Acting Comptroller of the Currency Michael Hsu
The OCC chief highlights centralized blockchains due to their "efficiency." If you want efficiency, a database will suffice. Centralized blockchains are merely dressed-up databases.
Centralizing for efficiency's sake is a "technocratic fallacy" reminiscent of economic central planning. The true value of a decentralized blockchain is in reducing reliance and on trust on centralized actors, and in aligning incentives to promote good behavior across
In a decentralized blockchain, market participants receive rewards and punishments for checking, or failing to check, the work of others. The result is a transparent, rules-based, self-regulating market system that promotes integrity of transactions and ensures provenance.
The 2008 financial crisis laid bare the pitfalls of centralized systems and "trusted actors" such as ratings agencies and investment banks. Remember 2008 subprime securitizations, Libor shenanigans and credit default swap counterparty risk piling up across the system? Decentralized blockchains, functioning on game-theoretic principles, could have helped mitigate each of these issues.
Here's how.
Consider the murky asset backed securitizations during the 2008 crisis. In a decentralized blockchain environment, the process of securitization could be standardized and transparent. Every asset backed security could be tokenized, and its underlying assets could be tracked in real time.
Smart contracts could enforce compliance by ensuring that only loans meeting qualifying criteria are bundled. This on-chain transparency could have prevented the blind accumulation of toxic assets or asymmetric information advantages that favor certain participants.
How about Libor shenanigans?
A decentralized blockchain could replace the dependence on banks' self-reported interest rates with a more transparent and automated system. Banks that misreport rates would face an economic penalty in the same way a malevolent node on the ethereum network is punished (e.g., "slashed") for bad behavior.
Smart contracts could be used to aggregate data from various sources to calculate a fair and transparent reference rate. This would eliminate the opportunity for manipulation, as the data would be openly verifiable and not under the control of any single party.
Lastly, decentralized blockchains could have created transparent marketplaces for credit default swaps. The blockchain would have allowed participants to see the level of risk exposure in real time, ensuring that companies couldn't take on excessive risk without the market being aware.
Smart contracts could also automatically execute payments in the event of a default. This would eliminate the need to concentrate ever more counterparty risk in centralized clearinghouses.
In all these cases, game-theoretic principles embedded in decentralized blockchains ensure that market participants are incentivized to act in the best interest of the market's health.
Decentralized blockchains share the same benefits of competitive, decentralized rules-based market systems. The openness and immutability of the blockchain means that any attempted manipulation or dishonesty is both more difficult to accomplish and easier to detect. This ultimately reinforces the integrity and stability of the financial system.
Trust and transparency are pillars of healthy financial systems. Yet, markets have not significantly evolved to address the deficiencies in trust and transparency since the financial crisis. It's remarkable we still do not have loan-level transparency in Rule 144A securities. The GameStop saga exposed the outdated securities settlement system.
Hsu's comments also reveal an inherent contradiction. On one hand, Hsu correctly identifies the lack of comprehensive legal frameworks as a key issue. On the other hand, he expresses frustration over the lack of traction in the crypto space.
Yet it is the absence of legal clarity that's throttling the pace of progress. It reminds one of how Lincoln defined a hypocrite: the man who murdered his parents, and then pleaded for mercy on the grounds that he was an orphan.
Projects are underway at a number of payment firms including PayPal, Circle and Ripple. Location and regulation will also play a big role in what the market looks like in the next year.
Clear legal frameworks aren't just necessary — they're the proverbial floodgates that once opened, could propel the crypto industry toward unprecedented growth. Capital markets would greatly benefit from a more resilient decentralized all-to-all market that wrests data and control from a small group of "too big to fail" investment banks and clearinghouses.
The use-cases abound.
When combined with updates to securities laws, tokenization would enable banks sitting on loads of commercial real estate they are unable to refinance to tap a broader, standardized, institutional capital market on-chain.
Private capital lacks an immediate access point to purchase loans particularly from the 'long tail' of smaller banks.
Sophisticated Americans that seek investment opportunities in their own community could invest alongside their local banks in the Small Business Administration's 7(a) program — sitting alongside banks and/or sponsors in a senior secured position.
A final example.
There are 1,000 promising creatives like Taylor Swift who are just as talented and as hardworking. But there are a finite set of "bets" the gatekeeping studio business can make each year. There are only so many concert venues, and promotion campaigns that taste-making studios can run per year.
Decentralized systems would enable the next Taylor Swift to fund her own concert tour and promote her content with a very special group of underwriters — her fans. And the fans could share in the upside. Royalty collections and their syndication would all take place on-chain.
Decentralization opens up capital and innovation across the long tail.
As former SEC Chair Jay Clayton notes, embracing decentralized blockchain technology in our financial system should not be a matter of controversy.
Decentralization was central to the Founding Fathers' vision of America.
Whether in application to the design of the U.S. government, decentralization is a sound organizing principle. It's time to start settling tokenized assets on decentralized public blockchains like ethereum.
