Blockchain and payment infrastructure: Are regulators in a dilemma?

Gabrielle Patrick is an attorney specializing in crypto-finance and distributed ledger technology. She is the co-founder and general counsel of Epiphyte, a startup dedicated to using distributed ledger technology for instant trade and transaction settlement.

In this feature, Patrick discusses the balancing act for regulators in this rapidly changing technological environment and describes some of the issues raised at the ECB conference.

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

On the one hand, they are expected to ensure market stability and ensure public trust and confidence. On the other hand, they are required to stimulate innovation.

In this era, technology is advancing faster than laws and regulations can keep up. Now the Bitcoin blockchain is bringing a fundamental change, in which we can transfer value instantly and improve the management of money supply.

The opportunities for regulators seem clear: blockchain’s ability to increase regulatory transparency, infrastructure built on blockchain technology that has inherent regulatory capabilities, and real-time access to the best data (e.g., built-in settlement and compliance capabilities, real-time monitoring of end-to-end transaction flows).

So why shouldn’t regulators seize this opportunity?

The problem with regulators

Epiphyte was invited to give a presentation to 25 European Central Banks to discuss the impact of financial technology on payment and settlement systems and digital innovation regulation. The discussion focused on the impact of the Bitcoin blockchain network.

Some of the topics raised include:

1. The pros and cons of closed loop vs. permissioned open distributed ledgers

2. Cross-border capital flows and how to avoid systemic risks if Bitcoin adoption increases significantly

3. Global blockchain standards and ensuring all proprietary systems are interoperable

4. Scalability and liquidity of the Bitcoin blockchain network

5. Use distributed ledgers to save resources, maintain resource density of multiple databases, and use distributed ledgers to improve sharing mechanisms

6. Large banks lack incentive to promote instant settlement solutions

7. Capital efficiency and reduction of (capital, market and peer) risk

Instant Settlement Solutions

Discussions also focused on settlement cycles and blockchain-based assets. It is speculated that settlement cycles could be significantly shortened if blockchain networks were used. This would not require regulatory changes, only changes in settlement assets, such as bonds issued on a distributed ledger, would trigger regulatory changes.

Another major point raised was that of prematurely exposing the underlying systems of the system to a distributed ledger.

Because central banks must rely on mature and resilient systems, it may not be premature to introduce a currency based on a distributed ledger.

Digital Recognition

Perhaps the most interesting discussion point was around identity and addressing digital IDs as part of an evolving financial services ecosystem.

In the current system, the ID framework is still largely paper-based, and onboarding new employees in the financial services system is still rife with inefficiencies, friction, and high costs.

The transition to digital IDs is still coming late. In Estonia, for example, the electronic national ID card can be used not only as a digital signature and as proof of a wide range of electronic access, but also provides users with a legal ID photo.

The ECB meeting discussed an open source standard being developed by Epiphyte whereby IDs could be embedded into a multi-signature key mechanism with different schemes and different access layers created for different views of the data.

What about Regulatory Technology (RegTech)?

Regulators should focus more on how to leverage the benefits of distributed ledgers to help companies better understand and manage their risks.

After all, RegTech is a new financial technology.