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Congressional Hearing on RWA Tokenization Shows Confusion Over Public Blockchain Securities – Ledger Insights
The House Financial Services Subcommittee met yesterday hearing on tokenization exposed the confusion and policy differences surrounding public blockchains and tokenized securities. More than one Democrat has complained that the FIT 21 cryptocurrency bill recently passed by the House would allow the issuance of securities without the usual collateral. Such statements needed caveats, making some inaccurate. The other point of contention and confusion was around public blockchains and compliance.
All witnesses agreed on the benefits of tokenization. They said it will create efficiencies in the issuance, management and settlement of tokenized securities transactions. Potentially, splitting could allow distribution to a broader group of investors.
Public blockchains can support KYC, AML, and other checks
The main differences concern public blockchains. Two witnesses suggested that public blockchains should be avoided for traditional tokenized securities. Congressman Casten, one of the most observant representatives, has major problems with public blockchains that stem from anonymity.
Multiple media outlets have reported that people have been sending various crypto tokens to BlackRock’s BUIDL wallet, which Congressman Casten says indicates that activities on a public blockchain are out of control. A random person who finds out my bank account number could send me money that I didn’t ask for. This does not mean that the banking system is free of controls.
Carlos Domingo, CEO of Securitize, noted that the wallet was actually not the BUIDL wallet. Securitize is responsible for tokenizing BlackRock’s BUIDL fund. He added: “The tokens we issue are only transferable to whitelisted wallets.” He objected to statements that implied it was not possible to transact on a public blockchain that complies with KYC and anti-money laundering laws. Public blockchain securities issued by Franklin Templeton and WisdomTree are also similarly compliant.
Outside the United States, a handful of large institutions have already used public blockchains for securities. In 2019 General Society issued a 100 million euro bond on the public Ethereum blockchain, followed in 2021 by the European Investment Bank with a deposit of the same amount. The bondholders have been identified and whitelisted. Several large institutions are experimenting with more complex regulated transactions on public blockchains in Singapore Guardian Project.
In Europe, the DLT pilot scheme supports the testing of real digital securities transactions. One of Apply for the pilot scheme outlined controls that address the pioneering aspect of some public blockchains.
As noted by one of the witnesses, blockchains involve layers. The blockchain itself can have anonymous validators and it is difficult for regulators to control or influence the core infrastructure. However, controls can be imposed at the smart contract level, and tokens are often smart contracts.
Does FIT 21 law allow securities a free pass?
While the FIT 21 crypto bill it passed with 71 Democratic votes, other Democrats are still licking their wounds. Congressman Sherman, while generally anti-cryptocurrency, is usually quite thoughtful. He said: “The FIT 21 law included an extremely dangerous title dealing with investment contract activities. This would open the door for existing publicly traded companies to avoid regulation by tokenizing their securities and calling them investment contracts.
With all due respect, we believe Congressman Sherman’s statement is false because the situation is much more nuanced. This comment may be based on the testimony of one of the witnesses who referred to the definition of a contractual investment asset.
Here is the relevant clause in the FIT 21 Act:
The term “investment contract asset” means a fungible digital representation of value:
(A) that can be held and transferred exclusively, from person to person, without necessary dependence on an intermediary, and is recorded on a cryptographically protected distributed public ledger;
(B) sold or otherwise transferred, or intended to be sold or otherwise transferred, pursuant to an investment contract; AND
(C) that is not otherwise a warranty under the first sentence of paragraph (1).
The nuances of the FIT 21 Act
The reason for the nuance is the last two words which refer to “paragraph (1)” of US Code 77b(a). This paragraph lists several instruments included in the definition of securities, such as stocks, bonds, Treasury securities, fractional interests in oil and gas, profit-sharing agreements, certificates of deposit, etc. Therefore these would not be classified as investment contract assets. Therefore, if a publicly traded company tokenizes its securities, it will not be an investment contract asset.
However, other tokenized assets that might be considered securities today could potentially qualify as investment contract assets, such as the tokenization of a work of art or a fractional NFT.
Meanwhile, one of the key objectives of the hearing was to explore potential legal changes to facilitate the tokenization of real-world assets. This was covered primarily in the written testimonies of Securitize and the USDF Consortium. We may publish a separate piece summarizing their suggestions.
The author is not a lawyer and this is not legal advice