead to one-size-fits-all policy and legal frameworks that leave industry confused and clamoring for deeper clarity… good policy for blockchain technology requires understanding the technology, its uses, and its limitations.”
More Than Crypto
A deeper understanding of the technology and its practical applications for financial institutions would help illustrate to regulators that the mere presence of the word “digital” in front of an asset, product, or service should not automatically trigger a paradigm shift in regulation. In many instances, particularly with the tokenization of real-world assets – many of which have well-established legal histories and track records – there is little if any, regulatory ambiguity. The rules are clear and they already exist. As the GFMA report states, “Where the legal nature of a service of function does not change, we do not believe that the use of DLT-based technology to support or record the provision of that service or function should result in a change in the regulation or regulatory characterization of that service of function…. As regulated financial institutions innovate using DLT protocols to enhance Books and Records capabilities, this should not result in a change in the regulatory characteristics of the assets recorded on such Books and Records systems – including additional punitive capital treatment or creating barriers for responsible innovation.”
Unfortunately, this key thesis is still not widely understood, and the industry continues to be obstructed by confusion and conflation of a myriad of different assets, products, and services underneath the ever-expanding term “digital assets”, and the enduring regulatory uncertainty. This greatly hampers ongoing efforts by the financial services industry to utilize new, transformative infrastructures and technologies to evolve our capital markets and make them fit for purpose in the modern world.
While policymakers and regulators must strike a delicate balance between fostering innovation and protecting consumers, if we are to ever move forward, there needs to be a greater willingness to delve deeper into the weeds; to understand that there is more to all of this than just crypto; and that the underlying technology, when fused with other innovative components, can significantly evolve our capital markets. Continued conflation, misappropriation, or misrepresentation of terms makes the path toward a more liquid, accessible, and transparent marketplace for all much more difficult to achieve.
By Jackson Mueller, Policy Director, The Digital Chamber