SEC Staff Provides Clarification on Custody Regulations for Tokenized Equities and Debt Securities

The Trading and Markets Division of the US Securities and Exchange Commission (SEC) outlined on Wednesday how broker-dealers can hold tokenized stocks and bonds under existing customer protection regulations, indicating that blockchain-based crypto asset securities will be integrated into traditional securities frameworks instead of being classified as a new category.

The division stated that it will not object to broker-dealers considering themselves as custodians of crypto asset securities under existing customer protection rules, provided they fulfill a set of operational, security, and governance conditions. This applies solely to crypto securities, including tokenized stocks or bonds.

Although the statement is not a formal rule, it clarifies how US regulators anticipate tokenized securities will conform to traditional market protections. 

The guidance indicates that tokenized securities are categorized within existing broker-dealer frameworks rather than being classified as a distinct asset class with specific regulations, even if they are settled on blockchain networks. 

TradFi on a blockchain: Custody regulations for tokenized securities

At the heart of the statement lies Rule 15c3-3, the consumer protection rule from the regulator. This mandates that broker-dealers maintain control or physical possession of fully paid customer securities. 

The division clarified that crypto asset securities recorded on blockchains may fulfill the “physical possession” requirement under particular conditions. This necessitates that broker-dealers retain exclusive control over the private keys used for accessing and transferring these assets. 

Even though these assets reside on a blockchain, customers and third parties, including affiliates, should not be able to transfer the security without the broker’s authorization. 

The statement clearly differentiates between tokenized securities and crypto-native self-custody models, emphasizing customer protection over the permissionless nature of crypto. 

Broker-dealers are expected to prepare for scenarios such as 51% attacks, hard forks, airdrops, and other potential disruptions. Additionally, they must maintain plans that address potential seizure, freezing, or transfer restrictions imposed by legal orders. 

The guidance reinforces the expectation that regardless of the technologies utilized to issue or settle tokenized stocks or bonds, they must behave as securities primarily. 

Trading tokenized securities on regulated platforms

In another statement released on the same day, SEC Commissioner Hester Peirce underscored the ongoing challenges surrounding the trading of crypto asset securities.

Peirce raised concerns regarding national securities exchanges and alternative trading systems facilitating the trading of crypto asset securities, particularly in instances where one asset is a security, and the other is not. 

These concerns highlight the increasing pressure to reconcile blockchain-based asset settlements with market-structure regulations originally intended for traditional equities. 

Peirce’s queries consider whether existing frameworks along with their corresponding disclosures and reporting requirements impose burdens that negate their benefits when applied to crypto trading platforms. 

Related: US Fed pulls guidance blocking its banks from engaging with crypto

Platforms diving into tokenized equities

The statements arrive amid a growing trend of crypto platforms and trading institutions beginning to tokenize securities. 

On November 30, Nasdaq’s head of digital assets strategy, Matt Savarese, announced that the exchange intends to expedite the launch of tokenized stocks, stating that it plans to collaborate with the SEC to facilitate this feature on its trading platform.

On Tuesday, Securitize, which specializes in tokenizing securities, revealed plans to initiate compliant, on-chain trading for tokenized stocks, utilizing a swap-style interface that is familiar to decentralized finance (DeFi) users. 

On Thursday, crypto exchange Coinbase unveiled a stock trading option as part of its ambition to become an “everything exchange.”