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 1) outright scams; 2) unregistered securities offerings and/or violations in some global jurisdiction; or, 3) 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, it was this confluence that drove 10XTS to recognize the merits to the proper architecture and application of the 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.
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. The stark reality is, like any other significant technology shift, there exists many generations of legacy incumbents who have already functioned within the regulated framework long before the technological shift.
While there has been a lot of clamoring to the contrary by the crypto crowd, aside from an operational tweaking standpoint, securities law is pretty good - and clear. The United States capital marketplace is considered the pole position globally for good reason.
Part of this market are… get this… banks and custodians. They already provide electronic forms for custody of securities and have for decades. Brokers and marketplaces trade and transact these electronic forms of securities today. They exchange information with transfer agents and administrative servicing companies. Everyone reports in some prescribed manner (xBRL & EDGAR for example).
Inefficient Governance, Risk, and Compliance Records
The problem and risk in using the status quo system are the inherent lags and fraudulent vectors created from inefficient handling of records and data. This antiquated system forces - longer cycle times for transactions & processing, creating inefficiencies that lead to increased costs for investors
10XTS recognized this gap, and also saw the opportunity to leverage new technologies to architect a clean, scalable solution to achieve compliance while creating a more efficient market.
Distributed Ledger Technology, itself, has been battle tested for years. It has created incredible efficiency and speed, new product methodologies, trading strategies, and compliant liquidity strategies. While crypto has been the center of attention lately, just hasn't been proven to achieve these goals 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, there are similar market goals to some of the cryptocurrency projects, however, they represent a radical departure from the recognition of the actual law and the recognition for the need of those laws. Customer protection being at the top of the list, regulation and compliance enforcement are generally the result of nefarious actors who caused the need for such rules.
In the regulatory "pecking order", aside from the government itself, there's no more regulated institution than a chartered bank.
At their core, safety and soundness to protect the American people is the resounding, common philosophy of all that which chartered institutions do. Risk mitigation, process control, and governance is at the heart of everything.
The Need for Qualified Custody
We recognized the evolution of capital markets was impeded by the absence of institutions - capable of supporting a regulatory-compliant implementation of the technology. This "last mile" is the final capability required to enable a more efficient and compliant market.
Banking core processors are notoriously slow to innovate, and the market was over-run with the "banking your cryptocurrency" discussions. Looking past the cryptocurrency custody noise of the moment, we saw the need and opportunity to focus on the qualified custody of traditional securities that had been enumerated in a controllable electronic record vs. the simple institutional custody of a customer's cryptocurrency.
During 2018, 10XTS established the concept of a bank project to support the market demand, and, subsequently registered the domain commerciumbank.com. The idea of 'commercium' and its Latin roots from Roman citizenship and the right to conduct commerce 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."
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 exists 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.
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, GOOGL, or AMZN to you because those shares are really a pro rata share of your broker's street name account.
Yes, we're talking about the potential of an FTX kind of event 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!
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.
This means that if something was missed in diligence by a buyer prior to acquiring an asset, they can be confident at any time those assets are free and clear. Clean, no trailing liabilities. Your purchased asset remains your asset!
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 Uniform Law Commission 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 has moved away from 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 ability to conduct any authorized operation or activity against that data record, in this case, by way of "private keys" to the customer's account. These keys give the client complete ownership of the record, which is not part of the institution's balance sheet, nor co-mingled with other assets and liabilities.
The new Section 12 UCC revisions are now on the docket in 16 states for further adoption. Wyoming's foresight and leadership in this area has given them and their SPDI's pole position for banks to realize these new advances.
Commercium Bank and 10XTS
Aside from the philosophical alignments with serving the market and clients while bringing new efficiencies through the tech, Wyoming and the SPDI banking legislation has been very near and dear to 10XTS.
When the Wyoming laws were signed, the 10XTS team determined that it would pursue a Wyoming SPDI application charter and began formal incubation of the project. 10XTS incubated and launched what became the fourth SPDI charter approval - Commercium Bank.
Together we managed to create a highly experienced banking team with over 100 years of banking and Compliance experience who agreed to be both Founders and part of the core proposed executive team. With the core team established, 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 core thesis and developed a disciplined approach for our application of a Wyoming SPDI charter. By the end of 2020, we had developed an application totaling nearly 1,000 pages that was subsequently approved by the Wyoming Banking Division to proceed towards a charter hearing set for August of 2021.
Commercium Bank's charter was subsequently approved, and the bank team began working on funding the operations required to be approved to operate as a de novo charter.
Advancing Qualified Custody of Digital Securities
We know you've heard very little about Commercium Bank, that's because it has intentionally focused solely on building a regulatory compliant Bank. Commercium Bank was never conceived around cryptocurrency, providing banking legitimacy to cryptocurrency assets, stablecoins, or any other crypto market focused noise. Our mission is to provide clients with a more compliant, efficient, and secure solution to ownership of their assets.
The thesis of Commercium Bank has always been about providing the highest form of ownership assurance that exceeds compliance requirements for institutions and individuals participating in the securities markets. In fact, Commercium's solution provides better security for than the present market-wide system of indirect ownership. Our service does not depend on intermediary sub-ledger accounting which as described earlier, is a risk to every security holder.
The real SPDI disruption was always about giving ownership of your assets as an investor back to you. We believe you should have a secure, simple, and safe path to liquidity that operates 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.
Corey Reason, CEO of Commercium Bank
Michael Hiles, Founder & CEO of 10XTS
February 28, 2023