Daniel S. Alter is a Shareholder in the New York, NY office of Murphy & McGonigle P.C. and is the WLF Legal Pulse’s Featured Expert Contributor, Legal & Regulatory Challenges for Digital Assets.
Way back in the day—say, between 2016 and 2018—there was a real rush by crypto- enthusiasts to mine (or otherwise create) all manner of coins on the blockchain. The rallying cry of “disrupt or bust” was soon targeted at the global equities markets, with their collective trading volume in 2018 of $68.212 trillion. There was a dewy-eyed expectation among true believers that world financial regulators, wowed by the redundancy, transparency, and incorruptibility of distributed ledger technology, would expedite the displacement of trusted intermediaries (e.g. banks and prime brokers) and their inefficient mechanisms for completing transactions.
As if . . .
In the United States, we have experienced the cautious pace at which the Securities and Exchange Commission (SEC) has prospected for appropriate rules to cover virtual assets and decentralized trading platforms. And neither the Federal Reserve Board (FRB) nor the Office of the Comptroller of the Currency (OCC) has aggressively staked a governance claim covering the dissemination of cryptocurrencies and the myriad payment systems that employ them. In large part, these regulators are panning for nuggets—waiting for smaller yet important marketplace applications to confirm that the transformative innovations on the blockchain are not digital pyrite.
They may have just struck something. On September 5, 2019, the New York State Department of Financial Services (DFS) announced that it had approved the issuance, sale, and trading of a tokenized ownership interest in gold bars by Paxos Trust Company, LLC (Paxos)—a New York State chartered financial institution. The name of this new digital asset is PAX Gold, and DFS superintendent Linda Lacewell assured the public that her agency took adequate care to address “potential risks associated with [its] issuance and offering.”
Full disclosure: earlier in my career, I served as both DFS general counsel and general counsel to Paxos (when Paxos was known as itBit Trust Company). I had nothing whatsoever to do, though, with the approval of PAX Gold, and I have no financial ties to either of them now. I therefore can objectively say that this development is an important regulatory milestone—one worth its weight in tokens.
Founded at the end of the seventeenth century, the London gold market would be an excellent case-study in which to assay the value of using blockchain systems as infrastructure for large financial markets. Each day in London, dealers trade approximately 75% of the world’s gold in over-the-counter transactions (in May 2019, nearly $24 billion per day). Yet historically, the “banks, brokers and dealers” in the trade “have been reluctant to reveal their activity.”
In 1987, the Bank of England formed the London Bullion Market Association (LBMA), which is an international trade association that both represents and supervises its members from at least 24 countries. But it was not until November 2018 that the London gold market—“for the first time in [its] long history”—replaced guesswork with reliable measurements of daily trading volumes. The LBMA hailed this development as “an exciting moment for transparency in the global OTC market.”
Less than one year later, Paxos and DFS have taken what might be an even bigger step towards effective regulatory oversight.
Each PAX Gold token “encapsulat[es] the legal title to a physical bar of gold stored in the Brink’s London vault.” Specifically, each token “represent[s] 1 fine troy ounce of London Good Delivery gold” that is “owned by holders of the token” and for which “access to the serial number, weight and various other attributes of their gold holdings” is available to token holders. Consequently, under appropriate circumstances and careful protocols, such information could be available to regulators, too.
That design is already unfolding. In approving the issuance and trading of PAX Gold, Superintendent Lacewell underscored that DFS “applied New York’s high standards regarding anti-money laundering, anti-fraud, and consumer protection, and cybersecurity measures.” And DFS—along with the rest of the world—can examine the expected independent auditor’s monthly online reports verifying “that the entire supply of PAX Gold tokens is consistent with troy ounces of gold held within the custody of third parties in the United Kingdom.”
As a business strategy, Paxos is searching for treasure buried in market inefficiencies. It believes that blockchain technology can eliminate many of the complications and costs associated with the precious metals trade by making such assets “easily moveable and divisible and not . . . tied to a manual, physical process.” In other words, by increasing their liquidity.
For this venture to grow and succeed on the blockchain, however, both Paxos and DFS will need to address a mountain of issues common to trade in other asset classes. These challenges include establishing well-defined clearing and settlement procedures and securing adequate custody solutions for traded assets, just to name a few. The SEC, FRB, and OCC (along with other market regulators) would do well to pay close attention to the technological and legal answers forged in New York. There might be gold in them there hills.