Hester Peirce: The Positive Future of Digital Asset Regulation (Huge Catalysts Coming)

Got to start with my disclaimer, which is that my views are my own views as a commissioner, not necessarily those of the SEC or my fellow commissioners. I think we really do need to switch the framing to say that it is natural, as you said, we should expect people to want to protect their privacy. When I just look across the landscape of assets, I come to a very different conclusion than some others at the SEC in the past have come to. Tokenization is one of those areas that since the administration changed and since the attitude toward crypto and blockchain changed, people have come to us and they've said, 'We really think tokenization has potential here.'

Thanks, Robbie. It's great to be with you. I of course have to give you my disclaimer, which is that my views are my own views as a commissioner, not necessarily those at the SEC or my fellow commissioners.

Well, we've been busy and I think one of the most exciting projects we're working on is thinking about how we can make it more likely that more companies will go public earlier in their lives. That's a project with many different pieces to it. Just yesterday, we proposed a rule that would eliminate Rule 611, which is the trade-through rule in equity markets. That is a 20-year-old rule that I think was really ripe for reconsideration. So I'm excited about that. There's obviously a lot going on on the crypto side. I'm excited to see clarity move forward and I think that will give us a lot of work to do. I won't be here to do it, so maybe that's why I'm excited about it. But I think it will be quite helpful for the industry to have this legislative framework within which we and the CFTC are writing rules.

Yeah. The rule came from the concern that there were different marketplaces that were not being united and so you might not be getting the price that you could get if you were trading at some other venue. The idea is that in order for a trade to go through, it has to either be at the national best bid or offer, or you have to improve on it. Otherwise that trade can't go through. It's called the trade-through rule because it doesn't allow you to trade through a better price. My view is that markets don't need a rule to bind them together. That's what arbitrageurs do. That's what markets are all about. If you see a good deal in one place and it's a worse deal in another, market participants will figure out a way to even that out. That was my concern at the time the rule was initially adopted. Even if you thought it was necessary then, that was a time where the New York Stock Exchange, for example, wasn't using the most modern technology. Since then, everyone has upgraded to extremely modern technology. There are a lot of interconnections between markets now. They're all hooked together. Even people who might have thought it was a good idea then are questioning whether it still is. We just put it out for proposal so we'll be getting good comments and I'm excited about that. We've seen some things happen like the fragmentation of the marketplace, lots of different exchanges and complex order types, and some of that we believe to be tied to the fact that this rule exists. So yes, I think it could be helpful as we move toward tokenization not to have this kind of rule in place, but that isn't really what was driving the proposal.

The innovation exemption. First, the innovation exemption has not yet been released. I know there have been people writing news stories, but it's not actually out there yet. That's one myth that should be dispelled. The second is some people have talked about it as if it's going to be used to support the trading of synthetic securities. The staff put out a taxonomy with three categories, and one of those is synthetic securities where you're getting exposure to a security but you don't actually hold the security. Those were not ever something that we were thinking about including in the innovation exemption. Now someone could come and register those kinds of securities in the United States if they wanted to, but that wasn't what I had been thinking about. So what the idea is is to allow tokens to trade onchain basically. It's onchain finance. It's not decentralized finance. It's onchain finance. There's still permissioning involved. What we're trying to do is allow people to do controlled experiments using onchain finance to help the market think through whether tokenization makes sense. See what it looks like to try to do this not fully at scale, but at least to be able to try it in the real world, but also allow us as the regulator an opportunity to see how this works and to think about where the proper points of regulation are. There are going to be some differences with the way the traditional financial world works and we want to make sure that we're applying regulation at the right points. I think people should look at it as an opportunity for everyone to really explore trading of tokenized securities. We don't see a lot of tokenized securities yet and I expect that we will. There are advantages to being able to have things trading on chain. There are advantages to being able to put a smart contract with an asset. It's very powerful and could be helpful to meeting regulatory requirements. Having securities on chain could be helpful for people who want to use them as collateral. There are a lot of potential reasons it could be useful, but until we allow people to do some experimentation with trading I don't see that people are going to move to tokenization. This really I view as a step toward allowing folks to imagine what the future will look like.

I certainly hear the people who are purists, as you put it. I've been watching this technology for a long time and I think it's really interesting that people are figuring out ways that they can do a lot of things without having an intermediary where you had to have one before. But we're operating in a very regulatory world and so we have to think about that. I agree with you that we need to see what it looks like to have things on chain and then we'll see what the appetite of folks is to take some of those securities and put them into decentralized environments. But that's really not where we are right now. It just isn't.

One thing that I think will affect where the commission goes is whether clarity passes, because as I said, clarity does give us quite a few rule writing obligations. That's something we're watching and trying to prepare for. That's one piece. The next thing is the innovation exemption. That is one thing I'd like to see get done. Another thing I have talked about for a long time is the ability to use tokens in fundraising and raising capital. We have been doing some work on that. That's also a priority. And then we are dealing with the nuts and bolts issues around transfer agents, interaction between transfer agents and blockchain, custody of crypto assets on both the investment advisor side and broker dealer side, clearing agencies. The staff greenlighted the DTCC to do some experimentation here with a new action letter. We're thinking longer term about definitions of things like brokers. The staff put out a statement around user interfaces as a temporary measure while they think about how broker dealer regulation interacts with this area. Vaults are another issue that deserves attention. I'm urging people to come in and talk to us because there are potential areas where activities could implicate the securities laws. Now I should say that my term ended last June. I can stay until the end of the year unless someone else gets put into this spot, but I will be leaving before that time. My time here is short and I am very enthusiastic that the commission will continue to do good work in this area. It's not just the SEC, it's the CFTC. We're doing a lot of joint work with them, coordinating around where products sit, where they should be regulated, what it looks like for an entity to trade products that may fit within both the SEC's and CFTC's jurisdiction. Thinking about those kinds of issues will also be a big focus.

The biggest thing I would recommend is think about what you're trying to do, what you need to do to make that commercially viable, and then what kind of regulatory relief you need. This is a very complicated legal area and people really need to be thinking about, do I need to come in and register this product? Do I need to ask for no action relief? Might I be pulled into the definition of broker, dealer, investment advisor, investment company? Don't panic if that's the case. Come in and talk to us and we can think about what makes sense. Are there any requirements that don't make sense because we have information on the blockchain that maybe replicates information that would otherwise be generated through a regulatory requirement? Best practices are, I hate to tell people that they have to go talk to lawyers, but go talk to a good lawyer who specializes in this area. The crypto task force, but more generally the staff at the SEC, is very eager to engage and I think we can make some good progress. It's only by people being willing to come in and say, 'Hey, this is what I'm trying to do, we need some relief here,' that we can move things forward.

I'm very grateful for people who are coming in and talking to us. The frustration that I still have and that others have is that things don't move fast. When you're dealing with a complicated regulatory regime with a lot of people taking different approaches, things can move very slowly. I talk to companies that say, 'We're trying to do this, but we need to go to market soon. We can't just wait and wait and wait.' I feel that pressure and I would love to be able to move things along faster. There is a bit of an apology here that things do take a long time.

I think as long as Chairman Atkins is here, the pace will continue. He's very committed to getting clear rules in place and he's someone who spent a lot of time thinking about what good financial regulation looks like. He has a real appreciation for the need for people to be able to do things that are commercially viable but also a high commitment to achieving the goals of the commission — protecting investors, facilitating capital formation, and fostering market integrity. That piece will be fine as long as he's here. I would also say, and this is the message I give everywhere, build things that people want and need and then it will be more likely to stay around because people will speak up if a regulator tries to take them away.

Existing laws already give us the ability to create exemptions. We can do that by rule or by order. It's a commission decision. It doesn't require input from Congress because they already gave us the permission to do this. It's really an internal process, but as we discussed before, there are a lot of complicated issues here and we want to make sure that we get it right. That's what we're working on.

There are actually three categories. I point people back to the staff statement. One is natively tokenized. The second is an entitlement where there's actually a share being custodied on behalf and the token represents that. Then you've got the third category which is the synthetic category. With respect to the third category, people can register those kinds of securities but it's important for people holding securities that way to understand that they're getting economic exposure to the asset but they're not actually holding the asset itself. If you were to register something like that in the United States, you would have to really explain that to your investors.

Again, it's not out, but as I said I had never envisioned it as involving that third category — synthetics, which are securities held in an SPV but then someone can get economic exposure to the securities through that SPV. That's not what I had been thinking. I may not be here when the innovation exemption comes out, so it's important to say it's a conception. We'll have to see what the final looks like. But I think there was a lot of hyperbole arguing that it's much broader than it is. Some people are going to be disappointed because it's actually pretty traditional. It's onchain finance. It's a step to see how tokenized securities will trade. I think it's not even that big of a step frankly. It's important but it's not that big of a step.

When we think about tokenization, it's really just a new format for securities. You can have paper certificates, dematerialized certificates, or tokenization, which allows things to run on the same rails that your stablecoins will be running on. That could be efficient and effective. You may want to post tokenized securities as collateral or lend them out. It'll make it easier and you can make a return potentially without having to pay someone else to help you do that. I think you will see an advantage to being able to program securities. If you're a founder, we want to put restrictions on your sales — we can do that through a smart contract. There will be interesting possibilities for companies to communicate with their investors by dropping an NFT in the investor's wallet. They won't necessarily need to know who the investor is, but they'll be able to communicate. That could have implications for voting as well. For companies with treasuries, tokenized money market funds will make treasury management easier and more precise. And it could be helpful in combating naked short selling — this will be a way to hold people to account for actually locating shares ahead of time. I see a number of different possibilities. I'm just a regulator and I really am excited to see what the market decides it wants to do. I think there are a lot of possibilities there.

It's important because retail investors are going to get most of their access to the markets through the public markets. We can and are planning to take steps that will make it easier for them to participate in the private markets, but realistically public markets are a great place for retail investors to get access. There's a lot of information out there about those companies. The valuations are tested by the public markets and that's a good thing. It can be very good for companies too because it enables them to give liquidity to their employees and use their shares as acquisition capital. The thing we're looking at is why are companies deciding to stay private? One good reason is they can find a lot of capital in the private markets. I don't want to stop that. But there are some negative associations with being public. One is required disclosures about a whole range of things, many of which are not important to investors. I hear all the time, 'The SEC requires these disclosures. Our investors never ask about them.' That seems like an area where we could pull back. Shareholder litigation is another reason. We've tried to take steps to make it possible for companies to use arbitration. Research analyst coverage is another area — if companies don't get that coverage they often don't trade as well. We're looking at a range of other possibilities. Is there anything we can do to make it easier for exchanges to experiment with how securities trade? I think there are a lot of factors that go into whether a company decides to go public. But I do think we have a role to play and we're trying to fulfill that.

I think what you're describing is there's a real retail appetite to get access to these companies earlier in their growth cycle. That's why my preference is that we work on ways to encourage companies to go public earlier and create a framework that gets investors the information they need without burdening companies so they don't want to go public. There are other alternatives out there, many available overseas, to get economic exposure to companies. If things like that are to trade in the United States they would have to go through the processes required — if you want to sell a security it has to either be registered or subject to an exemption. In terms of perpetual markets, they're an interesting product, and as the CFTC is looking at them and trying to figure out how to bring that market onshore, that's interesting to watch. Some of those could potentially be within our remit. That's an area where I talked about the CFTC-SEC harmonization — we're trying to make sure everyone's on the same page about where a product is regulated.

It's a work in progress. We're doing a lot of joint work to think through these issues, look at different products and discuss them, but we're also looking for people to help us do that. We're looking for feedback from the public and we welcome that feedback. There are a lot of opportunities to comment and weigh in on that process. If folks have a product they're trying to launch and want to know where it fits, we do welcome specific requests.

I hope that we'll just keep an open mind about innovation and about the possibility of improvements in the financial world that we regulate. Regulators can get very comfortable with the status quo because we know how it works. So an open-mindedness is important. I'm not concerned about that with Chairman Atkins. He is very open-minded to thinking about how new technologies fit within the existing regulatory scheme and he's open to adjusting rules where needed. I'm not too worried about how things will be after I leave because there's real momentum here at the CFTC, in Congress, at the banking regulators to think about these issues and come up with rules that make sense. I hope that we will respect certain basic principles. The ability of people to self-custody is very important and should not be compromised. The ability of people to protect their privacy in their financial transactions is very important and should be protected. The ability of developers to develop code and put it out there without having to get permission from someone to do so. These principles are really important. We've seen a lot of hacks and bad activity and I think it's in everyone's interest to prevent bad actors from taking advantage of the technology. I love seeing industry-led grassroots initiatives to combat those things. But really for me the biggest concern is that as we draft these rules and statutes, we respect those core principles. I think we will find that that will put us in a better place at the end of the day.

They're difficult questions and it is a balance. You do have to make some decisions about what you're trying to protect, but we've done that in other instances. Keeping the base layer neutral is a good way to start. You can build on top of it things that are consistent with regulatory requirements, or you can make things more centralized or less centralized. There are applications for which decentralization makes a lot of sense. You might find other applications where you want an intermediary with a freezing function and the ability to reverse transactions. One of the advantages of the technology is it does allow this layering. My message that I really have learned as a regulator is it's not a perfect world and there are some choices that we make because we're a free people. It's wonderful that there are folks out there who are really good at tracking down bad actors and maybe their onchain transactions are part of helping to find them. But we really need to look at this as protecting the privacy of innocent people's transactions should be very important to us at the same time as it's also important to try to track down the bad guys. If we put those two things out there as very important objectives, you'll find a lot of creativity in the private sector and public sector in achieving those two things. We just can't leave the privacy of innocent people on the cutting room floor. That may seem like the right answer, but I think there are other ways to get to the right outcome.

I'm going to be teaching law school. So I'm excited about working with the next generation. I always look at what we've done and we've left a lot of problems for the next generation to solve. I want to be part of preparing people who will grab those problems and fix them.

Well, thanks so much for having me.