SEC's ATS nod, Mastercard, and Twitter's Blockchain Strategy
Off The Blocks, Vol 125, September 30, 2020
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Alternative Trading Systems and Digital Assets
In last week’s newsletter, I noted that the ‘business of banking’ is on the move. Bringing traditional financial institutions to play in a decentralized financial world is a natural progression of it. Traditional financial institutions are embracing the change and increasingly thinking of ways to build better on/off ramps for digital assets to coexist with and also to get around cash. See the Mastercard story below.
In more regulatory news, last week the Securities and Exchange Commission (SEC) provided more clarity on the role of Alternative Trading Systems in settling trades that involve digital assets and securities. In a no-action letter to FINRA, issued by the staff of the SEC’s Division of Trading and Markets, the SEC endorsed a 3 step process for settlement of digital asset securities held in a third-party’s custody. This modifies a previously proposed 4 step process and makes it easier for non-custodial services to work with ATS and crypto exchanges if certain customer-protection conditions are met.
Some registered broker-dealers also operate ATS that trade digital assets. However, for digital assets, custody has always been an issue of contention. Traders may self custody their assets, or deposit them with the broker-dealer/ATS or any other third party. Digital assets are cryptographically secured by a private key and anyone who has access to the private keys can access the underlying assets. As a result, when digital assets are ‘self-custodied’ or deposited with a third party, there can be added friction to the transaction and settlement process. Additionally, third parties carry a risk of ownership - without consumer guardrails, the assets themselves may be vulnerable to fraudulent claims of ownership. Many purist Bitcoin hodlers have gone on to say “Not your keys, not your Bitcoin.”
The trading and settlement process also includes several non-custodial activities involving digital asset securities. Frequently, an ATS may only match the orders of buyers and sellers of digital asset securities and the trades are settled directly between the buyer and seller. Alternatively, the buyer and seller may provide instructions to their respective custodians to settle the transactions. In both cases, the broker-dealer typically has no control over the digital assets and cannot guarantee that the trades otherwise settle as matched by the ATS. This increases operational and settlement risks and injects more uncertainty in the trading process.
This friction adds to the operational and compliance cost of the trade and is happily passed on to the customers, which is opposite to the spirit of low transactional costs for digital assets. Therefore, broker-dealers preferred a bit more streamlined process and it seems that the SEC listened to their feedback. The modified process would work as below:
The buyer and seller send their respective orders to the ATS, notify their respective custodians of their respective orders submitted to the ATS, and instruct their respective custodians to settle transactions in accordance with the terms of their orders when the ATS notifies the custodians of a match on the ATS;
The ATS matches the orders; and
The ATS notifies the buyer and seller and their respective custodians of the matched trade and the custodians carry out the conditional instructions.
The trades are still settled by the custodians of the digital assets The custodians would then settle the trade on behalf of the buyer and seller based on the instructions submitted to the custodians. The broker-dealers still cannot guarantee or take the responsibility that trades will eventually settle or exercise any level of control over the digital asset securities being traded. It simply notifies the custodians for the buyer and seller, and the buyer and seller, of the available trading match. By bringing more certainty to the process, and keeping a log of information transparent to all the participants, the operational and settlement risk can be reduced, directly reducing the transactional costs. In this respect, the no-action letter seems to align the market participants and green-lighting a process for an ATS that trades digital assets.
The no-action letter states that a broker-dealer operating an ATS that trades digital asset securities and uses the Three-Step Process will not be the target of an enforcement action if it adheres to a set of requirements as defined by the no-action letter. The obligations for the broker-dealer include maintaining a minimum of $250K in net capital, and an explicit agreement with its customers that they do not guarantee nor do they have a responsibility for trade settlements.
Non-custodial services have been waiting in the wings for a long time. As users become more familiar with digital assets and crypto in general, the tendency to migrate over to non-custodial wallets will only increase as it provides more control and more use cases. This SEC action clarifies the roles and responsibilities of each party in the ecosystem and I do expect a flurry of activity in this space.
Now for some news from the world this week:
Payments | Everything Ends in Transactions and Payments: Mastercard has shown how innovation and solutions in the blockchain sector can carry over and influence the mainstream financial industry. Due to the rise of stable coins and of people trying to transact with them, many merchants have begun to accept these forms of payment. Due to the changes in consumer preferences, Mastercard has found a new niche where it can provide a service by facilitating digital payments. The company continues to make strategic investments in fintech and cryptocurrencies, likely as a means of proactively adapting to changes in the financial world. …Link
Mastercard’s tagline is always about making transactions more efficient. This includes getting around cash. The question is, how do we make digital payments, and how do we realize the day-to-day use of digital currencies?
- Ashok Ventakeswaran, Blockchain and Digital Assets Lead, APAC, Mastercard
Business | Brazil's JBS Vows To Monitor Deforestation Through a Cattle Blockchain: JBS SA, the world’s top meatpacker, said on Wednesday it plans to combat destruction in the Amazon by monitoring its entire supply chain for deforestation by 2025, as pressure mounts from environmentalists and investors. JBS, along with other major Brazilian meatpackers, has worked to ensure it does not buy cattle from farms that have cut down the forest without permission but have previously only monitored the final ranch that sells to them. Ranches further down the chain, so-called indirect suppliers, have avoided these checks, meaning cattle can be easily “laundered” from illegally cleared pastures to farms with no environmental record that then sells to slaughterhouses like JBS. JBS said it plans to monitor 100% of its indirect cattle suppliers by 2025, using blockchain. …Link
B2B Trade | Ant Launches Business Trade Blockchain in Run-Up to $35B IPO: Ant Group has launched a cross-border trading blockchain platform as it prepares for what could be the largest stock market flotation of all time. Ant said that its new trade platform, called "Trusple," will make it easier for small and medium-sized enterprises (SMEs) to sell their wares to clients overseas. Built on AntChain, Trusple automates key aspects of the payments process, such as order placement and tax liabilities. This makes cross-border trades feasible for entities that would otherwise struggle had they used legacy systems, according to the firm. Ant has partnered with the likes of Standard Chartered, Deutsche Bank and BNP Paribas to help "optimize" the process. …Link
Governance | Inside the Blockchain Developer’s Mind: The Governance Crisis: Developers must be able to code up the behaviors they would like to see in the blockchain as smart contracts, and there must be an on-chain process for adding this behavior to the system through an explicit upgrade path. In short, we should be able to see the history of an upgrade just as we can see the history of a given token. The appropriate place for governance is in determining which smart contracts are made into “system” contracts based on whether they will increase the value of the protocol. The challenge is, of course, coming to a consensus on that value. …Link
The most controversial point I will make is the critical need for algorithmically distinct classes that act as checks and balances on one another. While intuition might suggest that more classes make consensus more difficult, this is not the case.
- Andrew Levine, CEO, OpenOrchard
Twitter | Jack Dorsey Details Twitter's Blockchain Strategy: When Twitter and Square CEO Jack Dorsey spoke at the virtual Oslo Freedom Forum 2020 on Friday, he said blockchain technology is the future of Twitter. In short, Dorsey expects the nonprofit Blue Sky to create an open Twitter protocol, which users can contribute to and access data from instead of a centralized service where the social media platform hosts content on its website. Dorsey broadly spoke to the importance of safeguarding users’ identities, which may be the key to healthy discourse. Plus, Twitter’s staff are amping up reliance and machine-learning tools to help identify non-authentic user behavior, aka propaganda. …Link
Blockchain and bitcoin point to a future, point to a world, where content exists forever. We’re not in the content hosting business anymore, we’re in the discovery business.
- Jack Dorsey, CEO, Twitter
The service branch protecting U.S. interests outside the stratosphere may use blockchain to render its computer systems, on earth and in space, unhackable. Last week, Xage Security won a contract from the United States Space Force (USSF) to develop and roll out a blockchain-based data protection system across its networks. Called the Xage Security Fabric, the blockchain verifies data and protects the network from third party intervention, so confidential data sent from satellites to earth isn't intercepted en-route. It also ensures security remains consistent across the entire USSF network, preventing hackers and other malicious entities from identifying and exploiting any weak spots. …Link
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