Tokenization can transform US markets if Trump clears the way

Opinion by: Alex O’Donnell, senior writer for Cointelegraph.

Tokenization can revolutionize the United States financial markets, but flawed rules have stymied adoption. Crypto-friendly President-elect Donald Trump has a historic chance to lead the way and change things. 

Ending America’s cryptocurrency crackdown is an excellent first step, but it doesn’t go far enough. For tokenization to thrive, Trump’s team — including his potential crypto czar and Commodity Futures Trading Commission chair — must reinvent old rules, combining the best aspects of traditional markets and decentralized finance (DeFi).

The challenge will be preserving core investor protections such as Know Your Customer (KYC) checks, exchange oversight and custody rules without compromising tokenization’s benefits. That’s a big ask, but it doesn’t require new laws. Trump’s team should start on day one.

Improving financial markets 

Tokenized real-world assets (RWAs) — including securities such as stocks, bonds and mutual funds — can improve virtually every aspect of securities markets. 

Programmable smart contracts enshrine investors’ rights in unchangeable code and open endless avenues for innovation. Public blockchain ledgers enhance transparency and automate settling and reporting trades. Self-custody preserves tokenholders’ autonomy.

Even the US Treasury Department is a fan. Tokenization “promises to unleash new economic arrangements and enhance efficiencies,” the department said in an October report. It’s considering tokenizing US Treasury bills.

Security tokens are gaining traction, but far less than they should. As at Nov. 20, they commanded some $12 billion in total value locked (TVL), according to RWA.xyz. Tokenized money funds are top-rated. BlackRock’s USD Institutional Digital Liquidity Fund (BUIDL), the largest, manages over $540 million. 

This barely dents security tokens’ $30 trillion addressable market, Colin Butler, Polygon’s global head of institutional capital, told Cointelegraph in August.

Recent: Building the future of RWA tokenization: X Spaces recap with MANTRA

The problem isn’t a secret. America’s investor protections are nearly a century old, inadvertently stifling token issuers. Adapting them to blockchain only works if regulators know how to harness decentralization. 

Streamlining KYC checks

KYC rules are among tokenization’s biggest blockers. They require every consumer-facing investment application to independently verify users’ identities, including personal details such as net worth and trading experience. 

Imposing similar demands on DeFi would be a death sentence. Web3 is an interconnected web of open-source smart contracts. Wedge in too many identity checks, and the web unravels. Regulators must update KYC guidelines accordingly. 

Decentralized identity protocols, like Circle’s Verite, are the best bet. Users can complete one comprehensive KYC check to whitelist wallets for dozens of permissioned DeFi apps. Meanwhile, protocols can simply call Verite’s smart contracts to KYC users without gathering personal data.

Decentralizing securities exchanges 

Integrating decentralized exchanges into US financial markets is trickier. Securities exchanges are heavily regulated and rely on a central clearinghouse called the Depository Trust & Clearing Corporation (DTCC) to settle trades.

The DTCC must go onchain. It’s already testing onchain trade settlement and even piloted a permissioned Avalanche subnet. That’s good, but security tokens mainly reside on permissionless networks like Ethereum and its layer-2 scaling chains. That’s where the DTCC should focus.

It can start by routing security token transactions to private validator sets, which pre-commit to DTCC guidelines. Restaking protocols like EigenLayer can help bootstrap economic security and customize consensus rules. Eventually, the DTCC may opt to completely outsource trade settlement to decentralized blockchain networks.

Embracing self-custody

Existing custody rules prioritize funds held in brokerage accounts. In Web3, self-custody prevails. According to Arrington Capital, approximately 70% of crypto holders use non-custodial wallets like MetaMask. Regulators must adapt.

Self-custody isn’t new. Before investors held tokens in wallets, they kept paper stock certificates in safes. Rules still exist for handling physically custodied shares. They offer a blueprint for regulating Web3 wallets. 

Meanwhile, third-party crypto custodians are proliferating. Insured against cybersecurity exploits, they may become many investors’ preferred choice. Regulators should welcome this and promote adoption by easing onboarding for new users and token types as much as possible.

These changes are baby steps, but much more must be done to bring securities markets onchain. Trump wants to form a strategic Bitcoin (BTC) reserve and turn America into the “world’s crypto capital.” His presidency is a historic win for the industry. The time to start is now.

Alex O’Donnell is a senior writer for Cointelegraph. He previously founded DeFi developer Umami Labs and worked for seven years as a financial journalist at Reuters, where he covered M&A and IPOs. He is also the crypto growth lead at startup accelerator, Expert Dojo.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.