”A year after Europe’s DLT Pilot Regime came into force in March 2023, not a single platform has been approved,” Ledger Insights notes in a recent article. The European Securities and Markets Authority (ESMA) has been upfront about the regime’s slow uptake, forgoing its planned one-year progress report last month for one that focused on the challenges hindering applicant approval. Ledger Insights, however, speculates that things could soon change with DLT exchange 21X, the only applicant so far that has applied for a DLT trading and settlement systems licence (DLT TSS).     

As Ledger Insights mentions, there is traditionally a strict separation between the exchange and the CSD. The TSS licence under the DLT Pilot Regime relaxes this demarcation. Another traditonal finance (TradFi) rule the regime breaks is allowing brokers direct access to retail users.

Lining up ducks

Although 21X is expecting fund listings from “some of the world’s largest asset managers”, it will mainly “aim to deal with issuances for SMEs” – a move that will suit the low transaction limits specified by the DLT Pilot Regime. It plans to match, trade, and settle on chain, using its own central limit order book (CLOB) and Polygon as the chosen blockchain. For settlement, it will use “tokenised e-money from a licenced e-money insitution”.

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21X CEO Max Heinzle has revealed to Ledger Insights that the firm has “an open market infrastructure and also an open market approach” and is looking to “enable tokenisation for service providers”.

Security concerns

One of the biggest concerns for regulators is the risk of blockchain frontrunning, or maximal extractable value (MEV). As described by blockchain security auditor Hacken, it occurs when validators or crypto miners with knowledge of the transaction queue “reorder, include, or omit transactions in ways that benefit them financially”. A crypto miner who notices a large buy order for a cryptocurrency token, for example, “might insert their own buy order first, then validate the larger buy order, and subsequently net an arbitrage”. Frontrunning has developed into a major security issue in crypto due to MEV bots.

21X claims that it offers greater security due to its choice of blockchain – only about one per cent of Polygon validators use MEV systems, compared to the 90 per cent on Ethereum. In addition, “MEV is more prevalent on DeFi automated market makers (AMMs) where there’s an open formula for pricing trades”, writes Ledger Insights. Because 21X has a CLOB, attackers will not be able to use existing programmes, or the AMM’s formula, but will have to come up with a different code.