Blockchain technology is a nascent technology that is providing evolving applications in finance every day. Several regulators have already signaled their intention to examine the use of blockchain, also referred to as distributed ledger technology (DLT).
While potentially attractive to regulators due to increased transaction security and reduced risk of manipulation, this new technology gives rise to difficult legal challenges that regulators are grappling to understand. This short article analyses the regulators’ approach to blockchain.
A BRIEF OVERVIEW OF THE US REGULATORY ENVIRONMENT
US regulators are closely monitoring the development of blockchain and other DLTs (as well as the virtual currencies exchanged on them). Some have expressed concerns regarding their impact on financial stability and market integrity.
Among US regulators, the SEC has been actively exploring potential application of blockchain and other DLTs for financial services transactions in the public securities market. In a November 2015 speech, Commissioner Kara Stein first touted the potential of blockchain for tracing securities lending, repo, and margin financing and monitoring systemic risk by, for example, overseeing collateral reuse. However, Commissioner Stein also cautioned that as the market embraces Blockchain technology, “regulators need to be in a position to lead, harnessing its benefits and responding quickly to potential weaknesses.” Moreover, the SEC has embraced the early adoption of Blockchain as it relates to securities using its t0.com blockchain platform.
The Commodity Futures Trading Commission (CFTC) is another US regulator examining how blockchain and DLTs could be used in the derivatives market. In March 2016, CFTC Commissioner J. Christopher Giancarlo discussed the emergence of DLT and stressed the importance of adopting a “do not harm” regulatory approach that establishes “uniform principles in an effort to encourage DLT investment and innovation.”
More formally, the CFTC Technology Advisory Committee (TAC) meeting, held in April 2016, included a blockchain panel. The TAC noted that the lack of industry standards to date is a result of the fact that blockchain and DLTs are still emerging and their implementation will be incremental.
FinCEN is another US regulator issuing administrative rulings and interpretive guidance regarding virtual currencies and blockchain. FinCEN issued a ruling that an online precious metals brokerage using blockchain was subject to the regulator’s money transmission regulations.
Most recently, the Office of the Comptroller of the Currency (OCC) warned in its semi-annual risk survey that virtual currencies “enable anonymity for cyber criminals, including terrorists and other groups seeking to transfer and launder money globally.”
Other US agencies, such as the Federal Trade Commission (FTC) and the Consumer Financial Production Bureau (CFPB), have brought enforcement actions and issued warnings to consumers regarding the risks associated with bitcoin and virtual currencies more generally.
A BRIEF OVERVIEW OF THE EUROPEAN REGULATORY ENVIRONMENT
The European Securities Market Authority (ESMA), which is the umbrella of all national securities commissions in Europe, published a discussion paper in June 2016entitled “The Distributed Ledger Technology Applied to Securities Markets,” which addresses potential benefits and risks that DLT could have on securities markets, especially from a public policy perspective.
In the UK, the FCA has been extensively involved in fintech through the development of a regulatory fintech sandbox. The approach has largely been to watch and see how the technology develops. The FCA recently published its “Discussion Paper on Distributed Ledger Technology,” in which it calls for comment on the risks, uses and opportunities for the development of distributed ledger technology in the finance sector. The paper looks at the use of DLT in the context of shared database models, digital currencies, digital asset trading and initial coin offerings, among other things, with a view to if and how regulation should be applied to the uses arising from the development of the technology.
MOVING FORWARD FROM A REGULATORY PERSPECTIVE
It is clear that regulators will pay close attention to the development and use of DLT in the regulated sector. Regulators have generally avoided regulating technology itself and have paid attention to the uses and products that may be promoted or developed across the technology platform.
While the market monitors potential regulatory developments, effective governance is the key to the successful implementation of DLT to protect participants, investors and stakeholders while ensuring that the system is resilient in the face of systemic risk, privacy concerns and cybersecurity threats.
The development of the regulatory approach is still unclear, but it is incumbent on the industry as a whole to monitor applications to which blockchain may be put and avoid products and processes that are abusive or will lead to systemic risk. Otherwise, we can expect heavy- handed regulation that will limit the future development of the technology and the benefits it can provide.