Last night, the news that Coinbase’s stock will be included in the S&P 500 index sparked heated discussions, positioning pure encryption companies in a higher status in the eyes of traditional capital markets and investors.

But beyond individual companies, the entire encryption industry and technology actually need more recognition.

Also last night, an article titled ‘encryption and the evolution of the capital market’Thesis postIssued, it has quickly generated 200,000 views and nearly 1000 likes in a short period of time, rapidly becoming a hot topic of discussion in the English CT.

This paper has not only received widespread support from the encryption community but also attracted the attention of traditional financial practitioners. Dragonfly’s founder Haseeb said the paper has been printed out for study and captioned LFG (Let’s fxxx go).

Beyond the serious academic content, what this paper brings is more about the gradual acceptance of encryption technology by U.S. regulatory authorities:

The author of the paper, TuongVy Le, has not yet reached tens of thousands of fans. One of the reasons why her post has attracted such high attention is that she was a senior adviser and senior lawyer in the Enforcement Division of the SEC (U.S. Securities and Exchange Commission), responsible for handling enforcement cases involving the securities market, including the SEC’s earliest encryption-related investigations.

The main idea of this paper is that blockchain technology and tokenization can solve the inefficiency problems in traditional securities markets, although encryption technology is not perfect, it is still worth using.

The original post pointed out, “Blockchain and tokenization represent the natural evolution of the capital market, just like paper stock certificates were naturally eliminated half a century ago.”

At the same time, former SEC enforcement experts believe that encryption technology is very useful in the securities market, and current SEC commissioners Hester PeirceThe statement is also considering similar issues and suggesting the use of distributed ledger technology to issue, trade, and settle securities.

There are community comments joking that even the SEC is starting to show up, is the spring of encryption far away?

We also read this paper, providing you with another macro-level information reference amid the various ups and downs in the market noise.

Insiders write encryption

First, we can take a closer look at the background of the paper’s author TuongVy Le.

TuongVy Le not only worked at the SEC for nearly six years but also was promoted to the Chief Legal Counsel of the Legislative and Intergovernmental Affairs Office, directly dealing with the ‘big shots’ such as the U.S. Congress and Treasury Department, participating in the formulation of regulatory policies for digital assets.

The GameStop event in 2021, where retail investors battled Wall Street, exposed many loopholes in the traditional market. TuongVy Le was working inside the SEC at that time, assisting in dealing with this crisis and providing advice for market structure reform.

After leaving the SEC, she entered the encryption industry, first serving as a partner at Bain Capital Crypto, focusing on promoting the application of blockchain technology in traditional finance, also briefly serving as legal counsel and compliance officer at the Worldcoin team; now serving as the Chief Legal Officer at Anchorage Digital, helping this encryption company, which was the first to obtain the OCC federal banking license, establish a solid foundation.

With years of experience in financial regulation spanning regulatory agencies, traditional finance, and the encryption industry, TuongVy Le may have a more comprehensive experience than most practitioners in the encryption industry, understanding both the ‘unwritten rules’ of regulation and the ‘new ways’ of encryption.

People who are knowledgeable about the industry are calling for the use of encryption technology in traditional capital markets, which is not only beneficial to the interests of the current encryption asset management companies, but also can provide a positive view of encryption technology and the industry to more current SEC colleagues through their own influence.

Overly complicated capital markets

TuongVy’s paper actually does not have much technical exposition and formulas. One interesting point is the comic strip called ‘The Self-Operating Napkin’ from the following figure.

This painting depicts an extremely complex and absurd mechanical device designed to accomplish a very simple task - wiping the mouth with a napkin. The painting is full of various peculiar parts and movements, such as levers, ball bearings, springs, and even animals, together forming a seemingly sophisticated yet comical system.

The irony of this painting is very obvious, the core phenomenon is over-complication. By designing a mechanical system with dozens of steps to complete the simple action of “wiping the mouth”, humans sometimes make simple problems complicated.

And this is very similar to today’s securities trading system, with multiple roles and unnecessary links in the trading and settlement process, seemingly cooperating in their respective duties, but actually being widely criticized.

Traditional securities trading involves multiple intermediary steps. Each transaction is not just a simple interaction between buyers and sellers, but also involves multiple intermediaries such as brokers, clearing institutions, transfer agents, etc. These intermediaries add layers of operational friction and costs to the trading process.

Secondly, the author points out that the current market structure was designed to deal with the “paper crisis” of the 1960s. At that time, stock trading mainly relied on paper certificates, and this manual processing method became difficult to maintain as trading volume rapidly increased.

Due to the inability of the back office to process a large number of paper documents in a timely manner, many brokerage firms are facing delivery failures, and even closures.

To cope with this crisis, the market began to adopt more complex clearing and settlement systems, introducing more intermediaries and regulations. Although this highly intermediated system resolved the crisis at that time, it also brought more complexity and inefficiency.

For example, individual investors who want to trade must have a broker to help them trade on the stock exchange. This actually increases the risk of agency, as brokers may engage in excessive trading or recommend unsuitable investments for their own benefit.

In addition, national stock exchanges and alternative trading systems need to follow complex rules to prevent trade prices from being inferior to quotes from other trading centers, but these rules are difficult to fully implement in practice.

The presence of clearing and settlement agents adds another layer of intermediaries. As a central counterparty, the clearing institution ensures the settlement and delivery of transactions. However, this system leads to settlement delays and risks, requiring additional intermediaries to ensure the finality of transactions.

Each link has intermediaries, full of redundancy and inefficiency, but this is actually due to policy choices made in an era of insufficient technology.

One point in the author’s paper is thought-provoking, that is, if paper stock certificates could be phased out in the past, then the current stock trading system can also be replaced.

CEX, better than exchanges?

Although encryption technology also has its own problems, such as private key loss or imperfect smart contract code design, the paper authors proposed a very bold idea:

Doing P2P transactions and using CEX, some places are better than traditional securities market transactions.

For example, CEX allows users to access the trading platform directly, without the need to go through a registered broker. This reduces agency costs and enables users to have more direct control over order execution;

On CEX, trades are settled instantly upon execution, reducing the counterparty risk brought by T+1 settlement in traditional markets. This also eliminates the need for clearing agents, custodians, or transfer agents; meanwhile, CEX supports 24/7 trading, allowing users to react to market changes at any time, reducing liquidity gaps and price inefficiencies during non-trading hours.

In addition, users can withdraw encrypted assets to self-hosted wallets at any time, holding direct ownership of the assets. This contrasts with indirect ownership of securities in traditional markets.

These features make CEX superior to traditional securities markets in terms of efficiency, flexibility, and user control. However, the author also points out that CEX has its own issues, such as centralized custody, self-theft and attacks, insider trading, and lack of rules.

The author’s paper figures are also very simple, in plain language, it is to use technology to replace too many intermediary links. However, this does have a bit of a “rare” taste, a former SEC enforcement expert not only did not show a high-pressure and exclusionary attitude towards encryption technology, but instead guided the construction of the securities market by taking its essence.

Although the paper does not address the attitude towards encrypted assets, the publication and dissemination of such papers itself is a positive signal, making it easier to attract more regulators to examine and embrace encryption technology, rather than viewing it completely as a monster.

However, the author feels that the views in the article do bring a long-lost sense of certainty:

Encryption technology is no longer a toy for a small group of players, but a real opportunity to break through and become the “new engine” of the traditional financial market.

The good days for the industry are yet to come, and I hope you can also taste the sweetness in it.

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