On June 5, the House Financial Services Committee Subcommittee on Digital Assets, Financial Technology, and Inclusion held a hearing entitled “Next Generation Infrastructure: How Tokenization of Real-World Assets Will Facilitate Efficient Markets.” Witnesses in the hearing were:
- Mr. Carlos Domingo, Co-founder and CEO, Securitize
- Ms. Nadine Chakar, Global Head of DTCC Digital Assets, Depository Trust and Clearing Corporation
- Mr. Robert Morgan, Chief Executive Officer, USDF Consortium
- Ms. Lilya Tessler, Partner, Sidley Austin LLP
- Professor Hilary Allen, Professor of Law, American University Washington College of Law
Legislation considered was:
- H.R. _____, To require the Commodity Futures Trading Commission and the Securities and Exchange Commission to conduct a study to assess whether additional guidance or rules are necessary to facilitate the development of tokenized securities and derivatives products, and for other purposes
- H.R. 8464, the “Tokenization Report Act of 2024”
Below is a summary of the hearing prepared by Delta Strategy Group. It includes several high-level takeaways, followed by summaries of opening statements and witness testimonies and a summary of the Q&A portion of the hearing.
Key Takeaways
The following is a summary of the main topics explored in today’s hearing. Each is discussed in further detail in the Discussion section below.
- The hearing discussed the potential of blockchain and tokenization to enhance efficiency and transparency in various markets, including agriculture, while highlighting the associated risks and regulatory challenges. There was a focus on how current regulatory frameworks, such as those under Staff Accounting Bulletin 121 (SAB 121) and proposed legislation like the Financial Innovation and Technology for the 21st Century Act (FIT21), impact the implementation and integration of tokenized assets within the financial system.
SUMMARY
Opening Statements and Testimony
Subcommittee Chairman French Hill (R-AR)
- Tokenization might be seen as an extension of the digital asset discussion we have had in this committee for over a year, but it requires its own conversation and priority. While digital assets are generally managed on blockchain networks, tokenization can integrate traditional finance on-chain. This process leverages blockchain’s efficiency and transparency to modernize U.S. markets, addressing issues like inflated costs, stranded liquidity, siloed markets, and high barriers to entry. These problems also exist in the banking system, where transferring funds and reconciling ledgers between financial institutions is time-consuming. Blockchain can automate these critical processes, streamlining settlement, lowering costs, and reducing agency costs, benefiting consumers. Its transparency and immutability provide a secure record of ownership for tokenized assets, reducing fraud and errors while increasing trust and visibility into transactions.
Subcommittee Ranking Member Stephen Lynch (D-MA)
- While it is important to distinguish tokenization from cryptocurrency, the two have become so interwoven that I am cautious about risks such as fraud, cybersecurity, and illicit finance. Thus far, it seems the only uptake has been by the crypto industry, whose products are primarily used by gamblers and criminals. Despite these warning signs, major financial institutions, including large banks and asset managers, are announcing their intention to offer tokenized products. As financial institutions consider this path, policymakers should consider the various risks and legal considerations around ownership and transfer of tokens, investor protection, anti-money laundering concerns, and privacy and consumer data protection.
Carlos Domingo, Co-founder and CEO, Securitize
- The Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) do not always use consistent definitions of digital asset securities and, at times, also conflate crypto assets. It is important to distinguish between these very different instruments as many risks that this Committee has sought to address with crypto assets deemed securities do not exist with tokenized securities. Tokenized securities must be allowed to flourish on public, permissionless blockchains, in addition to private, permissioned chains, to realize the full benefits of blockchain technology. Digital Transfer Agents are critical to the tokenization ecosystem and must be recognized as such.
Nadine Chakar, Global Head of DTCC Digital Assets, Depository Trust and Clearing Corporation
- The tokenization of traditional financial assets has the potential to address certain limitations of the current post-trade process by modernizing, streamlining, and simplifying financial industry infrastructure with a shared fabric of common information. Several key features make this technology an attractive option to existing processes, including standardized rules for financial transaction validation and replication, and immutable transaction history. While Distributed Ledger Technology (DLT) has captured the imagination of the industry, there are challenges that will need to be overcome before it can be widely adopted and used. For example, to date, industry engagement has been generally uncoordinated. Years of smaller-scale deployments have resulted in isolated pools of instrument liquidity on proprietary DLTs, which now form obstacles to further industry growth.
Robert Morgan, Chief Executive Officer, USDF Consortium
- Tokenization should not be confused with cryptocurrency despite similar technological underpinnings. DLT is the next evolution in ledger technology. Financial infrastructure today consists of a series of siloed systems, separating banks and even products within an individual bank. DLT has the potential to break down these silos, facilitating efficiency within a financial institution as well as real-time collaboration among financial institutions. Tokenization can provide efficiencies that lower the cost of offering financial services, allowing banks to reach more Americans with safe, affordable, and inclusive products. The DLT space needs more regulatory clarity.
Lilya Tessler, Partner, Sidley Austin LLP
- Tokenization does not change the essential nature of an asset. A security represents the same bundle of rights, whether it is represented by a paper certificate, an entry on a centralized database, or a token on a decentralized blockchain ledger. However, regulatory considerations for securities market participants that utilize a blockchain ledger as opposed to a traditional database are still being considered by the market and regulators. I urge the Committee to continue to learn about the capabilities offered by blockchain technology and how the tokenization of real-world assets can support the U.S. in being the leader in a digital world.
Professor Hilary Allen, Professor of Law, American University Washington College of Law
- It is bad policy to tie legislation or administrative rulemaking to the state of technology at a particular moment in time, which is a mistake of FIT21. Doing so opens up opportunities to exploit loopholes by tweaking the technology itself, as well as guaranteeing that the legislation or rule will soon be rendered obsolete by technological evolution. Trust in tokenized deposits will flow from the application of traditional bank regulation to the banks that issue them. Investor confidence in tokenized capital markets will flow from the application of traditional securities laws.
- There are, however, some changes that may need to be explored outside of the boundaries of U.S. financial regulation to accommodate the tokenization of physical real-world assets and to facilitate cross-border transactions. For example, there may need to be changes in private law to address potential discrepancies between ledger-recorded and physical ownership of assets like real estate and art, or for ledgers to operate cross-border, which may require the harmonization of laws between countries.
Discussion
Tokenization and DLT
Hill (R-AR): How does tokenization allow assets to be traded more freely and efficiently across silos? Can this help bring market liquidity and marketability? Tessler: Yes, if everyone can look at the same ledger in real time to see the information, this eliminates the need to reconcile across multiple siloed ledgers.
Hill (R-AR): Does tokenization provide a more efficient way of managing the underlying securities of a fund? Domingo: Yes.
Hill (R-AR): Would tokenization aid in bank loan participation? Chakar: Yes; Morgan: Yes, there is a tremendous opportunity for tokenized deposits to help streamline particularly complex transactions.
Lynch (D-MA): What are some of the risks of tokenization? Allen: Tokenization could introduce volatility into traditional markets, potentially causing widespread suffering if something goes wrong. While blockchain offers efficiency benefits, it also introduces rigidity, and unforeseen circumstances could cause significant problems, like the financial crisis of 2008.
Davidson (R-OH): What are some implications and opportunities of tokenized assets? Chakar: There must be an interoperable structure, and compliance must be an underlying component.
Davidson (R-OH): How could tokenization be different in private markets versus public markets? Chakar: The private side of markets is more liquid and mature.
Sherman (D-CA): What are your thoughts regarding tokenization and blockchain? Allen: Stablecoins are not a good settlement asset as they live on an inefficient blockchain.
Rose (R-TN): Can you explain how an ag product can be represented by a digital token? What benefits would the representation of ag products as digital tokens bring to the ag industry or the consuming public? Tessler: Tokenized commodities can be integrated into commodities markets, enabling anyone to buy and sell those assets. Tokenization brings numerous utilities, including enhanced tracking and trading.
Rose (R-TN): Do you agree that the current regulatory regime created by SEC Chair Gensler lacks the necessary flexibility to fully realize blockchain technologies’ capabilities? Tessler: The definition of crypto assets is broad and can encompass tokenized securities, even if they are traditional securities recorded on a blockchain ledger. This means tokenized securities have different accounting treatments and custody requirements compared to traditional securities of the same asset.
Casten (D-IL): Do you agree that a blockchain system that allows mixers can provide a robust ledger of all the transactions and address anti-money laundering? Domingo: Yes, it is public infrastructure.
Steil (R-WI): How would DLT help some smaller financial institutions? Morgan: DLT is a shared infrastructure that can allow for real time collaboration so a group of community banks might be able to band together to make a loan when they otherwise would not.
Nickel (D-NC): How will tokenization increase market efficiency? Domingo: Tokenization would greatly impact how dividends are paid out today.
Nickel (D-NC): How should Congress address risks that may come with tokenization? Chakar: Congress should focus on risk management, cybersecurity, and resiliency.
FIT21
Sherman (D-CA): How will FIT21 impact retail investors? Allen: If FIT21 were to become law, the new Title II would permit placing any investment contract on a blockchain, potentially exempting it from traditional securities laws. This could significantly impact retail investors by reducing the regulatory protections currently in place.
Staff Accounting Bulletin 121
Nickel (D-NC): Staff Accounting Bulletin 121 should be withdrawn.