Wednesday , 21 March 2018

Blockchain and Payments Infrastructure: A Regulator’s Dilemma?

European Central Bank To Leave Interest Rates Unchanged

Today, regulators face the challenge of delicately balancing innovation enablement and avoiding premature and overly burdensome regulation.

On the one hand, they are expected to ensure market stability and ensure public trust and confidence, yet on the other they are being asked to spur innovation.

This all comes at a time when technology is advancing much faster than laws can adapt and when the bitcoin blockchain network offers a fundamental shift in how we transact value instantaneously and how money supply management can be improved.

The opportunity for regulators seems clear: an ability to regulate with enhanced transparency, with access to the best data in real time with regulatory features built into the infrastructure itself (eg: monitoring transaction flow end to end in real time with built-in settlement and compliance functionality).

So why aren’t regulators jumping at this opportunity?

Regulators’ questions

Epiphyte was invited to address 25 central banks at the ECB this week to discuss the FinTech impact on payment and settlement systems, and the regulation of digital innovations. The discussion was dominated by the impact of the bitcoin blockchain network.

Some of the topics raised were:

  • the pros and cons of closed loop vs permissioned and open distributed ledgers
  • cross-border flows and how to avoid systemic risk if adoption of bitcoin significantly increases
  • global blockchain standards and ensuring that all proprietary systems are built with interoperability
  • the scalability of the bitcoin blockchain network and liquidity
  • resource savings using distributed ledgers, resource intensity of maintaining multiple databases and using distributed ledgers as an enhanced sharing mechanism
  • the lack of incentive of large banks to progress instant settlement solutions
  • capital efficiency and reduction of (capital, market and counterparty) risk.

Instant settlement solutions

Focus was also placed on settlement cycles versus assets using the blockchain. Presumably, if using the network, the settlement cycle is significantly reduced. This would not require regulatory change, but a change in settlement asset, such as bonds issued on a distributed ledger, would trigger a regulatory change.

Another major point raised was the premature exposure of systemically fundamental systems to distributed ledgers.

Since central banks must rely on mature and resilient systems, the introduction of base money on a distributed ledger at this time may be premature.

Digital identification

Perhaps one of the most interesting discussions was on identification and the need to address digital ID as part of the essential fabric of an evolved financial services ecosystem.

In the current system, ID frameworks still remain primarily paper based, and the process of onboarding into the financial services system is riddled with inefficiencies, friction and expense.

A transformation to digital ID is long overdue, taking the Estonian example, whereby an electronic national ID card provides the user with legal picture ID in addition to use for digital signatures and for proof of e-access generally.

At the ECB meeting, the open-source standard Epiphyte has been developing was also discussed, whereby ID can be ported using a multi-signature key mechanism with different schemes and different layers of access being created for different views of subject data.

What about RegTech?

While regulatory interest continues worldwide, perhaps regulators should pay more attention to how they can leverage the advantages of distributed ledgers themselves to help firms better understand and manage their risks.

After all, RegTech is the new FinTech.


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