Tokenized Securities

The world of finance is on the cusp of a revolution, with tokenized securities poised to transform the way we invest. But as this new technology gains traction, regulators are faced with a critical question: how to balance innovation with investor protection. According to Patrick McHenry, vice chairman at Ondo Finance and former Chairman of the House Financial Services Committee, the key to success lies in fostering competition, not relying on gatekeepers.

America's capital markets have long been a benchmark for the world, and their ability to adapt has been a major factor in their success. From paper certificates to book-entry records, and from trading floors to electronic markets, each step has raised concerns, but also brought opportunities for growth. Tokenization is the next step in this evolution, and it's essential that regulators don't treat it as a threat to the old system.

The current debate over tokenized stocks centers on a basic question: what is the proper form for securities in the U.S. market? Some argue that tokenization should happen primarily through existing market infrastructure, while others propose new models that cater to the needs of investors who prefer to invest on-chain. But rather than focusing on a single approved model, the question should be whether different models can compete on substance while preserving investor protection and the strength of U.S. markets.

Tokenized securities are not a one-size-fits-all solution; they can take different forms, carry different rights, and sit in different parts of the market structure. Treating them all the same will lead to bad policy and worse products for investors and issuers alike, ultimately putting the U.S. capital markets at a competitive disadvantage globally. There are at least three models to consider: market infrastructure tokenization, customer-driven tokenization, and issuer-driven tokenization.

Market infrastructure tokenization uses blockchain for recordkeeping, reconciliation, collateral monitoring, transfer controls, and operational efficiency, all within the existing legal and operational framework. Customer-driven tokenization, on the other hand, starts with the investor's needs and creates products that track the performance of U.S.-listed stocks or ETFs, supported by underlying securities and collateral. These products are not the same as directly registered shares and should not be marketed as such.

The third model, issuer-driven tokenization, is still in its infancy, but it has the potential to revolutionize the way companies raise capital. By allowing companies to issue tokenized securities directly to investors, this model could reduce costs, increase efficiency, and provide greater transparency. However, it also raises important questions about regulatory oversight, investor protection, and market stability.

As the tokenized securities market continues to grow, it's essential that regulators take a nuanced approach, one that balances innovation with investor protection. By allowing different models to compete and evolve, regulators can create a vibrant and competitive market that benefits both investors and issuers. The future of finance is being written, and tokenized securities are poised to play a starring role. But it's up to regulators to ensure that this new technology is harnessed for the benefit of all, rather than being stifled by outdated rules and gatekeepers.