Bitcoin and the blockchain – what has been the regulatory response?
Satoshi Nakamoto, the person or persons unknown behind the 2008 paper "Bitcoin: A Peer-to-Peer Electronic Cash System", has given regulators and policymakers something to think about. Since the launch of Bitcoin, the prominent virtual currency, it seems to be the innovation itself, the blockchain, or distributed leger technology, that is likely to have the most impact on the financial sector.
The terminology is still evolving but, in essence, a blockchain is a type of database that takes a number of records and puts them in a block. Each block is then chained to the next block, using a cryptographic signature. This allows blockchains to be used like a ledger, which can be shared and corroborated by anyone with the appropriate permissions. The ledger provides a secure, permanent record that cannot be manipulated by a single entity and does not require a central registry.
The application of this technology in the financial sector and beyond has generated much interest. In the financial sector prominent examples of where the technology might be used are in clearing and settlement. A report by the UK Chief Scientific Advisor,1 gives case studies of some of the non-financial applications for example to trace diamonds.
Worldwide, policymakers and regulators are looking with interest at this subject. Many are adopting a "wait and see" approach with some being more pro-active than others.
- The Financial Stability Board announced on 22 February 2016 that "The FSB is evaluating the potential financial stability implications of emerging financial technology innovation for the financial system as a whole, working with standard setters that are monitoring developments in their respective sectors. We are also working to understand better the potential impacts on financial stability of operational disruption to core financial institutions or infrastructure".
- The International Organization of Securities Commissions (IOSCO) announced on 22 February 2016 that the IOSCO board "discussed and endorsed intensifying work on technological change – with a focus on harnessing the opportunities while mitigating the risks. The Board agreed on further research on financial technology subsectors with particular relevance for securities regulators, including blockchain". IOSCO does not itself make "hard law" but is influential in setting policies and standards for the financial markets.
- The U.S. Commodities Futures Trading Commission held a Technology Advisory Committee Meeting on 23 February 2016 to discuss blockchain technology and its potential application to the derivatives market.
- In a speech, Christopher Woolard, Director of Strategy and Competition of the UK Financial Conduct Authority, stated that "During the phase of any digital development, it's crucial that innovators are allowed the space to develop their solutions. The FCA continues to monitor the development of this technology but is yet to take a stance until its application is clearer". The FCA indicated that it works with firms to ensure consumer protection is factored in during the development phase of this technology. The FCA is particularly interested in exploring whether blockchain technology can help firms meet "know your customer" or antimoney laundering requirements more efficiently and effectively.
- The state of Delaware (the domicile of the majority of U.S. corporations) is engaging in a blockchain initiative. This initiative has four aspects: (i) Delaware is adopting a waitand- see approach and confirmed it has no immediate plans to engage in licensing. It is happy to let the industry and others take the lead and adopt appropriate regulation when the time comes; (ii) Delaware will be developing a new category of shares, distributed ledger shares, which will take advantage of the technology's benefits, including automatic share registration; (iii) Delaware is creating a dedicated blockchain ombudsperson who will engage and assist the industry; and (iv) Delaware itself will adopt blockchain technology in aspects of state governance, beginning with archival records, but potentially digitizing security filings.
Existing European regulations will still apply
As with business on the web and over the internet, there is no reason why existing regulation will not continue to apply. From an EU perspective, this has been confirmed by the European Parliament's Committee on Economic and Monetary Affairs (ECON Committee) which notes2 that existing EU legislation is likely to apply, irrespective of the use of certain underlying technology. So it seems that the ECON Committee anticipates there will be a period of reflection before any express legislative action is required. At the same time the ECON Committee calls for "smart regulation fostering innovation and safeguarding integrity, while taking seriously the regulatory challenges that the widespread use of virtual currencies and [distributed leger technology] might pose". The risks identified include the potential for money laundering, terrorist financing and tax fraud based on the difficulty in tracing the identity of those using the technology.
Regulated financial institutions should:
- assess whether new technologies used in their business operations are safe and sound, and meet current regulatory standards for financial stability, investor protection, market integrity, privacy and data protection;
- and liaise with their regulator before implementing new technology to make sure that the regulator understands that the technology meets existing requirements.
1 See: https://www.gov.uk/government/uploads/system /uploads/attachment_data/file/492972/gs-161-distributed-ledger-technology.pdf
2 See: http://www.europarl.europa.eu/sides/getDoc.do?pubRef=//EP//NONSGML%2BCOMPARL%2BPE575.277%2B01%2BDOC%2BPDF%2BV0//