The conversation around
The rise of decentralized blockchain networks is a continuation of an ongoing technological evolution — digital ledgers tracking the ownership and transfer of assets no longer need to be maintained on an electronic database maintained only by one entity. In addition,
Alongside this technological evolution, regulators again need to adapt their approach. However, rather than viewing blockchain's attributes as obstacles, regulators should embrace them. When viewed through an opportunistic lens, it becomes clear that blockchain provides a certain set of benefits that are lacking in the current world of intermediated financial markets.
To understand blockchain's benefits to regulators, we must first boil down regulators' key concerns. Once this is done, we can then look to see which blockchain characteristics address those specific concerns.
For example, one key concern that regulators care about is maintaining market data reliability. To do so, they need to have a highly accurate and nearly real-time view into the state of a specific market. To get this view in today's markets, regulators generally rely on reporting obligations imposed on market participants. However, today's system has flaws.
Firstly, it is piecemeal. Each institution and financial intermediary reports on its own actions in a given market. Once that information is sent to a regulator, it is the regulator's job to stitch together a wider understanding of the data. Whether it is securities, mortgages or lending activity, there is no single source of truth for the market as a whole. If a regulator receives incorrect data, whether due to fraud or simple negligence, the picture becomes skewed.
Secondly, by the time a regulator receives data, it is often stale. For example, where regulations require quarterly reports, market views can now be several months old. This lack of current data is problematic and may impede regulators' needs to adjust policies based on market conditions. This was evident during the financial crisis of 2007 — the opaqueness of the mortgage-backed securities market resulted in valuable time being wasted unwinding transactions to understand participants' positions before regulators were able to determine how to act.
Blockchain networks can help address these concerns. Through accessing an always-on, tamper resistant, publicly available ledger, regulators can ascertain the current state of a blockchain-based market in real time. To the extent that policy shifts are required, regulators can act on accurate information in a manner specifically tailored to current market conditions.
Another consistent regulatory concern is the safety of customer assets. Whether it is cash, stocks or bonds, if a customer entrusts a third party with its assets, there is a need for that third party to act properly. In today's financial markets, regulators target these centralized third parties with specific regulations pertaining to matters such as custody, money transmission and a litany of others. Fundamentally, however, there is no way to verify that an intermediary is doing what they say they are — regulators rely on their representations. If something goes wrong, like fraud or a comingling of assets, regulators only become aware after the fact. Nonetheless, holding these intermediaries accountable is today's best option.
Blockchain networks are ideally suited to address this concern as well. When an individual or entity holds a token in a wallet on a blockchain network, the association between that wallet and token is verifiable. Anyone with an internet connection can confirm that association.
The agency said VyStar customers took on fees and credit report demerits because they could not access banking functions for months following an attempted upgrade.
In addition, to the extent a user accesses a blockchain network directly, she can be confident that the ledger data is tamper resistant. No third party can change such data once it has been written to the "data availability" layer of a blockchain network. Accordingly, a regulator can have full comfort in the data recorded on a blockchain ledger.
A further regulatory concern revolves around keeping bad actors out of financial markets. Specifically, regulators want to ensure that sanctioned entities do not have access to our markets. To do so, there are several identity related regulatory requirements (e.g., know your customer), all of which rely on intermediaries to monitor compliance.
Blockchain networks are also well suited to address part of this concern. Their strengths lie in their ability to track all assets that move between wallets. In a truly decentralized network, regulators can be sure that there is a consistently verifiable audit trail of an asset back to its genesis. Accordingly, regulators will have the ability to determine if a specific asset passed through a sanctioned wallet.
An interesting result of the above benefits is that regulators can maintain regulatory oversight of markets on a "self-sovereign" basis. By being direct market observers, regulators do not need to rely solely on representations made by intermediaries. Instead, they can access networks themselves to obtain accurate, up-to-date, verified data of their choosing. This provides regulators with an opportunity that they simply lack in today's financial markets.
There are other benefits that blockchain networks can provide to regulators, as set forth in
How will "on-chain" identity be tied to "off-chain" identity?
How do we build systems that simultaneously use the benefits of public blockchains while maintaining transaction privacy?
What security measures can be implemented to better safeguard private keys from theft or inadvertent loss?
However, rather than running from these questions, regulators should think about the ways in which the answers to them will help bring insights and further benefits.
