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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 excitement in recent years.
- Its supporters 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.
Wall Street giants – from investment banks like JPMorgan to the world’s largest asset manager, BlackRock – are touting the benefits onchain securities issuance and processing.
These companies claim that 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 of these benefits could be achieved with other types of ledgers and databases besides blockchain, a finance academic told Congress on Wednesday.
“Cryptography works on public blockchains without permission, and tokenization is not necessary,” said Hilary Allen, a law professor at American University Washington College of Law.
Allen testified at a hearing called by the House Subcommittee on Digital Assets, Financial Technology and Inclusion to debate whether tokenization will facilitate efficient markets.
“Blockchains suffer from inevitable operational inefficiencies and weaknesses that make them unsuitable as supporting infrastructure for real-world assets.
– Professor Hilary Allen
Consensus concerns
Wall Street has been interested in tokenization for years, mainly – 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 inevitable inefficiencies and operational weaknesses 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 of a blockchain together to verify transactions — are ineffective and wasteful, she said.
This often happens intentionally – many blockchains have built-in delays, for example – but this means they cannot process large volumes of transactions.
Furthermore, governance is an issue.
Global financial markets operate based on centralized databases that are monitored for cybersecurity and operational risk and are subject to strict controls, rather than being run 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 begs 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 generally inaccessible to ordinary Americans.
“I urge you not to pin your hopes on tokenization as a means of improving financial inclusion,” she 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.”
Best rules
Allen sounded the only skeptical note at the hearing.
Other witnesses represented companies that explored or were actively involved in the handling of tokenized securities.
These witnesses called on Congress to ease legal and regulatory obstacles to tokenization.
“Existing statutes and regulations were not drafted with blockchain in mind,” Carlos Domingo, co-founder and CEO of Securitize, told lawmakers.
Securitize is the transfer agent for 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 protect digital assets.
The SEC introduced a special broker license for this purpose in 2021.
However, Domingo said, it is “frustratingly difficult to achieve, limited in scope and unclear which tokenized securities are eligible” for the license.
Email the author at joanna@dlnews.com.