A16z: After securities are tokenized on the blockchain, intermediaries will be replaced by code

Original title: A Former SEC Chief Economist Analyzed How Tokenized Securities Can Benefit From DeFi

Original author: @milesjennings, @rstwalker and Aiden Slavin, a16z crypto

Translation: Peggy, BlockBeats

Original author: a16z crypto

Original source:

Reprint: Mars Finance

Editor’s note: When regulators begin actively pushing for “traditional securities to be put on-chain,” the question is no longer whether the technology is feasible—it’s whether the system is ready to keep up.

This article centers on a key proposal: against the backdrop of the U.S. Securities and Exchange Commission (SEC) advancing the on-chain transformation of financial markets, a16z and the DeFi Education Fund propose a “software safe harbor” framework, seeking to draw the regulatory boundaries for a new class of market participants—non-custodial, intermediary-free blockchain applications.

Its core logic is not complicated: if these applications are merely neutral software interfaces—do not control assets, do not execute trades, and do not provide advice—should they still be included in the regulatory framework traditionally applied to broker-dealers?

The analysis by Craig Lewis, the former SEC Chief Economist, provides a more structured answer. Instead of starting from “whether it should be regulated,” he returns to a more fundamental comparison: given that today’s broker-dealer system already has high costs and opacity, does introducing on-chain trading and automated settlement weaken the market—or does it instead reconfigure how it operates?

On the one hand, atomic settlement, on-chain transparency, and 7×24 trading are redefining the efficiency boundaries of financial infrastructure; on the other hand, investor protection mechanisms, market fragmentation, and new forms of risk are emerging at the same time. The real disagreement is not whether these risks exist, but whether they already exist in the traditional system in another form—only they have been overlooked for a long time.

From this perspective, the “safe harbor proposal” is more like an institutional experiment: it aims to open up a limited but verifiable space for on-chain finance without thoroughly overturning the existing regulatory framework. The key question, accordingly, shifts from “whether to put it on-chain” to “which parts can be put on-chain first.”

If, over the past decade, the crypto industry has been approaching traditional finance from the technology side, then the next real variable may come from how regulation redefines the boundary of what the role of “intermediaries” should be.

The following is the original text:

Bringing traditional securities on-chain is one of the SEC’s core work priorities this term. The Commission recognizes the potential of tokenization. Under the leadership of Chair Atkins, it launched “Project Crypto” nine months ago to update the rules and regulatory framework related to U.S. securities. The goal is to gradually move the nation’s financial markets to on-chain systems, thereby achieving a range of advantages such as instant settlement, 7×24 trading, and lower costs.

But to truly unlock the full potential of tokenized securities, innovators and investors still need to know the “rules of the game”—especially for blockchain applications that enable users to trade tokenized securities in a point-to-point manner without intermediaries.

Based on this, last August we, together with DeFi Education Fund, submitted a “software safe harbor” proposal to the SEC, specifying under what conditions blockchain-based applications—i.e., programs that function as neutral software and enable users to interact with public blockchain network and smart contract protocol—can be exempt from the registration requirements of the Securities Exchange Act of 1934. The proposal not only explains how these applications create value for market participants, but also how they align with the SEC’s core mission in protecting investors, maintaining fair and orderly markets, and promoting capital formation.

Today, Craig Lewis—Vanderbilt University professor, former SEC Chief Economist, and Director of the Division of Economics and Risk Analysis—has officially submitted an economic analysis report to the SEC regarding this “software safe harbor” proposal. Although Lewis’s research focuses on the proposal itself, it also more broadly evaluates the economic costs and benefits of tokenized securities, offering important insight into how blockchain technology may reshape traditional financial systems. Although the research received funding support from a16z, Professor Lewis used an independent and rigorous methodology throughout the evaluation process.

In his analysis, Lewis proposed five key benefits the safe harbor mechanism could unlock for compliant applications:

· Atomic settlement: Eliminates counterparty credit risk caused by delayed settlement, and reduces the systemic risk that could be triggered by the failure of a central counterparty.

· On-chain transparency: Replaces opaque private-ledger systems with publicly verifiable records of transactions.

· 7×24 hours of continuous trading: Breaks through the time and geographic limitations of traditional exchanges, improving price discovery efficiency and liquidity.

· A substantial reduction in costs: Through automatic execution of dividend distributions via smart contracts, compliance processes, and more. For example, research by Ripple and BCG shows that tokenizing investment-grade bond securities can reduce operating costs by 40% to 60%.

· Lowering the barrier to entry: Attracts new developers into the market, creates competitive pressure on traditional financial institutions, drives their innovation, and ultimately benefits users.

Meanwhile, Lewis also pointed out four categories of potential costs that the proposal could bring:

· Investor protection may be weakened: For example, traditional broker-dealers can freeze assets or roll back trades, while compliant applications, by design, do not have this capability.

· Regulatory arbitrage risk: Some traditional institutions may try to transition into compliant applications to evade regulatory obligations, but the costs of such transitions may be high.

· Market fragmentation risk: Trading tokenized securities may further disperse market liquidity and transmit risks to the traditional financial system via DeFi leverage mechanisms. But Lewis believes the assessment should be made in comparison with the current dark pool and over-the-counter trading systems that already exist.

· Retail trading cost issues: Risks such as volatility in Gas fees, slippage, and smart contract vulnerabilities. However, these should be compared against the implicit costs within traditional finance. At the same time, DeFi fees are falling significantly—for instance, Ethereum’s Dencun upgrade has reduced L2 data costs by more than 90%.

Lewis’s analysis is specifically limited to front-end applications that meet the safe harbor conditions, and he emphasizes that these applications are, in essence, “passive software interfaces,” whose design does not introduce the kinds of risks that the Securities Exchange Act seeks to avoid. These conditions include:

· A non-custodial architecture

· No autonomous authority to execute trades

· No marketing or investment advice

· Only connecting to genuinely decentralized (or actively working toward decentralization) protocols

He further noted that the appropriate comparison benchmark should not be some idealized market structure, but rather the current broker-dealer system—which includes many implicit costs, such as DTC fees, clearing and settlement fees, intermediary markups, and insurance buffers, among others.

In the end, Lewis concludes: if the SEC formally evaluates these costs and benefits, it will likely find that the safe harbor mechanism helps unlock substantial economic value embedded in tokenized securities.

As Chair Atkins said, tokenization “may reshape the financial system we know.” The SEC has already signaled its support for this direction through “Project Crypto,” joint guidance documents, and related actions.

But to truly realize this vision, clear and effective regulatory frameworks still need to be established for blockchain applications that support point-to-point trading. That is exactly the goal of this safe harbor proposal, and Professor Lewis’s analysis also indicates that its overall economic logic is sufficiently convincing—although there are trade-offs, the benefits are likely greater than the costs.

Lewis has drawn a path. We look forward to the Commission moving forward along it.