Blockchain began as a conjoined element with the stateless Bitcoin. Blockchain is one name for the distributed ledger technology behind the virtual currency. The likelihood of financial applications of blockchain remaining free of significant regulatory oversight is small. How small? Shall we say, as small as the space between two stacked dollar coins of the traditional metal variety.
Yet with the assumption that regulation will arrive, what should it look like?
Jurisdictional angling by combined federal and state authorities from multiple disciplines can be “the death of 1,000 cuts,” observed J. Christopher Giancarlo, a commissioner of the Commodities Futures Trading Commission. Giancarlo, speaking on a panel at a recent blockchain industry event, Consensus 2016: Making Blockchain Real, said that he recognized concerns that blockchain’s potential could be hindered by stringent regulation.
To regulate or to regulate less?
“I believe in a ‘first, do no harm’ approach,” said Giancarlo. He cited the U.S.’s original approach to the development of the internet as a model that could be followed. The federal government determined to leave much of the development of the internet and the World Wide Web to the private sector. While the nature of the blockchain and the internet technologies differs, said Giancarlo, he believes a relatively hands-off approach would work well.
Indeed, Giancarlo noted, the United Kingdom and some other entities have gone beyond a “do no harm” stance, actively encouraging development of blockchain and other fintech activities, clearly with an eye on economic development and leadership. In the U.K. new efforts can now be launched in a special “sandbox,” for instance, to enable development without undue regulatory interference.
Moderator Jerry Brito, executive director of Coin Center, a cryptocurrency advocacy group, immediately turned to Giancarlo’s fellow panelist, Benjamin Lawsky. He is now a consultant, CEO of The Lawsky Group, but previously was New York’s Superintendent of Financial Services, head of its Department of Financial Services (DFS). On his watch New York State’s digital currency regulation was created. Brito asked how he felt about regulating the blockchain.
Lawsky said he had two views on the matter. For many of the applications proposed for blockchain technology, he agreed to a softer hand.
But not for financial usage.
“DFS saw responsibility for where blockchain was used for the money of other people,” Lawsky explained. New regulations had to be devised, he said, because anything that seemed to apply dated back to the Civil War.
“The goal was to put the right guardrails in place to protect consumers,” said Lawsky. As for how the state’s regulation is working, he said, “the jury’s still out on that.”
Is there a regulatory “race to the bottom”?
Later during the panel discussion, Brito instigated a bit of debate between Lawsky and Giancarlo on the role of government in innovation. He suggested that while the U.K. and other jurisdictions are actively encouraging innovation (Read “Fintech on the other side of the pond”), the federal government in this country has behaved more cautiously. (Read “OCC would balance innovation against risk”)
Could that impact U.S. competitive ability, Brito asked.
Lawsky said that for the most part he liked what the U.K. was doing, but he had concerns.
“You want to avoid a regulatory approach that is a race to the bottom, to see who can have the lightest touch of regulation,” said Lawsky. “You need some thoughtful regulations that at the same time protect innovations.”
As an example, Lawsky said he could not see any way it would be appropriate to not subject electronic wallets to BSA/AML oversight, especially given that not all accounts contained in such wallets have necessarily been through their own BSA/AML know your customer screening.
Lawsky’s choice of analogy brought Giancarlo into the fray.
“I don’t think there is any regulatory race to the bottom,” Giancarlo countered.
Giancarlo said that he didn’t think most financial players wanted to go to “the least-regulated jurisdiction. If they did, then Zimbabwe might be the financial capital of the world. I think market participants will go where they’ll find the best regulation, which is the best balance of regulation.”
The commissioner noted that the U.S. is a favored market for launching initial public offerings, and not because that market is unregulated.
“London is seriously looking to compete with the U.S. for fintech,” said Giancarlo. “We need to take that seriously. We got it right with the internet, but there’s no reason we should expect to get it right with the blockchain if we don’t take steps.”
Blockchain as a regulatory tool
The flip side of the discussion about regulating blockchain activity is how regulatory access to blockchain might help regulators do their jobs better.
This was discussed in the context of the financial crisis and in terms of the establishment under the Dodd-Frank Act of swap data repositories, private entities that consolidate reporting and record keeping for all swaps, both those that are cleared and those uncleared. The CFTC, Giancarlo’s agency, has oversight of the repositories. The Securities and Exchange Commission shares elements of this issue, Giancarlo explained, because it regulates complementary elements of the market.
Giancarlo noted that these markets are very complex and that putting together these databases has proven more difficult than conceived when the legislation was written. In addition, from the regulators’ perspective, the information comes together much after the fact.
“It has become clear to me that in the case of the financial crisis there was a lack of visibility by regulators into the counterparty credit exposures of the once-largest trading banks with each other,” said Giancarlo. So complex is this information that he expects the effort to establish repositories will be going on for some time.
On the other hand, adoption of blockchain, with regulatory access in real time, would give regulators insights that they didn’t have during the run-up to the financial crisis, said Giancarlo.
Giancarlo hesitated to say that this would enable risk avoidance, but he said “this could help with risk response.” He said blockchain technology could lead to data sets that are timelier and more complete, and thus more useful to regulators gauging what’s happening.
“A ledger in real time across the databases and across asset classes would be a tremendous step forward,” said Giancarlo. He added that “this doesn’t mean avoiding failures. Technology isn’t going to avoid failure.” He believes the outcome will still hinge on the regulators—how they use the fresher data that they would be gaining.
More coverage about blockchain from Consensus 2016: Making Blockchain Real: