Law Decoded: Bringing blockchain into securities markets, Feb. 12–19

But security tokens are not ready to take over the world quite yet.

Every Friday, Law Decoded delivers analysis on the week’s critical stories in the realms of policy, regulation and law.

Editor’s note

Technology is by and large not the major barrier — though many in the industry have a decent bit of hubris about it. More important is that people, whenever their money is on the line, get mighty conservative. Which is not necessarily greedy or unreasonable, but it is why it was easier for lawmakers to greenlight email than electronic signatures.

Conservatism surrounding money also means that old systems have to fail in a pretty conspicuous fashion for anyone to seriously talk about reforming or even discarding them. Think about how grotesque the subprime mortgage bubble of 2008 looked as regulators and news outlets dug through its wreckage in subsequent years: That’s what it took for Dodd-Frank to pass into law.

The whole Robinhood turbulence at the end of last month is not in the same league. But any casual observer, uncontaminated by the MBA jargon that exists to justify such shenanigans, can look at the events surrounding GME trading and know that these markets are not as free as we might imagine. And maybe it’s for that reason that we’ve spent so much time talking about it, because it’s an intro to standing problems in securities trading that is interesting enough to teach a whole generation of casual observers what short-selling is.

The thing is, the stock market is not going anywhere. But everyone sees in this eye-catching crisis an occasion to petition for what they want. For the blockchain community, it’s been an opportunity to consider how you can disintermediate securities trading or even facilitate same-day settlement of trades — securities tokens in other words. Others have, however, used it as an opportunity to disown classic securities altogether. But, more low-profile than the Robinhood affair, this week has seen a number of developments that bring crypto into securities markets and securities markets onto blockchains.

DLT for Israeli securities

Israel’s securities regulator approved Simetria’s digital bulletin board for advertising tech offerings, a step on the way to the start-up’s planned DLT securities exchange.

Simetria aims to provide a platform for other Israeli start-ups to issue private equity to international investors in a streamlined fashion. They expect to launch in May.

Relative to its population, Israel has one of the liveliest tech ecosystems in the world. Simetria’s application builds on the country’s Ministry of Finance’s declaration of interest in new trading platforms that operate in more niche markets than the Tel Aviv stock exchange. Simetria, however, is looking to focus on institutional investors, keeping the securities token market away from public offerings for yet another day.

Despite the promise of peer-to-peer securities trading for the public, the biggest impact has been restricted to private platforms. Platforms that have focused on retail investors have been plagued with low volumes and, frankly, unattractive offerings. There is hope that, as more of these private platforms crop up around the world, they will produce a network that can build into public offerings that will, ultimately, break down the siloed operations of the individual public platforms. For now, however, the most exciting offerings are limited to institutions.

For years now, the prospect of tokenizing traditional securities markets has been one of the crypto world’s core promises for how blockchain would revolutionize legacy finance. It’s been what you might call a long time coming. 

Robin who?

Oh sorry, did you want to hear about that Robinhood hearing yesterday? The full House Financial Services Committee gathered virtually to yell at the CEOs involved in the GME flurry last month.

I don’t like writing much about these hearings, as I don’t want to give them that much weight. They are generally full of sound and signaling, legislating nothing. But the range of reactions may actually signify something about tomorrow and tomorrow and tomorrow. As they say.

Democrats largely wavered on their earlier calls to end naked short-selling by hedge funds, though Melvin Capital’s CEO swore up-and-down that his firm did not, and could not, engage in naked short-selling at all. Democrats remained, however, quite hostile to Robinhood’s shortcomings in collateral — which, if they were as bad as they look, may well end up being the subject of an SEC action. A broadly bipartisan question was the wisdom of providing options and margin trading to retail investors.

Republicans were, per tradition, more sympathetic to the financiers. In addition to advocating for expanded access to “accredited investor” labeling, the idea of day-of — or T-0 — settlement loomed large. Robinhood’s Tenev definitely leaned on a T-0 solution as a way of evading blame. As a technological development, T-0 seems to depend upon new digitization of the U.S. dollar in addition to securities. While this is unlikely to happen in the near future, this is an area where blockchain lays a persuasive claim to being the best solution to both issues.

Ever-tightening circle of sanctions compliance

The U.S. Treasury’s Office of Foreign Asset Control announced fines on BitPay for providing services to users in sanctioned countries.

The settlement is remarkably similar to one that OFAC reached with BitGo at the end of December. Both attribute the services provided to negligence rather than active sanctions evasion. Helping the cases of both was that the dollar amounts of transactions in sanctioned areas were fairly low, and OFAC accused neither of servicing specially designated nationals. Consequently, the fines have been fairly limited.

Nonetheless, these settlements are shots across the bow for the crypto industry. OFAC is saying that it’s watching. And while it took a few years to actually get around to finding the activity, that suggests that it’s digging through the past with the latest technological tools.

The issue with sanctions is that the compliance regime necessary to identify user IP addresses by location and avoid any interaction with a sanctioned geographical region is pretty hard to square with most crypto practices. For contrast, the Treasury’s FinCEN office enforces money laundering regimes, which is more merciful — if your practices are sound, laundering can still happen on your platform and you’re not necessarily liable. Sanctions violations work on the standard of strict liability, which means that OFAC can come for any amount.

In practice, OFAC is working with limited resources and, despite its best efforts, has not yet reached omniscience. But there are hundreds of millions of people living in sanctioned countries, many of whom are particularly keen on crypto as those sanctions and local capital controls have ravaged their respective currencies. So OFAC’s advancing interest in the field is worth looking out for.

Further reads

For the Atlantic Council, Josh Lipsky outlines Treasury Secretary Janet Yellen’s role in bringing a digital dollar to market.

Attorney Peter Connors writes on new FinCEN requirements for disclosing foreign cryptocurrency accounts.

More commentary on the implications for crypto of Biden’s nominee to chair the SEC comes from Scott Kimpel.