Arca asserts that its offer of digital securities rather than traditional shares will allow investors to transfer shares peer-to-peer quickly, in small increments, and at lower cost. Additionally, peer-to-peer transactions using ArCoins will be trackable by the fund administrator and transfer agent on the Ethereum blockchain on a real-time basis.
Digital Asset Milestone
While the advent of ArCoins is not a watershed moment (such as when an exchange-traded fund finally obtains the SEC’s blessing to hold cryptocurrencies or stablecoins as underlying assets), the share delivery via ArCoins deserves distinction as a digital asset milestone. By offering shares as ArCoin tokens and the ability to transfer the digital securities peer-to-peer over the blockchain, Arca has effectively removed financial intermediaries from a long-standing equation in the investment universe. While the fund’s underlying assets will be held at a third-party custodian bank, shares will be directly tradable among individual or institutional investors. Arca also claims that investors and digital asset firms can theoretically benefit from the friction-free transferability of ArCoins in multiple use-cases, such as payments, lending, clearing, settlement, treasury management, and insurance.
Additionally, the ERC-1404 protocol that is being employed provides investors with an enhanced measure of security over the popular ERC-20 protocol, as ERC-1404 tokens can only be transferred to white-listed wallet addresses (in the case of the Arca US Treasury Fund, that this means anti-money laundering/know your customer (AML/KYC) and other documentary clearance).
The Arca US Treasury Fund and ArCoin innovation is the first in a series of blockchain-based financial products that Arca plans to offer, and others firms are sure to follow with similar products and competitive offerings.
Innovation and the Consequences of Regulator Inaction
The ArCoin innovation sheds light on an issue that has been apparent since the dawn of digital assets: regulators are much slower to act than innovators, and the consequences of foot-dragging may be contrary to the regulatory mandate to protect markets and investors. The promise of securities tokens has been severely limited by the failure of the SEC and the Financial Industry Regulatory Authority (FINRA) to permit registered broker-dealers to custody digital assets given their stated concerns about such assets. As a result, secondary markets for security tokens have been extremely limited.
By disintermediating broker-dealers, Arca will avoid this regulatory logjam by issuing security tokens directly to investors and permitting them to trade the tokens on a peer-to-peer basis. And while peer-to-peer trading may offer certain advantages to markets and investors, it is clear that by eliminating the regulated intermediary from secondary market trading, a good portion of the protections ordinarily afforded investors under the securities laws will no longer apply. It is ironic that the inability of the SEC and FINRA to find an appropriate way for broker-dealers to trade in these assets may actually lead to less protection of investors as innovators work around them.
This article was originally published on the Global Fintech & Payments Blog of Latham & Watkins LLP by Stephen P. Wink and Deric Behar
