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Blockchain Won’t Fix Financial Markets, Law Professor Tells Congress – DL News
- The so-called tokenization of real-world assets has generated a lot of hype in recent years.
- Its proponents say it automates inefficient processes in financial markets.
- But those benefits could be achieved with better technology than blockchain, Hilary Allen, a professor at American University’s law school, said Wednesday.
The giants of Wall Street – from investment banks like JPMorgan to the world’s largest asset manager BlackRock – advertise its benefits onchain securities issuance and processing.
These companies say the so-called tokenization of assets, from stocks and bonds to art and real estate, will automate what are currently inefficient and error-prone operations in financial markets.
However, all these benefits could be achieved with other types of ledgers and databases besides blockchain, a finance academic told Congress on Wednesday.
“Cryptocurrencies run on public blockchains without permission, and tokenization is not necessary,” said Hilary Allen, a law professor at the American University Washington College of Law.
Allen testified at a hearing called by the House Subcommittee on Digital Assets, Financial Technology and Inclusion to discuss whether tokenization will facilitate efficient markets.
“Blockchains suffer from unavoidable operational inefficiencies and fragilities that make them unsuitable as supporting infrastructure for real-world assets.
— Prof. Hilary Allen
Consent concerns
Wall Street has dabbled in tokenization for years, especially – thanks to competitive and regulatory concerns – on closed, so-called “permissioned” blockchains.
More recently, however, banks have begun testing the capabilities of public blockchains like Ethereum.
The problem is that these blockchains “suffer from unavoidable inefficiencies and operational fragilities that make them unsuitable as supporting infrastructure for real-world assets,” Allen said.
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For example, consensus mechanisms – protocols for bringing nodes on a blockchain into agreement to verify transactions – are ineffective and wasteful, he said.
This is often by design (many blockchains, for example, have built-in delays), but this means they cannot process large volumes of transactions.
Furthermore, governance is an issue.
Global financial markets operate on centralized databases monitored for cybersecurity and operational risk and subject to strict controls, rather than by unregulated and sometimes anonymous master developers.
When financial companies experiment with blockchain, they often address these scalability and governance issues by recentralizing control of certain processes, Allen said.
But this raises the question: “Why use public, permissionless blockchain in the first place?” she asked.
Allen also took aim at the claim that tokenization projects make in their marketing: that they are democratizing finance by offering fractional ownership of assets usually inaccessible to everyday Americans.
“I urge you not to pin your hopes on tokenization as a means to improve financial inclusion,” he said.
“With so many Americans living paycheck to paycheck, the problem is not a lack of investment opportunities, but a lack of money to invest in the first place.”
Better rules
Allen sounded the only skeptical note during the hearing.
Other witnesses represented companies exploring or actively involved in managing tokenized securities.
These witnesses called on Congress to ease legal and regulatory barriers to tokenization.
“Existing statutes and regulations were not designed with blockchain in mind,” Carlos Domingo, co-founder and CEO of Securitize, told lawmakers.
Securitize is the transfer agent of BlackRock’s tokenized fund BUIDL.
Among other measures, he called for improvements to the Securities and Exchange Commission’s licensing regime to allow brokers to safeguard digital assets.
For this purpose, the SEC introduced a special broker license in 2021.
However, Domingo said, it is “frustratingly difficult to achieve, is limited in scope, and it is unclear which tokenized securities are eligible” for licensing.
Email the author at joanna@dlnews.com.