Background
10XTS was founded in 2017 in the peak of the blockchain era of pure hype, when thousands of projects were flooding the market. Billions of dollars poured into the sector within a short period of time.
In the years following, the overwhelming majority of projects have proven to be:
- outright scams;
- unregistered securities offerings and/or violations in some global jurisdiction; or,
- just a stupid idea that didn’t actually solve any real-world problem simply because of the existence of a “blockchain” in the stack somewhere.
At the same time, this confluence inspired 10XTS to recognize the actual merits to the proper architecture and application of the underlying technology to bring forward the envisioned efficiency, transparency, automation, trust, etc… as prophesied by the blockchain futurists and gurus in the earliest of stages of the Gartner Hype Cycle.
With a significant background in legaltech, regtech, and compliance prior to the “blockchain revolution,” the founding team of 10XTS dedicated themselves to bridging the gap between the capability of the tech and the jurisdictional regulations that will never disappear simply because some form of technology CAN enable something.
Sorry Ancaps, anonymous cryptocurrencies being used to purchase fractional direct ownership in a titled real estate property in some parallel monetary system is the result of puffing on whatever was being passed around at your crypto conference industry party.
Blockchain technology has an immense potential to bring global benefit to capital and investing. However, the vector of approach in getting there has been convoluted and tainted by such fantasies, and subsequent regulatory idiosyncrasies and fraud.
While there has been a lot of clamoring to the contrary by the crypto crowd, aside from a operational tweaking standpoint, securities law is pretty good – and clear. The United States capital marketplace is considered the pole position globally for good reason.
Like any other significant technology shift, there are legacy incumbents who have already long functioned within the regulated framework prior to the technological shift. This includes banks and custodians, brokers and marketplaces, transfer agents, etc… who all trade and transact today. Everyone reports in some prescribed manner (xBRL & EDGAR for example).
Inefficient Governance, Risk, and Compliance Records
The problem and risk in the status quo is the inefficient handling of records and data, forcing a longer cycle time for transactions & processing.
10XTS recognized this gap, and also saw the opportunity to architect a more efficient solution that leverages the technology’s very apparent capabilities.
Despite the functional human failures of many cryptocurrency-centric institutions, blockchain technology itself has been battle tested for years. It has created incredible efficiency and speed, new product methodologies, trading strategies, and liquidity.
Crypto just didn’t do it in a regulatory-compliant way. The rush to build ran afoul of the reality of the actual rule of law.
So what’s the gap?
It’s easy to move a crypto token from one wallet to another. It’s not as easy to make all the extended governance, risk, and compliance records metadata as equally immutable, secure, provable, and efficient.
And that was the catalyst for 10XTS to pursue the goal of democratizing access to capital markets and wealth-producing assets for more people.
On one hand, a similar ethos to some of the cryptocurrency world, on the other hand, a radical departure because of the recognition of the actual law – and the reasons behind the need for those laws. Customer protection being at the top of the list, regulation and compliance enforcement are generally the result of people behaving badly such to bring about the need for rules.
In the regulatory “pecking order,” aside from the government itself, there’s no more regulated institution than a chartered bank. And even despite that extreme level of supervisory scrutiny, the myriad of issues stemming from how banks operate at scale, the complexities of their systems, and the monolithic legacy focus of physical branches and human-powered processes (albeit those are thankfully changing due to COVID) have, in some manner, contributed to violations within many legacy institutions.
But at the core, safety and soundness is the resounding, common philosophy of all that which chartered institutions do. Risk mitigation, process control, governance… risk… compliance… governance… risk… compliance…
Catch a trend here?
The Need for Qualified Custody
10XTS recognized the evolution of capital markets was impeded by the last mile of there being an absence of institutions remotely capable of supporting a regulatory-compliant implementation of the technology.
Banking core processors are notoriously slow to innovate, and the market was over-run with the “banking your cryptocurrency” discussions. Even among the chartered institutions, the focus was on giving a banking rail to people with Bitcoin.
Looking past the cryptocurrency custody noise of the moment, 10XTS saw the need and opportunity to focus on the qualified custody of traditional securities that had been enumerated in a token-based form vs. the simple institutional custody of a customer’s cryptocurrency.
In 2018 I had even floated to some of the stakeholders and team that 10XTS needs to buy a legacy state bank charter to build the solution. Although at the time, it was still very early, and no states had moved to create the path towards the intersect with banking – which is why we chose to table the discussion.
But it was during that period I spent a little bit of time thinking about branding a bank project, and I subsequently even registered the domain commerciumbank.com. The idea of ‘commercium’ and its Latin roots from Roman citizenship and the right to conduct commerce, it made a great reference to what would eventually become our foray into the chartered banking side.
Wyoming Special Purpose Depository Institutions (SPDI)
In 2019, the State of Wyoming blazed the trail when it enacted SF 125 defining a regulatory framework for digital assets, and HB 74, which authorized a new form of financial institution called a “special purpose depository institution” – or as it’s referred to as a “speedy” by way of acronym, SPDI.
And then later the same year, the SEC/FINRA released a joint staff statement pertaining to the broker-dealer custody of digital securities, which bolstered support for Wyoming’s regulatory approach to market infrastructure and custody operations.
The custodial requirements under Rule 15c3-3 under the Securities Exchange Act of 1934, is commonly referred to as the “Customer Protection Rule,” which applies to entities that buy, sell, or are otherwise involved in securities transactions, including transactions involving digital instruments that are both deemed to be a security AND a digital instrument that is specifically used to account for something that is indisputably a traditional security instrument.
The SEC/FINRA joint staff statement specifically calls out the custodial requirements under the Customer Protection Rule, which exist to protect customers’ securities held by broker-dealers should that broker fail. The Customer Protection Rule requires brokers to separate customer assets from the firm’s own investment accounts.
Under the Customer Protection Rule, broker-dealers are required to maintain physical possession or control over a customers’ securities that are fully paid and excess margin securities, or they must maintain them free of any encumbrances or liens at a “good control location.” The good control location requirement permits broker-dealers to use third-party custodians, such as banks and transfer agents, to custody their brokerage client securities. This isn’t new stuff.
While the great advancements by Wyoming quickly got overshadowed by the cryptocurrency conversation, there were a few interesting advancements that significantly favors consumers with respect to qualified custody and banking.
Do you own your security if it’s held on the balance sheet of your broker subordinate to their own interests with any liability ahead of your position?
While “custody” exists today in securities markets, the bailment aspect becomes highly convoluted with the indirect ownership rendering the bailment ineffective. If your broker dealer fails, it may not necessarily return your shares of AAPL to you because your shares are really a pro rata share of your broker’s street name account.
Yes, we’re talking about the potential of an FTX event kind of thing happening with your traditional shares of AAPL in your traditional brokerage account.
Let that sink in.
You do not own a single share of stock in the current market. It’s not in your name.
The brilliance of Wyoming’s approach mitigates this risk – albeit along with the dismantling of the mandated intermediary system.
When SF 125 was signed into law, it made the current construct of indirect ownership “optional” while preserving owners of digital securities to retain their direct property rights under the Uniform Commercial Code without jeopardizing protection for lenders. SF 125 aligned digital assets with the existing law while extending a lot of benefits to all parties engaged in transactions.
It also eliminated the indirect ownership regime imposed by UCC Article 8 because the ledger confirms in almost real time the seller of an asset has actual real ownership. Manual verification by traditional process via intermediaries can be facilitated by the trust enablement of the mathematical proofing of a distributed ledger or blockchain.
In effect, no securities custodian in existence can provide what an SPDI can for assets, an effective bailment while preserving direct ownership made mathematically provable via a cryptographically secured, distributed network!
The other, very interesting and unique aspect of SF 125 is that with respect to digital assets and securities that have not been perfected by the control, any trailing encumbrances of an asset purchased by any third party without knowledge of the existence of the prior adverse claims are removed. This is a massive risk mitigation feature to facilitate liquidity for assets.
What if something got missed in diligence by a buyer prior to acquiring an asset? With this law, they can be confident that after two years, those assets are free and clear.
Clean, no trailing liabilities.
Uniform Law Commission and Uniform Commercial Code (UCC)
At the time in 2019, the Uniform Law Commission was pushing their Supplemental Act, which extended the existing Section 8 of the UCC. The State of Wyoming rightly rejected the overtures by the ULC to embrace their approach. The state held steady with their approach to making indirect ownership of a digital asset, along with all the associated risks of indirect ownership, an option – not a requirement.
Since 2019, the Uniform Law Commission moved away from their rolling everything under Section 8 towards the Wyoming approach, and in 2022 introduced revised UCC language that creates an entirely new Section 12 defining the bailment and perfection by control of an electronic record.
By the way, that’s the legal nomenclature that will be enshrined into code: controllable electronic record (CER), which may or may not be a “token” since technology could change in the future.
Perfection by control of an electronic record is a fancy way for saying that an institution controls the digital unit of account, like a token, within an institutional account wallet wherein only the institution has the private keys to conduct any authorized operation or activity against that data record. The client completely owns the record, which is not part of the institution’s balance sheet co-mingled with other assets and liabilities.
The new Section 12 UCC revisions are now on the docket in 16 states for further adoption. But Wyoming presently maintains the pole position lead, specifically with respect to their treatment of the banking side.
10XTS and Commercium Bank
Aside from the philosophical alignments with serving the market and clients while bringing new efficiencies through the tech, Wyoming and the SPDI banking model has been very near and dear to 10XTS.
When the Wyoming laws were signed, I recognized this was the bellwether moment in connecting the dots. The 10XTS team determined that it would pursue a Wyoming SPDI application charter and began formal incubation of the project. 10XTS incubated and spun out what became the fourth SPDI charter approval – my beloved Commercium Bank.
In November of 2019, I visited a friend in Chicago, Tim Marselle, who was in management at HSBC. I thought he’d be a great person to chat with about 10XTS and the project. In fact, he became one of the founding management team members. Tim introduced several others, and through his relationships we subsequently recruited another HSBC Global colleague out of recent retirement, Neil Parsons. Neil is a bank finops rock star, having opened multiple banks in many global jurisdictions during his career at HSBC. They also recruited Corey Reason, who is a bank compliance guru with international experience in complex, forensic compliance matters. With some help (and hinderance) from folks from the 10XTS team, the core team was established, and it was off to the races to file an application for the de novo charter.
While COVID disrupted early 2020, by the end of second quarter of that year, we’d fully fleshed out the path to developing the core thesis and application, which took the remainder of that year to complete. By the end of the year, the application was nearly 1,000 pages, and was subsequently approved to proceed towards a charter hearing that was set for June of 2021.
Commercium Bank’s charter was subsequently approved, and the bank team began working on operations towards being approved to operate as a de novo charter.
Advancing Qualified Custody of Digital Securities
Of course, if you’ve followed along with the public news about Wyoming and SPDI’s you’ve maybe heard about one SPDI’s challenges with the Federal Reserve Bank. Or maybe you’ve heard about a different SPDI’s association with a large, legacy cryptocurrency exchange. Great folks out there with very different missions.
Conversely, I absolutely know you’ve heard nothing about Commercium Bank, because it has remained quiet and focused on building. Government folks aren’t fans of media attention-seeking while these kinds of things are happening. Rather than trying to be the feature story of the day on Coindesk right now, the goal is to get into operation and build the institution.
Commercium Bank was never conceived around cryptocurrency, providing banking legitimacy to cryptocurrency assets, esoteric stablecoin products, or any other crypto market focused noise. The thesis of Commercium Bank was always about providing the highest form of ownership assurance while meeting the compliance requirements for traditional institutions and old fashioned securities markets trading.
In fact, the construct is even more secure than the present market-wide system of indirect ownership through intermediary sub-ledger accounting, which is a risk to every security holder.
The real SPDI disruption was never about providing banking to cryptocurrency markets and clients as an “end run” around the Federal Reserve system. It was always about giving ownership of your assets as an investor back to you, while meeting the definition of that good control location to effectuate market trading and liquidity WITHIN the law and the Federal Reserve system.
This makes good on providing the transparency, security, and opportunities afforded by the technology – with a good old-fashioned dose of banking safety and soundness attached.
