Two high profile statements on blockchain technology in the past week underscore the varying views around the technology’s usefulness — and summarise the precariousness of the market’s position in the face of its advance.
The European Securities and Markets Authority’s (EMSA) wide-ranging consultation paper, released June 2, raised the possibility of blockchain-style tech having numerous benefits for financial markets, but also spoke of the challenges that it will need to overcome, as well as risks that it might engender.
To see ESMA taking a forthright outlook on the subject is welcome, particularly given the customary sluggishness with which European regulation operates.
Another sceptical view came from Intercontinental Exchange (ICE) chief executive Jeff Sprecher, who told a London conference on Tuesday that he had “not yet seen a business case for blockchain”.
ICE has proved itself a smart company time and again, but it will surely find itself on the wrong side of history if it fails to spot blockchain’s potential.
While many in financial markets still believe the technology to be in a proof-of-concept phase with limited application, those at its forefront have set their sights on much bigger goals. These even extend to a metanarrative for the industry, where essential structural underpinnings — such as transaction mechanisms, central clearing and even regulation itself — all cede to blockchain .
A company like ICE can, maybe, get away with a wait-and-see approach for now, but global market regulators do not have this luxury. (It should also be noted that Sprecher caveated his view by saying that ICE is paying attention to blockchain and has a minority investment in a bitcoin company.)
Regulators need to be up-to-speed with distributed ledger technology long before it starts to replace the main mechanisms that underpin the market. They need to understand not just the concept and structure itself, but how it will interface with other technologies, how users will preserve its integrity and where the potential threats may come from.
ESMA’s paper is a great call to arms on this. It recognised blockchain’s promise of tighter controls, lowering costs, managing trade flows and democratising activity. This all bodes well for practitioners and regulators.
Key benefits could be in clearing and settlement of transactions, reducing counterparty risk and the need to post collateral. Distributed ledger technology holds the ability to make reconciliations much more efficient — shortening the settlement cycle and perhaps even ultimately removing the need for central counterparty clearing.
This could be of huge benefit in future crisis-level situations, of the kind the industry faced in 2008 and 2009.
Lehman Brothers’ collapse created a systemic nightmare, due to the extent of counterparty trade exposure to the bank across the market. That mess took years to resolve — a matter that blockchain’s proponents say could have been much more easily and efficiently resolved with the instantaneous functions of distributed ledger technology.
But, if followed to metanarrative proportions, the blockchain’s advent in such areas presents alarming prospects. While the internal mechanisms of blockchain are inherently protected by the technology (the record of transactions is verified as each link in the blockchain is created) the problems come if one is operated on by outside triggers.
If the whole process of resolving credit event settlements was automated by blockchain — as many proponents indeed hope it will be — then the policing of outside triggers becomes paramount. The effect of a compromised or corrupted trigger for a credit event outside the blockchain could cause havoc, as instant, unbreakable settlement blasted through the system. Who would have the power to stop this before it multiplied its effects across time zones, institutions and markets?
The biggest proponents of blockchain technology will claim this is not possible as such triggers would be well policed. But you do not have to look far to find a cautionary real world example.
Bitcoin has famously never been compromised, claim its supporters. It has a 100% integrity record since inception, they say.
That is the record of bitcoin internally. But while bitcoin itself has never been hacked or compromised, just about everything that operates around it has been. Try telling holders of bitcoins on the Mt. Gox exchange who lost their earnings through thefts that occurred between 2011-2014 that the technology is foolproof.
So for all the promises of efficient collateral management, added security and resilience, and lower transactional costs, there are equally valid claims to make about the risks in each of these areas, particularly where the purity of distributed ledgers must interact with the rather messier realities of life.
Regulators must increase their vigilance around blockchain as the technology progresses rather than delegating responsibility to its ease of automation. That vigilance must start now.
