The SEC's Stance on Tokenized Stocks: A Regulatory Framework

The U.S. Securities and Exchange Commission (SEC) is clarifying how broker-dealers can manage tokenized stocks and bonds in line with existing customer protection regulations. This indicates that blockchain-based securities will fall under conventional securities protections rather than being classified as a wholly new category of assets.

Key Takeaways

The SEC provided guidance on how broker-dealers can manage tokenized stocks and bonds under existing regulations.
Tokenized securities are viewed under the traditional security framework, not as a new asset class.
Broker-dealers must maintain control over private keys and implement security measures to protect these assets.
Existing trading frameworks for securities may need adjustments for better compatibility with blockchain-based assets.
The interest in tokenized equities is rising, as platforms move quickly to adopt this technology.

Tokenized stocks may be onchain, but the SEC still wants the keys

The SEC's Trading and Markets Division announced that it will not object to broker-dealers claiming possession of these crypto asset securities, provided they adhere to specific operational, security, and governance guidelines. This applies solely to crypto securities, which encompass tokenized stocks or bonds. Although this guidance is not an official rule, it offers insight into how U.S. regulators foresee tokenized securities being integrated into current market safeguards.

The SEC's framework implies that tokenized securities will be placed within established broker-dealer structures, even when they operate on blockchain networks.

Source: US SEC

Understanding Custody Rules for Tokenized Securities

The foundational element of this statement is Rule 15c3-3, a consumer protection guideline that mandates broker-dealers to keep physical possession or control over fully paid customer securities. According to the SEC, crypto asset securities recorded on blockchains might fulfill the "physical possession" requirement under specific circumstances. This means broker-dealers must maintain sole control over the private keys necessary for accessing and transferring these assets.

Even though these securities exist on the blockchain, neither customers nor third parties, including affiliates, should be permitted to transfer the securities without the broker's authorization. This distinction significantly separates tokenized securities from self-custody models native to crypto, placing greater emphasis on customer protection over the decentralized nature of cryptocurrency.

Broker-dealers must also be equipped to deal with potential issues such as 51% attacks, hard forks, airdrops, and other possible disruptions. They are required to have contingency plans that address the seizure, freezing, or transfer restrictions imposed by lawful orders.

Ultimately, this guidance reinforces that tokenized stocks and bonds are expected to behave as traditional securities, irrespective of the technologies utilized for their issuance or settlement.

The Challenges of Trading Tokenized Securities

In a related statement, SEC Commissioner Hester Peirce addressed the trading challenges that persist for crypto asset securities. She highlighted concerns about national securities exchanges and alternative trading systems that facilitate the trade of these securities, especially when trading pairs include both a security and a non-security asset.

Peirce's inquiry reflects increasing pressure to align the trading of blockchain-based assets with market-structure regulations designed primarily for traditional stocks. She questioned if the current frameworks and associated disclosure and reporting requirements impose excessive costs that outweigh their benefits when applied to crypto trading platforms.

Related: US Fed halts guidance preventing banks from engaging with crypto

The Growing Interest in Tokenized Equities

These statements emerge as crypto platforms and trading institutions actively explore the tokenization of securities. On November 30, Nasdaq's head of digital assets strategy, Matt Savarese, indicated that the exchange intends to expedite the introduction of tokenized stocks. He emphasized that they plan to collaborate closely with the SEC to make this feature accessible on their trading platform.

Furthermore, on Tuesday, Securitize, a firm specializing in the tokenization of securities, announced plans to launch compliant, on-chain trading for tokenized stocks, which will feature a swap-style interface reminiscent of decentralized finance (DeFi) platforms.

Additionally, crypto exchange Coinbase introduced a stock trading feature as part of its strategy to position itself as an “everything exchange.”