The U.S. Securities and Exchange Commission is further stepping up its efforts in blockchain. Why is this technology so important?

The U.S. Securities and Exchange Commission (SEC) appears to be stepping up its efforts to further understand blockchain technology and what it means for the securities industry. While there is no single definition of blockchain technology, it generally refers to a distributed ledger technology that consists of a decentralized, public or private peer-to-peer network. In this network, transactions across the network will be recorded in a shared digital ledger. Typically, each node in the network stores all or part of this constantly updated copy of the digital ledger. Now, many financial services industry practitioners are considering and testing the application of blockchain technology in their industry.

The SEC officially started working on blockchain-related issues when it established the Digital Currency Working Group Currency Working Group in 2013. Since then, people have been asking the SEC whether digital currencies are securities.

The SEC’s opinion is that while digital currencies may not be securities, such currencies held in physical company shares would be securities. Similarly, the SEC has also introduced enforcement measures to prevent individuals from setting up online venues to conduct securities transactions using digital currencies without being a registered dealer or securities exchange.

Over the past year, the SEC’s activity in blockchain technology beyond digital currencies has been evident.

In December 2015, the SEC’s Division of Finance reviewed Overstock.com’s registration statement, which stated that it was attempting to sell digital securities through a public offering. This statement became effective on December 9, 2015. This appears to be the first time a publicly traded company has registered a public offering of digital securities with the SEC.

Shortly after Overstock’s registration statement became effective, the SEC issued an Advance Notice of Proposed Rulemaking and Concept Release Notice of Proposed Rulemaking and Concept Release on transfer agent regulations. In it, the SEC stated that it is currently testing blockchain technology in various scenarios to determine whether it is useful for the securities industry. The SEC then also mentioned whether a distributed public ledger system is useful for transfer agents, such as tracking the holders of listed company securities and collecting opinions on how to use this system. In addition, the SEC pointed out that investment in regulatory measures is also necessary, if any, to facilitate the application of distributed ledgers by agents and determine whether the application of these systems by agents complies with federal securities laws and regulations.

This spring, SEC Chair Mary Jo White discussed blockchain technology at a conference at the SEC-Rock Center Corporate Governance Silicon Valley Initiative Initiative at Stanford University. Noting the spread of blockchain technology, the chair noted that a key regulatory issue is whether blockchain applications should be registered with existing SEC regulations, such as those for transfer agents and clearing agents.

The SEC is considering two issuer applications to record funds for on-exchange transactions where the underlying asset is Bitcoin. This year, the SEC has also issued cease-and-desist orders against entities that issued securities with a value tied to Bitcoin in violation of certain trading rules.

On November 14, the SEC held its own FinTech Forum, which included a discussion on blockchain technology. In the FinTech Forum, Valerie Szczepanik, head of the SEC's Distributed Ledger Technology Working Group, moderated a panel discussion titled "The Impact of Current Innovations in Trading, Settlement, and Clearing," focusing on the application of blockchain technology in the financial services industry. Panelists included Brad Peterson, CTO of Nasdaq Information, Chris Church, Chief Business Development Officer of Digital Asset Holdings, Mark Wetjen, Global Public Policy Leader of the Depository Trust and Clearing Corporation (DTCC), Emin Gun Sirer, Professor at Cornell University, and Grainne McNamara, Head of PwC's Capital Markets Group.

The panelists discussed various topics on how to use blockchain technology in the financial services industry. They all agreed that blockchain technology has the potential to revolutionize and disrupt the financial services industry. However, they believe that blockchain technology will not eliminate the existence of existing intermediaries. Instead, companies such as clearing agents, trading platforms and transfer agents will need to use blockchain technology in their own businesses to further improve efficiency, accuracy and security.

Mr. Chris Church stated that certain measures, such as network effects, standards and regulations, must be in place before blockchain technology can be widely used. Regarding network effects, a large number of key institutions will need to use blockchain technology before the benefits of blockchain technology can be realized. Regarding standards, standards for regulating blockchain technology also need to be established. This task should be accomplished primarily by the blockchain community itself, through the efforts of standard setting groups such as the Hyperledger Project. Finally, regarding regulatory measures, they also need to be introduced to protect the privacy of data stored and transmitted by the blockchain.

Panelists also noted that blockchain technology may not be suitable for all businesses and other organizations. Ms. McNamara of PwC noted that the technology is most likely to be useful for organizations that:

• Multiple parties share data • Transactions require confirmation from multiple parties • Strive to minimize intermediaries • Carry out time-sensitive business • Have multi-party workflow

Once an organization has determined that blockchain technology may be applicable to its business, it must go through the following four steps before implementing the technology:

1. Proof of concept

2. Prototyping

3. Engineering pilot

4. Production Application

It is unclear what the SEC plans to do with blockchain technology. The SEC appears to be in the information gathering phase. These efforts appear to be primarily intended to show that the SEC is paying attention to blockchain technology as the agency attempts to adopt it under its regulatory regime. However, note that the current working group reportedly has at least 75 people from the agency.

However, it is clear that the SEC must make decisions in the near future regarding the regulation of blockchain technology. As noted above, the Department of Corporation Finance allowed Overstock’s registration statement to go into effect and offer digital securities to the public. Overstock recently announced a partnership with a dealer to begin trading digital shares in December 2016. However, there is no public record that the SEC or its staff has considered how securities issued digitally should be traded and settled. The SEC also needs to decide whether EIFs based on Bitcoin can be listed and traded on stock exchanges.

The SEC needs staff who understand the technology to propose regulatory measures for blockchain. The task force has reportedly hired external consultants to educate the regulator on blockchain technology. However, little is known about other efforts. The SEC's efforts in blockchain are still in their infancy, and as the application of blockchain technology in the securities industry evolves, its staff and resources may also evolve with it.

Matthew Comstock is a partner at Murphy and McGonigle PC. He has practiced in all aspects of dealer, trading, and markets. In particular, he was an attorney in the SEC’s Division of Trading and Markets, where he served as Division Chief, Special Counsel, and Legal Counsel in the Office of Financial Responsibility.