Not all digital securities were created equal

Remember when blockchain was all anyone on Wall Street could talk about? Now, as dozens of the most high profile blockchain initiatives in finance have been quietly shelved, a new fixation has captured the collective consciousness: digital assets.

Over the past year, major central banks, regulatory bodies, and banks and payments companies have launched significant initiatives focused on monetizing and monitoring digital assets. The most aggressive of these, such as the People’s Bank of China’s cryptocurrency initiative, are already in pilot testing and some commentators are calling the potential benefits of digital assets “too great to ignore.”

As I wrote in the pages of Waters Technology in 2016, blockchain had some serious limitations to overcome in order to fulfill its wildly optimistic expectations at the time; namely, it had to adapt to the features of traditional securities (and capital markets in general) that don’t have a parallel with blockchain’s native asset—the cryptocurrency.

Now, as we turn our gaze to the digital asset, we’re facing a similar set of challenges that the starry-eyed pundits continue to ignore. Chief among them is widespread confusion over what a digital asset really is.

The overall terminology in this space remains unruly and difficult to nail down: is a tokenized asset offering (TAO) the same as an initial coin offering (ICO) or a security token offering (STO)?  What are the differences and where does the Venn Diagram overlap? ICOs had a hot run in 2017-18 until the bottom fell out. It was an overhyped, unregulated market filled with what proved to be worthless offerings and investors chasing bitcoin-like returns. The SEC went so far as to set up a dummy website to point out some of the red flags in the ICO market: “buy now!” pressure, guarantees of implausible returns, and fictious executives.

In a small but significant step to bringing common agreement to the terminology used in digital assets, Sifma published a white paper that distinguished between security tokens and tokenized securities.  Simply put, the former is native to the blockchain environment, while the latter is a digital representation of a more traditional security format (e.g. book-entry). 

These efforts aside, there is a tendency—a flawed one—to view digital assets as a homogenous asset class unto itself. The error in this approach is that it grants too much cohesive power to the blockchain, which is basically just a fancy new way of transferring and recording ownership of the asset in question. 

But the blockchain doesn’t change the underlying nature of the asset. To draw an analogy, the “all digital assets are alike” approach would be akin to saying that every lot purchased at an auction house is similar because each item was bid on by people raising their paddles. But nobody would suggest that an auction’s rare manuscript had anything in common with the Impressionist painting or collector’s automobile. In a similar vein, a property deed is still a property deed whether it’s tokenized or not—and it has little in common with a security token. 

Put more simply: the first question about digital assets must always be “what is the asset?” and not “what is the mechanism for exchange?”

With that in mind, Cusip Global Services has been focused on providing the market with unique identifiers and descriptive data for TAOs that are also unregistered securities. But the starting point for a Cusip remains the same: the requirement to have a valid offering document from which we can extract the necessary data attributes to guarantee uniqueness.

As market participants and regulators work to realize the potential benefits of the digital asset space, including more efficient trade settlement, the industry needs to reach agreement on basic terminology and the appropriate guardrails for the market. This effort would also benefit from adhering to a basic axiom: not all digital assets are created equal.  

Matthew Bastian is senior director of market development at Cusip Global Services