Regulation a Doubled-Edged Sword for Blockchain Clearing and Settlement

William Mougayar is a Toronto-based entrepreneur, Ethereum Foundation advisor and advisor to Consensus 2016, CoinDesk's flagship conference. He is also the author of the upcoming book, The Business Blockchain.

In this feature, Mougayar explores how blockchain could shift the world's regulatory landscape for financial institutions, weighing some of the factors that will impact how governments and regulators interact with the technology.

Let's start with a fact. Interbank settlement takes days to clear because of regulation and a multi-party intermediary infrastructure.

This is also commonly accepted as a challenge the blockchain could help solve. Every segment of the global capital markets ecosystem today is getting ready for some type of leap to address friction in the settlement lifecycle.

Some of the applications being looked at today include:

• Bonds
• Collateral management
• Commodities
• Derivatives
• Over-the-counter (OTC) markets
• Swaps
• Syndicated loans
• The repurchase market
• Unregistered/registered securities
• Warehouse receipts.

Whether via lip service or real work, most stakeholders and participants providing these market functions have declared an interest in blockchain tech.

Yet some questions about their approach remain. For example, while we've heard about a range of big bank blockchain trials, we've yet to see their real-world impact.

Without this, we have to ask: Are we talking real disruption, or are we going to improve things by a little? Further, what is the role of regulation in lubricating this next evolution?

Seeking answers

The variety of financial services regulatory authorities around the world might rival the number of ice cream flavor varieties. More than 200 such bodies exist in 150 countries, and many of them have been eyeing the blockchain and exploring how to go about updating their rules to account for the technology.

Imagine if each one of these bodies issued their own type of blockchain regulations, without coordination, or without due consideration for the full implications of such policies. Not only would a mess ensue, but potentially, the blockchain technology industry might wind up shackled as a result of the resulting regulatory confusion.

The Commissioner of the US Commodity Futures Trading Commission (CFTC), J Christopher Giancarlo underscored that specific point during a speech he made on 29th March at a conference organized by the Depository Trust & Clearing Corporation (DTCC).

He said:

“Yet, this investment faces the danger that when regulation does come, it will come from a dozen different directions with different restrictions stifling crucial technological development before it reaches fruition.”

When the Internet arrived, governments and policy makers were smart enough to not regulate it too early – a choice that contributed to its long-term growth. The reality facing financial services institutions is that, once again, they will be at the mercy of the regulators when it comes to blockchain tech.

Some vexing situations could arise if regulations don’t keep up with technology or social developments. Look at the case of Uber fighting 50-year-old regulations geared toward taxi cartels, or the difficulty in updating regulations against telecommunication industry monopolies.

Banks are between a rock and a hard place. Blockchains are worldwide, but much of the current regulatory climate today has forced innovators to focus on serving local needs rather than global ones.

Legalizing blockchain transactions

Regulation has offered a degree of protection – but it could also be the blockchain's undoing.

In order for blockchain-based business interactions to achieve widespread use, transactions processed on blockchain will need to be recognized as legally binding and acceptable within existing compliance requirements.

This might involve revisiting recordkeeping rules, or at least ensuring that new regulation does not specifically prevent institutions from using the blockchain to run these kinds of transactions.

At the very least, rules should be put in place that allow them to experiment with that technology and continue showcasing new capabilities – learning where they can lead.

You can already see examples of this in various jurisdictions looking at creating so-called "sandboxes" for innovation.

A better inter-banking network?

Each financial institution has its own proprietary systems, and each is required to use private networks they either own or control to move money in their possession. This mesh of complexity is certainly not helpful for clearing transactions quickly.

By way of its powerful vision of a single ledger, blockchain tech is questioning if financial institutions can continue depending on proprietary systems that silo them off from one another. The prospect of a more homogeneous – but also more transparent – audit trail of global transactions could offer unique insights and lower risks.

The litmus test is to run transactions without a central intermediary in the middle.

Verifying identity and validating counterparties can be done in a peer-to-peer manner on the blockchain, and that is the preferred method that organizations should be trying to perfect. Already, several blockchain trials and proofs-of-concept have demonstrated this capability.

Can the financial services industry cut the intermediary umbilical cord and favor peer-to-peer transactions, while at the same time recording all activity in a way that satisfies regulators? Technically, the answer is yes. But here is the dilemma: Banks don’t want to change banking.

Rather, startups want to change banking. And if blockchain can alter the way these institutions interact, reconciling these positions will be interesting to watch.

These issues and subjects will be discussed during an upcoming panel session at Consensus 2016.

Settlement image via Shutterstock