Crypto assets will never catch on with institutional investors until post-trade standards match those of traditional financial markets, a new report claims.
According to a Depository Trust & Clearing Corporation (DTCC) white paper, the plethora of platforms trading the so-called crypto assets or “security tokens” require “appropriate rules and regulations” to govern post-trade risks.
“Furthermore, unless their rules, regulations and best practices provide similar levels of safety, soundness and risk mitigation found in the current post-trade processing system for traditional securities, Security Token trading platforms will fail to attract participation by the institutional investment community, thereby constraining their growth and limiting their future role in the securities markets,” the DTCC paper says.
DTCC lists seven post-trade responsibilities that crypto-trading platforms must deliver at the same standards as traditional financial market infrastructure firms. The report says crypto-trading platforms must have:
- a demonstrable legal basis;
- an identifiable governance structure;
- identifiable risk management procedures and systems;
- clear procedures and systems to ensure settlement finality;
- security token issuance, custody and asset servicing protocols;
- record-keeping standards; and,
The study distinguishes between “permissionless” crypto systems that depend on anonymous user-consensus to verify transactions, such as bitcoin, and “permissioned” blockchain networks, which feature a central authority and known users.
Permissionless crypto assets would likely struggle more than permissioned networks to meet most of the DTCC seven standards, the report says, in particular the core requirement for a sound legal backing.
Because permissionless networks rely on users who are often based in multiple jurisdictions, “the mechanisms by which a platform would adopt a choice of governing law, as well as how such choice would be agreed to and enforced, are unclear”, the study says.
Furthermore, DTCC says custody and asset servicing would require the crypto issuer to have control over “whether securities need to be issued or redeemed”.
“Implementing such functionality would be challenging on a Security Token Platform utilizing a permissionless blockchain network, but more feasible on a platform using a permissioned network,” the report says.
Despite the many obstacles, DTCC says crypto asset trading platforms might be able to conform with traditional post-trade standards by combining aspects of permissioned and permissionless networks.
In a statement, Mark Wetjen, DTCC managing director, says most discussion of crypto assets to date has focused on trade execution.
“But what occurs after a trade is executed is critically important and this issue has not been broadly discussed within the context of tokenized securities or crypto assets more generally”, Wetjen says. “The framework DTCC has developed identifies the key issues that we believe need to be addressed by those seeking to establish policy, rules or best practices to govern the conduct of entities providing post-trade services for crypto transactions. In our view, these issues are fundamental to protecting investors and establishing trust in the safety and soundness of security token platforms.”