Background
In the 114th Congress, the House Energy and Commerce Committee initiated a series of hearings to explore emerging technological innovations, and the potential opportunities and challenges associated with their adoption. This series recognized the significant technological advancements and the proliferation of innovative use cases occurring outside the scope of Congress and, in several cases, on an international scale.
Over the course of several years and across two congressional sessions, the ‘Disrupter Series’, as it was officially called, focused on a wide range of topics, including quantum computing, mobile payments, and the internet of things, to digital currency and blockchain technology. Multiple legislative bills were introduced and advanced as a result. It can be argued that this series significantly influenced future initiatives and legislative work unveiled in other committees such as the House Financial Services and House Agriculture Committees.
Then, as is the case today, lawmakers faced a difficult ‘balancing act’ in drawing a line between supporting technological innovation, while upholding longstanding consumer and investor protections and regulations. As then, House Energy and Commerce Tony Cardenas (D-CA) noted, “how must yesterday’s rules evolve to fit today’s technology?”
While the core question remains the same, yesterday’s emerging technologies have continued to evolve, use cases have expanded, and the opportunities (and challenges) have magnified. However, in many instances, policy discussions surrounding certain emerging technologies remain stagnant, often focused on outdated or singular use cases from the past.
Nowhere is this truer than when looking at the role of blockchain technology beyond the cryptocurrency use case to the various value propositions for U.S., and global capital markets. While policymakers have historically been transfixed on blockchain technology as the enabling technology supporting the crypto industry, a parallel discussion around blockchain’s role within our capital markets has yet to really manifest itself on Capitol Hill.
That’s unfortunate, especially when you consider the following:
- The industry conversation has shifted. In 2015, Santander InnoVentures – the venture capital arm of Santander Bank – produced a report, The FinTech 2.0 Paper, Rebooting Financial Services, that arguably lit a fire, if not the fire in driving institutional interest in the underlying technology supporting crypto markets to drive operational efficiency gains. The report found that distributed ledger technology (DLT) could reduce bank’s infrastructure costs associated with cross-border payments, securities trading, and regulatory compliance by $15-20 billion per year by 2022. By 2022, the industry conversation had already shifted, however, beyond just focusing on blockchain technology from a purely operational efficiency perspective to how the underlying technologies could enable the deployment of new products and services, new distribution models, and the ability to make current illiquid markets, liquid, that could dramatically transform how capital markets operate and who can take part. A widely-circulated 2022 paper from the Boston Consulting Group and ADDX estimated that the tokenization of illiquid assets, just illiquid assets, could reach $16 trillion by 2030. Other research provides more subdued numbers or expectations, such as a June 2024 report by McKinsey & Company, but even so, the fact remains that the industry has moved on from looking at the use of DLT from an operational efficiency perspective to a broader set of perspectives where DLT could play a role – a point echoed by leaders from several prominent financial institutions in the wake of the FTX collapse.
- The policy conversation has shifted (internationally): 2022 marked a seminal shift in the way policymakers publicly viewed DLT. To be fair, multiple jurisdictions had, for several years in some instances, put in place laws to enable the use of DLT for various purposes outside of the crypto use case (ex. Germany’s e-Securities Act, several ordinances (and amended ordinances) in France, and Switzerland’s DLT Act come to mind among other legislative efforts achieved globally). It was in 2022, however, that we arguably began to see regulators turn their attention more towards focusing on the opportunities associated with DLT use in capital markets, in parallel with continued discussions around appropriate regulatory guardrails for cryptoassets and stablecoins.
For instance, former managing director of the Monetary Authority of Singapore, Ravi Menon, stated that cryptocurrencies “are just one part of the entire digital ecosystem. To understand the issues more sharply and what the benefits and risks are, we need to be clear about what the different components of this ecosystem are.” Menon went on to list the promising use cases of digital assets in financial services and how asset tokenization, in particular, has “transformative potential”.
In the wake of the FTX collapse, the former deputy governor of the Bank of England Jon Cunliffe stated that while the initial use case for crypto may or may not have a limited future “the technologies that have been developing in the crypto ecosystem and their possible use cases are, I think, likely to be developed further in both the crypto world and in the much larger traditional financial system. Indeed, I suspect that the boundaries between these worlds will increasingly become blurred.”
- Convergence. Cunliffe’s remarks bring me to my third point around convergence. Indeed, as the traditional and digital markets continue to evolve they are increasingly moving towards convergence rather than divergence. As Carlo Comporti, Head of Italy’s CONSOB, remarked in the February 2024 release of EuroFi’s Views Magazine: “The domains of finance and technology have merged, becoming inextricably intertwined.”
Elizabeth McCaul, Member of the Supervisory Board and ECB Representative on the Single Supervisory Mechanism, expanded on Comporti’s points in an interview for the September 2024 edition of EuroFi Views Magazine. She writes:
“The financial landscape is shifting, and so should regulation and supervision. To evolve properly, collectively we need a holistic understanding of the new contours of the financial system.”
“A major restructuring is under way in financial services: integrating financial services into non-financial ecosystems, changing the risk landscape, blurring traditional industry lines and challenging conventional regulatory boundaries.”
- Competitiveness. This ongoing convergence presents opportunities for various jurisdictions seeking to establish themselves as leaders, while also posing potential challenges to jurisdictions where the conversations around how blockchain-based technologies are helping to fuel this convergence are not as advanced.
For instance, UK Finance – the main financial services trade group in the UK – said in a recent report that the UK government “is at a key juncture in terms of enabling experimentation and establishing shared standards around safety and compliance, business logic, and token structure for interoperability.” This is “not a nice-to-have…. The future is now,” the trade association added. “Establishing the UK as a leader in the tokenization of capital markets must be a key imperative to protect our international competitiveness as a global financial centre,” it said. “It is not a problem that minimal tokenized securities issuance activity has taken place in the UK nor that the industry is only beginning to experiment. More can and should be done. Now is the time to really gather momentum and further drive positive engagement between the UK government, regulators, and industry participants to take this forward.”
In the EuroFi regulatory update released alongside the EuroFi Views September 2024 edition, additional areas of focus regarding the “next steps” for the Capital Markets Union (CMU) include the development of a digital CMU for tokenized assets. Further, a longer-term option proposed “involves creating a ‘European unified ledger’ – a single blockchain infrastructure that could potentially be developed in connection with T2S – to provide a common platform for a future digital CMU based on asset tokenization.”
- Governance: From an interoperability perspective blockchain-based infrastructures that span and connect to multiple jurisdictions and/or multiple financial institutions could provide for greater efficiencies and synergies thereby generating liquidity and scale that is sorely absent in today’s largely siloed digital infrastructures.
Several efforts are underway internationally with the Bank for International Settlements (BIS) particularly leading the charge on several initiatives, including Project mBridge – one of the more notable experiments after having been able to push beyond the proof of concept stage to reach the minimum viable product stage.
Furthermore, the BIS has proposed the Unified Ledger concept as a “network of networks that would allow various components of the financial system to work seamlessly together. In particular, it would have the potential to combine the monetary system (that is, central bank money and commercial bank money) with other assets, making possible the instantaneous payment, clearing, and settlement of any transaction.”
Sounds impressive, right?
But the biggest question of all in relation to multi-jurisdictional or multi-firm networks – one that could conceivably pose challenges either from an anti-trust perspective, as was raised in the 2016 Disrupter Series hearing on blockchain, or to U.S. financial interests and influence globally in the not-so-distant-future – is “who governs?” and on top of that “who has access to these networks?”
Keep in mind, as was recently expressed by several panelists at a recent House Financial Services Subcommittee hearing on transparency in global governance, the opacity behind the decision-making and standards promulgation under multilateral agencies and organizations is a very real concern. Furthermore, to what extent are U.S. financial regulators, in particular, involved in these discussions and decision-making, especially when it comes to standard setting and governance rulemaking surrounding such projects like mBridge or around concepts like a ‘Unified Ledger’? This poses particular challenges especially if such projects or several alternative state-backed infrastructures are able to sufficiently scale.
There is a larger story here.
A parallel political conversation focused on DLT’s use in financial markets that rides alongside longstanding and continued political efforts to develop responsible frameworks for cryptocurrencies and stablecoins are sorely needed. Instead of riding shotgun, the policy conversation around broader use cases for DLT in our capital markets has taken a back seat.
What’s needed is for policymakers to set the foundation for discussion.
Congressman French Hill (R-AR) said it best during the first-ever congressional hearing on the tokenization of real world assets:
“Because tokenizing real-world assets involves blockchain or distributed ledger technology, some might view tokenization as a mere extension of the digital asset conversation that we’ve been having in this Committee for over a year. However, it deserves its own distinct conversation and prioritization.”
We couldn’t agree more.
To set the foundation, lawmakers on the House Financial Services Committee, in consultation with the House Agriculture Committee and House Energy & Commerce Committee, should establish a new ‘Disrupter Series’ (or maybe a more appropriate name would be ‘Convergence Series’) targeted exclusively at the opportunities and challenges associated with the use of DLT in our capital markets and the implications for all participants involved along the value chain. Participants operating in both the traditional and digital marketplaces should offer perspective on the future of our capital markets and what is needed from policymakers and/or regulators to ensure the U.S. continues to remain competitive. These discussions should also take international developments and alternative regulatory frameworks into consideration, particularly those developments that may pose challenges to exerting U.S. financial influence overseas.
Lawmakers also have the opportunity to set the foundation for discussions at the agency level. For example, Section 608 in the House-passed Financial Innovation and Technology for the 21st Century Act (FIT 21) calls on the Commodity Futures Trading Commission and the Securities and Exchange Commission to jointly conduct a study “to assess whether additional guidance or rules are necessary to facilitate the development of tokenized securities and derivatives products”.
Alternatively, Representatives William Timmons (R-SC) and Ritchie Torres (D-NY) introduced stand-alone, bipartisan legislation, the Tokenization Report Act of 2024, which would require the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the National Credit Union Administration to submit a report detailing the trends surrounding the tokenization of traditional assets.
As the sun sets on the 118th Congress, there is ample opportunity for the 119th Congress to establish a cohesive strategy that sets the foundation for a more holistic, broad-based discussion of the ongoing shifts in market structure and how the U.S. can remain the leader in the capital markets of tomorrow.