Last week, the SEC released a statement on what tokenized securities are and how they are regulated. The SEC likely felt the need to clarify its position in the wake of headlines about 24/7 stock trading using tokenized securities on blockchains. In a nutshell, the SEC reinforced that simply issuing on a blockchain does not allow an issuer to avoid registration requirements. The SEC is agnostic as to how a security is issued—on or off chain. It regulates by principle-“same activities, same risks, same regulatory outcomes”.

The reality is that tokenization of securities is still quite nascent. Only about $10 billion in bonds have been issued on blockchain compared with roughly $140 trillion outstanding globally. Issuers have taken two very distinct paths to incorporating blockchain into their operations.  One is to create a duplicate “digital twin” of an existing security. The other, more audacious route is to issue a security that is truly “native” to the blockchain.

Digital Twin – A tokenized version of a security that was originally issued off-chain. Why create a tokenized avatar? With a tokenized version of the security, certain activities can be much faster. For example, if the security exists as a token, moving it around for collateral can be far more efficient. Similarly, in securities lending, if the security was tokenized, many of the intermediaries involved in borrowing and lending could become redundant.

Example: Franklin Templeton’s BENJI money market fund is tokenized shares recorded on blockchain, acting as a digital twin of the underlying fund.

SEC’s take: The SEC mandates that if the tokenized version of a security is traded, the change in ownership must still be recorded off-chain. However, traditional and tokenized versions of the same instrument can be treated as a single class of security. This clarification is particularly helpful for DTCC, which is currently building a PILOT for moving “entitlements” of a security on-chain.

Native Tokens – These are securities issued directly on-chain, with no off-chain duplicate. Native tokens aim to capture the benefits of blockchain for the entire lifecycle of the instrument, from issuance through collateral movement. However, there is one lifecycle activity that still needs to be maintained off-chain: recordkeeping of ownership.

Example: SocGen issued a tokenized bond in the United States using Broadridge’s tokenization capabilities on the Canton Network blockchain.

SEC’s take: Recordkeeping (the transfer-agent function) must be split between on-chain and off-chain ledgers. Even when a token is issued on-chain and transaction information resides on the blockchain, private information about the security holder (such as address, date of birth, etc.) must be maintained off-chain.

What does this all mean? There was not much new in the SEC’s statement but it is helpful to get clarification. Issuers must register their securities even when they are issued on-chain. An on-chain issuance must still maintain off-chain records.

With this clarity, we are likely to see numerous announcements of PILOTs from exchanges, clearing houses, custodians, asset servicers, and others.

In the next blog, I will share my thoughts on third-party issued tokenized securities. Stay tuned.