How will regulation impact the development of blockchain technology ?

Jessi Baker, the Founder and CEO of Provenance, recently said: “At its heart, a blockchain is a system that allows people who don’t trust each other, to trust each other.”

There is no doubt that blockchain is all about bringing trust to transactions.  For almost any supply chain – be it food, medical records, precious gems and minerals, real estate, or credit default swaps, to name a few – success depends on the promise of transparency and auditability for all participants.  In this sense, we can view financial products as supply chains of primary and secondary markets – a supply chain of cash in one direction and of shares, CDs or derivatives in the other. Blockchain is designed to deliver on that promise, and do so transparently.  A regulator’s dream come true.

For financial markets, the 2008 global financial crisis was a nadir for market opacity and a lack of trust, for example in the events during the demise of Lehman Brothers. As a result Financial Services still carry the sting of increased scrutiny and regulation.  And while digitalization has made a difference to the client interface, it hasn’t changed the supply chain.  As a result, participants are increasingly looking at distributed ledger technology to become an open, secure, scalable, transparent way to imbue transactions with trust and confidence.    

Even regulators, who in many cases have driven up costs, are keen at this point to not slow down and possibly even promote technology that lowers costs and increases transparency.  Regulators are seeking to:

• Reduce systemic risk
• Ensure fairness by helping willing buyers meet willing sellers
• Complete transactions accurately without disputes that block supply chains
• Settle trades quickly and transparently so as to avoid settlement risk

We are encouraged by the enthusiasm of regulators, not often viewed as particularly innovative – or even concerned with innovation.  Around the world, they are becoming increasingly proactive about blockchain.  For example:

• The SEC has formed a Distributed Ledger Technology Working Group to build expertise; identify emerging risk areas, and coordinate efforts among the SEC’s divisions and offices. Approximately 75 members of the working group also assist in coordination with federal, state, and local law enforcement and regulatory partners and liaising with industry. 
• The Bank of England, working with a consulting firm, built a multi-node scalable blockchain environment that contained several smart contracts to illustrate the applications of the technology. 
• The general secretary of the Financial Stability Board (FSB) disclosed in November it is considering the financial stability implications of distributed ledger technology, and continues identifying key issues that market participants and policymakers need to address. 
• ESMA has recently published the results of its 2016 market consultation exercise, and in the US FINRA is in a similar market exercise.

Where will this proactivity lead ? Hopefully more regulators will follow the lead of the Japanese FSA who are directly participating with more than 25 other market participants in the blockchain consortium led by JPX.

And as an even stronger indication of proactivity, there is already one regulator operating a node on the blockchain network of a custodian, taking direct advantage of the trust and transparency that DLT brings to trade reporting within the private equity world.