Blockchain technology is a nascent innovation that is providing evolving applications in finance every day.
Several regulators have already signaled their intention to examine the use of blockchains. While potentially attractive to regulators due to increased transaction security and reduced risk of manipulation, this new technology gives rise to difficult legal and regulatory challenges that regulators are grappling to understand. While regulations for such a new technology are always in flux, this short article analyzes the current regulatory approach to blockchain technology.
A Brief Overview of the U.S. Regulatory Environment
U.S. regulators are closely monitoring the development of blockchains and other distributed ledger technologies (as well as the virtual currencies exchanged on them). Some have expressed concerns regarding their impact on financial stability and market integrity.
Among U.S. regulators, the U.S. Securities and Exchange Commission (SEC) has been actively exploring potential applications of blockchains for financial services transactions in the public securities market. In a November 2015 speech, Commissioner Kara Stein first touted the potential of blockchains 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 blockchains as it relates to securities using its t0.com blockchain platform.
The Commodity Futures Trading Commission (CFTC) is another U.S. regulator examining how blockchain and distributed ledger technology could be used in the derivatives market. In March 2016, CFTC Commissioner J. Christopher Giancarlo discussed the emergence of distributed ledger technolgoy and stressed the importance of adopting a "do not harm" regulatory approach that establishes "uniform principles in an effort to encourage [distributed ledger technology] 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 technology is still emerging and their implementation will be incremental.
The Financial Crimes Enforcement Network (FinCEN) is another U.S. regulator issuing administrative rulings and interpretive guidance regarding virtual currencies and blockchains. FinCEN issued a ruling that an online precious metals brokerage using blockchain technology 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 U.S. 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 2016 entitled "The Distributed Ledger Technology Applied to Securities Markets" which addresses potential benefits and risks that distributed ledgers could have on securities markets, especially from a public policy perspective.
In the U.K., the Financial Conduct Authority (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 has recently published a discussion paper entitled "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 financial sector. The paper looks at the use of distributed ledger technology in the context of shared database models, digital currencies, digital asset trading and initial coin offerings, amongst other things, with a view to if and how regulation should be applied to the uses arising from the development of the technology.
Moving Froward 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.
Whilst the market monitors potential regulatory developments, effective governance is the key to the successful implementation of distributed ledger technology to protect participants, investors and stakeholders whilst 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 blockchains 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.
Martin Bartlam is a partner based in the London office of DLA Piper and is the head of the firm’s Finance and Projects, International Practice. Mark Radcliffe is a partner based in the Silicon Valley office of DLA Piper and the former head of the firm’s Technology Sector.
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