Blockchain technology (“Blockchain”), also known as Distributed Ledger Technology, stands poised to transform the future of the financial industry. Generally speaking, Blockchain enables the creation of a continuously growing ledger of transactions that is resistant to alteration and ensures the integrity of new transactions through a system of checks-and-balances built into the system’s code. The combination of its speed, versatility, and built-in security features lend the technology well to applications in the financial industry. In a timely effort, the Financial Industry Regulatory Authority (“FINRA”) recently gathered top U.S. financial regulators and industry stakeholders to participate in its 2017 Blockchain Symposium. In a series of engaging discussions, panelists hashed out the potential benefits and pitfalls of the dynamic technology.
While Blockchain comes in many forms, Kathy Wang of the Federal Reserve Board explained that the technology typically involves some combination of peer-to-peer networking, distributed data storage, and cryptography. These features enable Blockchain participants to securely share identical sets of information, such as a running ledger of financial exchanges, that cannot be retroactively altered. Copies of this historical ledger are updated to reflect a newly-completed transaction and distributed to participants simultaneously. Todd McDonald of the financial technology firm R3 explained that, unlike the traditional practice of counterparties maintaining their separate transaction records that differ in both and form and content, Blockchain results in one “gold copy” of data that is synchronized and shared by all participants. The industry is devising ways to reveal ledger information on a need-to-know basis so that all data is not shared with all participants at all times.
All parties who hold a copy of the ledger share oversight responsibility for it. Because the true ledger resides with multiple parties rather than just one and modifications must be validated as legitimate by all parties, Blockchain networks are said to be decentralized. Experts argue that this decentralization is critical to reducing exposure to harm resulting from cyberattacks, which traditionally target the sole repository of critical data. The home burglar that might normally escape detection with ease would have a tougher time doing so if the entire neighborhood had to approve of his thievery first.
The “gold copy” concept proved appealing to regulators and industry panelists alike. Regulators are enamored with the prospect of real-time access to high-quality, undisputed, standardized databases of information that are resistant to alteration. Regulators also touted the ability of Blockchain to ease administrative burdens and mishaps through the instantaneous transmission of a transaction’s critical information to all participants. Of course, inputs into the system would have to be confirmed and validated in such a manner that provides users with confidence that the Blockchain record is trustworthy. This may prove easier said than done.
Industry stakeholders also look forward to the expected increased automation and accuracy in their bookkeeping, which translates to cost savings and a reduction in disputed transactions. Efficiencies afforded by the technology will also reduce the time between transactional payment and settlement. For example, Mr. McDonald explained how Blockchain users could utilize a “self-sovereign digital identity” whereby aspects of one’s circumstances or characteristics are pre-verified. This “digital identity locker” could then be carried around and utilized in multiple transactions. One could see how this feature would reduce reliance on the redundant paperwork currently required for each new transaction. Industry participants are also using Blockchain coding to enable “smart contracts” that self-execute when certain conditions are met. Blockchain has demonstrated its utility in many other areas, such as the facilitation of private equity raises, proxy voting, value exchange, and countless other product innovations.
Two of the biggest challenges to the implementation of Blockchain networks identified by the panelists are governance and trust. Part of the theoretical appeal of Blockchain is that, if utilized properly, it can essentially self-govern by utilizing coding that ensures the integrity of a transaction, which is then cast into an incorruptible record. This systemic faith is reflected by the fact that some of the most well-known Blockchain systems in operation are open network or “permissionless.” For some panelists, allowing financial systems to operate on self-governing permissionless networks proved a bridge-too-far at this point in time. Accordingly, interested parties are exploring the feasibility of permissioned Blockchain networks with designated overseers. Even if the governance issue is resolved, Blockchain will have to establish a track record of safety and success before it will be afforded the kind of trust the current battle-tested U.S. financial system enjoys.
Jeffrey Bandman, formerly of the Commodity Futures Trading Commission (“CFTC”), explained that while the CFTC took more of a hands-off approach in 2015 and 2016 so as to foster development of the nascent technology, it was now moving into a phase of proactive industry engagement. This view seemed to be shared by the other industry watchdogs present at the Symposium. Multiple regulators discussed their “Office Hour” events in various cities at which regulators have the opportunity to interact with attendees to discuss Blockchain’s development and related enforcement issues.
One of Blockchain’s great ironies is that while individual regulators and financial institutions have demonstrated an eagerness to establish internal R&D labs to test the technology and engage in discussion, its true potential will only be realized when multiple parties utilize the technology simultaneously. Without shared usage, the benefits afforded by the synchronized “gold copy” of data cease to exist. Panelists suggested that such collaboration will become more prevalent when the technology overcomes the aforementioned governance and trust issues. Consequently, the development of this goodwill, and thus Blockchain’s future, seems to rest heavily on the shoulders of the technology’s courageous first-movers.