a16z: why are intermediate institutions being replaced by codes when securities are chained

Original title: A Former SEC Chief Economicist Analyzed How Tokenized Security Can Benefit From DeFi

Original by:@millesjinnings, @rstwalker and Aiden Slavin, a16z crypto

Compiled:Peggy, Block Beats

 

Other OrganiserWhen regulators begin to proactively push "traditional securities up chains", the question is no longer whether technology is feasible, but whether the system is ready to keep up。

The article revolves around a key proposal: in the context of the United States Securities and Exchange Commission (SEC) move forward with the uplinking of financial markets, a16z and DeFi Education Fund proposed a "software safe harbour" framework that sought to delineate regulatory boundaries for a new class of market participants — non-trust, non-intermediated block chain applications。

Its core logic is not complex: if these applications are neutral software interfaces, do not control assets, do not execute transactions and do not provide advice, should they also be included in the regulatory framework of traditional voucher systems

The analysis of Craig Lewis, former chief economist of the SEC, provides a more structural answer to this question. He did not start from the point of view of whether or not he should regulate, but went back to a more basic comparison: The introduction of chain transactions and automated settlements, with high costs and non-transparent conditions in existing voucher systems, is weakening the market or reshaping its mode of operation。

On the one hand, atomic settlements, chain transparency and 7x24 transactions are redefining the efficiency boundaries of the financial infrastructure; on the other hand, investor protection mechanisms, market fragmentation and new types of risk are occurring simultaneously. The real difference lies not in the existence of these risks, but in their existence in another form in the traditional system, which has been neglected for a long time。

From this point of view, the Safe Haven proposal is more like an institutional experiment: It seeks to open a limited but verifiable space for chain finance without completely overturning the existing regulatory framework. The question then goes from "Whether or not to be chained" to "what links can be chained first."。

If the encryption industry in the last decade has been approaching traditional finance at the technical level, the real variables that follow may come from how regulation redefines the role boundaries of “intermediaries”。

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The following is the original text:

The introduction of traditional securities into the chain is one of the core priorities of the current United States Securities and Exchange Commission (SEC). Recognizing the potential for monetization, the Commission, under the leadership of its Chairman, Atkins, launched Project Crypto nine months ago, with the aim of updating United States securities-related rules and regulatory systems. The goal is to facilitate the gradual migration of national financial markets into chains, thereby achieving a range of advantages, such as immediate settlement, 7x24 hours of trading and cost reduction。

But to truly unleash the full potential of tokenized securities, innovators and investors still need clear “rules of the game”, especially for block chains that allow users to trade tokenized securities in a point-to-point manner without intermediaries。

On this basis, we and DeFi Education Fund submitted a "software safe harbour" proposal to the SEC last August, clearly defining the conditions under which such block chain-based applications — that is, procedures that enable users to interact with public chain networks and smart contract agreements as neutral software — may be exempted from the registration requirements of the Securities Exchange Act 1934. The programme describes not only how these applications create value for market participants, but also how they fit into the core mission of the SEC in terms of protecting investors, maintaining fair and orderly markets and promoting capital formation。

Today, Craig Lewis, a professor at the University of Vanderburg and former chief economist and head of the Economic and Risk Analysis Department of the SEC, has officially submitted to the SEC his economic analysis of the "software safe harbour" proposal. While the Lewis study focused on the proposal itself, a broader assessment of the economic costs and benefits of monetized securities provided an important insight into how block-chain technology could reshape the traditional financial system. Although the study was financially supported by a16z, Professor Lewis used independent and rigorous methodology in the assessment process。

In the analysis, Lewis identified five major benefits that the safe harbour mechanism could release for compliance:

• Atomic settlement:Eliminate the credit risk posed by late settlement and reduce the systemic risk that a failure by a central counterparty might trigger。

• Transparency on the chain:Replace the non-transparent system of private books with publicly verifiable records of transactions。

• 7x24 hours of continuous transactions:Breaking the time and geographical limits of traditional exchanges and increasing price efficiency and liquidity。

• Substantive reductions in costs:Automatically executes the red hair distribution, compliance process, etc. through smart contracts. For example, Ripple and BCG studies show that the monetization of investment-grade bonds can reduce operating costs by 40 to 60 per cent。

• Lower access threshold:Attracting new developers into markets creates competitive pressures on traditional financial institutions, stimulates their innovation and ultimately benefits users。

At the same time, Lewis pointed out four possible categories of potential costs of the proposal:

• Investor protection may be weakened:For example, traditional voucher dealers can freeze assets or roll back transactions, and compliance applications are not designed to do so。

• Regulatory arbitrage risk:Some traditional institutions may attempt to shift to compliance applications to circumvent regulatory obligations, but their transition costs may be higher。

• Market fragmentation risk:Currencyized securities transactions may further diversify market liquidity and channel risk to traditional financial systems through the DeFi leverage mechanism. However, Lewis argued that it should be assessed against the existing system of dark pools and off-site transactions。

• Bulk transaction costs:Risks such as Gas fee fluctuations, slide points and smart contract loopholes should be seen in comparison with implied costs in traditional finance. At the same time, DeFi costs are falling significantly, for example, the Dencun upgrade in Etheleum has reduced L2 data costs by more than 90%。

Lewis' analysis is limited in particular to front-end applications that meet the requirements of a safe port and emphasizes that such applications are essentially "passive software interfaces" and that their design does not introduce risks that the Securities Exchange Act seeks to circumvent. These conditions include:

• Non-host structure

• Lack of autonomous enforcement authority for transactions

• No marketing or investment advice

• Access only to agreements that are truly decentralised (or working in that direction)

HE FURTHER NOTED THAT THE BENCHMARK FOR COMPARISON SHOULD NOT BE AN IDEAL MARKET STRUCTURE, BUT RATHER A CURRENT VOUCHER SYSTEM — WHICH INCLUDED SIGNIFICANT HIDDEN COSTS SUCH AS DTC COSTS, LIQUIDATION AND SETTLEMENT COSTS, INTERMEDIARY PRICE INCREASES AND INSURANCE BUFFERS。

Ultimately, Lewis concluded that if the SEC were to make a formal assessment of these costs and benefits, it would be likely that the safe harbour mechanism would help to release the significant economic value inherent in monetized securities。

As President Atkins said, monetization "may reshape our well-known financial system". The EC has expressed its support for this direction through the Project Crypto, the joint guidance document, etc。

However, for this vision to be truly realized, clear and effective regulatory frameworks for the application of block chains for point-to-point trading at support points are still needed. This is precisely the goal of this proposal for safe ports, and Professor Lewis' analysis shows that his overall economic logic is sufficiently convincing — despite the trade-offs, the benefits are likely to outweigh the costs。

Lewis has drawn the path, and we look forward to the Commission moving forward。