Tag: Blockchain

Distributed Ledger Technologies in Payment, Clearing, and Settlement

Fed Governor Lael Brainard spoke about emerging distributed ledger technologies at the Institute of International Finance Blockchain Roundtable, Washington. She said today, many industry participants are experimenting with distributed ledger technology. She warned it will be important to address the challenge of how they would scale and achieve diffusion and how the different distributed ledger technologies interoperate with each other, and legacy systems.

She said new and highly fragmented “shared systems” may create unintended consequences even as they aim to address problems created by today’s siloed operations. Since distributed ledgers often involve shared databases, it will also be important to effectively manage access rights as information flows back and forth through shared systems.

It may require a trade-off between the privacy of trading partners and competitors on the one hand, and the ability to leverage shared transactions records for faster and cheaper settlement on the other hand.

Sound risk-management, resiliency, and recovery procedures will be necessary to address operational risks.

Financial products, services, and transactions lend themselves to successive waves of technological disruption because they can readily be represented as streams of numerical information ripe for digitization. However, as technological tools used by the industry change over time, it is important to keep sight of their impact on the public, whether it be on families seeking to own their own home, seniors seeking financial security, young adults seeking to invest in education and training, or small businesses attempting to smooth through volatile revenues and expenses.

Current developments in the digitization of finance are important and deserving of serious and sustained engagement on the part of policymakers and regulators. The Federal Reserve Board has established a multi-disciplinary working group that is engaged in a 360-degree analysis of fintech innovation. We are bringing together the best thinking across the Federal Reserve System, spanning key areas of responsibility, from supervision to community development, from financial stability to payments. As policymakers, we want to facilitate innovation where it has the potential to yield public benefit, while ensuring that risks are thoroughly understood and managed. That orientation may have different implications in the arena of consumer and small business finance, for instance, as compared with payment, clearing, and settlement in the wholesale financial markets.

Today, I will focus on newly emerging distributed ledger technologies and related protocols, which were inspired originally by Bitcoin, and their potentially important applications to payment, clearing, and settlement in the wholesale markets.

Successive waves of technological advance have swept through payment, clearing, and settlement over the past two centuries. In the 19th century, railroads and the telegraph helped improve speed and logistics. In the second half of the 20th century, computers were introduced to deal with the clearing of overwhelming volumes of paper checks and stock certificates stimulated by post-war growth. Starting at about the same time and continuing through today, new electronic networks have been established to allow high-speed computerized financial communication. As automation has evolved, payment, clearing, and settlement systems have been developed for conducting and processing transactions within and between firms. However, many of these systems have historically operated in silos, which can be hard to streamline or replace. In some areas, business processes may still rely heavily on manual or semi-automated procedures.

Over time, banks and other firms have organized various types of clearinghouses to coordinate clearing and settlement activities in order to reduce costs and risks. The adoption of multilateral clearing in the United States was a key organizational innovation that began with the founding of the New York Clearing House in the 1850s. This led to notable efficiencies and risk reduction in the clearing of checks. Multilateral clearing was also used early on to improve clearing in the securities and derivatives markets. By the 1970s, the United States turned to technologies based on the centralized custody and clearing of book-entry securities in order to respond to the paperwork crisis in the equities markets. Following the recent financial crisis, the United States–along with many other countries–expanded the scope of central clearing to help address problems in the bilateral clearing of derivatives contracts.

Today, the possible development and application of distributed ledger technology has raised questions about potentially far reaching changes to multilateral clearinghouses and the roles of financial institutions as intermediaries in trading, clearing, and settlement for their clients. In the extreme, distributed ledger technologies are seen as enabling a much larger universe of financial actors to transact directly with other financial actors and to exchange assets versus funds (that is, to “clear” and settle the underlying transactions) virtually instantaneously without the help of intermediaries both within and across borders. This dramatic reduction in frictions would be facilitated by distributed ledgers shared across various networks of financial actors that would keep a complete and accurate record of all transactions, and meet appropriate goals for transparency, privacy, and security.

At this stage, such a sea-change may sound like a remote possibility, particularly for the high volume and highly regulated clearing and settlement functions of the wholesale financial markets. But profound disruptions are not unprecedented in this arena. In the early 1960s, the use of computerized book-entry securities systems to streamline custody, clearing, and settlement in the securities markets may have seemed like a technologist’s pipe dream. But these technologies became an important part of industry-wide changes in the 1970s. Today we rely on these types of systems for the daily operation of the markets.

Given this backdrop, it is important to give promising technologies the serious consideration they merit, seek to understand their opportunities and risks, and actively engage in dialogue about their potential uses and evolution. At the Federal Reserve, we approach these issues from the perspective of policymakers safeguarding the public interest in safe and sound core banking institutions, financial stability, particularly as it pertains to the wholesale financial markets, and the security and efficiency of the payment system.

Distributed ledger technology was introduced for the transfer and record-keeping of Bitcoin and other digital currencies. The essential advantage of the technology is that it provides a credible way to transfer an asset without the need for trust in intermediaries or counterparties, much like a physical cash transaction. To do that, a transfer process must be able to credibly confirm that a sender of an asset is the owner and has enough of the asset to make the transfer to the receiver. This requires a secure system or protocol to transfer assets (the rails), protection against assets being transferred twice (the so-called double spend problem), and an immutable record of asset ownership that can be automatically and securely updated (the ledger). The tokenization of digital assets can facilitate the transfer process.

The genuinely innovative aspect of the technology combines a number of different core elements that support the transfer process and recordkeeping:

  • Peer-to-peer networking and distributed data storage provide multiple copies of a single ledger across participants in the system so that all participants have a shared history of all transactions in the system.
  • Cryptography, in the form of hashes and digital signatures, provides a secure way to initiate a transaction that helps verify ownership and the availability of the asset for transfer.
  • Consensus algorithms provide a process for transactions to be confirmed and added to the single ledger.

While Bitcoin was originally associated with the concept of a universally available, publicly shared digital ledger technology without any central authority, many of the use cases that are currently under development and discussion rely on “permissioned” ledgers in which only permitted, known participants can validate transactions. These in turn can be either public or private in terms of access to the ledger.

The resulting Internet of Value holds out the promise of addressing important frictions and reducing intermediation steps in the clearing and settlement process. For example, in cross-border payments, faster processing and reduced costs relative to current correspondent banking are cited as specific potential benefits. Reducing intermediation steps in cross-border payments may help reduce costs and counterparty risks and may additionally improve financial transparency.

In securities clearing and settlement, the potential shift to one master record shared among participants has some appeal. Having one immutable record may have the potential to reduce or even eliminate the need for reconciliation by avoiding duplicative records that have different details related to a transaction that is being cleared and settled. This also can lead to greater transparency, reduced costs, and faster securities settlement. Likewise, digital ledgers may improve collateral management by improving the tracking of ownership and transactions.

For derivatives, there is interest in the potential for digital ledger protocols to enable self-execution and possibly self-enforcement of contractual clauses, in the context of “smart contracts.”

As we engage with industry and stakeholders to assess the potential applications of digital ledger and related technologies in the payment, clearing, and settlement arena, we will be guided by the principles of efficiency, safety and integrity, and financial stability.

I want to close by remembering a simple point that central bankers and markets have learned through hard lessons over many years. The daily operation of markets and their clearing and settlement functions are built on trust and confidence. Market participants trust that clearing and settlement functions and institutions will work properly every day. Confidence has built over time that when market participants trade, accurate and timely clearing and settlement will follow. Any disruption to this confidence comes at great cost to market integrity and financial stability. This is a matter of fundamental public interest. In safeguarding the public interest, the first line of inquiry and protection will always rest with those closest to the technology innovations and to the organizations that consider adopting the technology. But regulators also should seek to analyze the implications of technology developments through constructive and timely engagement. We should be attentive to the potential benefits of these new technologies, and prepared to make the necessary regulatory adjustments if their safety and integrity is proven and their potential benefits found to be in the public interest.

How blockchain could be used to make trusts more transparent

From The Conversation.

Amid the outcry over David Cameron’s tax affairs is the UK prime minister’s intervention in 2013 to block EU transparency rules regarding offshore trusts. It was decided that trusts should not be held to the same standards as companies when it came to making the end owners and beneficiaries publicly known.

But now the Panama Papers raise important questions as to whether trusts ought to be more open to public scrutiny. A major reason for this relates to fairness when it comes to paying taxes. Blockchain may provide a solution to this problem, enabling trusts to be more transparent, while ensuring the security of their holdings, too.

Trusts are often highly complex legal arrangements; but they tend to work on the same fundamental basis. First conceived many hundreds of years ago, trusts provide a unique method of property management. This uniqueness relates to how wealth is used, and relies on the separation of beneficial ownership from the responsibilities of property management that come with holding legal title.

Trusts come in both public and private forms. But their history points to an intimate desire for individuals and families to be able to preserve their wealth and, importantly, pass it on to the next generation.

One popular story of how trusts came into being involved the Crusaders of the 11th and 12th centuries who, before leaving to fight in the Middle East, arranged for their land to be tended and managed by a friend in trust (a trustee), on behalf of their family (as beneficiaries). This method of property management and transfer had not previously been recognised by Common Law, which viewed the friend as taking the land absolutely when given charge of it. But Equity, at the time a separate body of law in England and Wales, saw things differently.

David Cameron’s shares in an offshore fund were kept secret. Dan Kitwood / PA Wire

Based on fairness, Equity developed rules that protected the beneficial interest of the family, while at the same time applying strict fiduciary duties and obligations of trust and loyalty to the friend. This meant that the friend had to look after the property as they had been directed to by the Crusader.

Trusts now appear in the form of international commercial investment and trade vehicles; public and private pension funds; and charities, to name but three of the more economically significant. Yet those same foundations and consensual principles between the Crusader, the friend and the family fundamentally remain.

This means that trusts conform to traditional privacy models found elsewhere in banking and finance, insofar as they shield from public view the identities of the objects of the trust, as well as the nature of many of the trust’s investments and transactions. It is primarily in regard to where this “shield” is positioned that greater levels of transparency apply on the blockchain.

Smart contracts

As part of some recent research, I have been considering how blockchain technology (most famous for its role in the cryptocurrency Bitcoin) and other legal-like processes that blockchain facilitates, namely computer programs called “smart contracts”, might be mapped onto trusts law and trusteeship.

The key to the question of whether or not blockchain can make trusts more open to the public lies in its fundamental characteristics. Blockchain is essentially a peer-to-peer, distributed ledger system that is able to register information in an immutable way. This could take the form of a register of legal titles to property and beneficial interests, both of which are central to trusts.

In this sense, blockchain is a highly reliable witness regarding the information it deals with. Furthermore, as part of the process of adding or registering information on blockchain, that information is announced publicly, providing an entire, transparent history capable of public scrutiny. This does not mean that the blockchain is not private – cultural as well as commercial sensitivity around the privacy of financial information can still be maintained – but it is achieved in a different way.

Using two sets of encrypted keys, one public and one private, to validate transactions provides the possibility for secure, private spaces that nevertheless remain in public view. Unlike other methods that maintain privacy of investments and transactions by shielding the entire process from public view, including the identities of individual parties, the blockchain breaks the flow of information in another place: by keeping public keys anonymous.

So a trust could take the form of a “private space”. More specifically what is legally defined as a trust could be mapped onto the blockchain processes behind that “private space”. This would create, what I call a “smart trust” – a secure private space, yet one primed for public scrutiny.

The potential of the blockchain as described here is something of a “third-way” to existing privacy models. Because trusts come in many shapes and sizes, blockchain “smart trusts” would undeniably suit some types more than others – it is not a case of one size fits all. While trusts have a very long history, the blockchain has a very short one. It will take time to understand if and how the two might work together. But if greater levels of honesty and transparency are needed, the blockchain could provide an answer.

Author: Robert Herian, Lecturer in Law, The Open University

How blockchain technology is about to transform sharemarket trading

From The Conversation.

Recently the Australian Securities Exchange (ASX) bought a $15 million stake in Digital Asset Holdings, a developer of blockchain technology. One of the main reasons is to upgrade its share registry system by using blockchain or distributed ledger technology.

And it’s been reported that JP Morgan Chase is also partnering with Digital Asset Holdings to trial the technology.

What is blockchain/distributed ledger technology?

Put simply, blockchain technology is a method of recording and confirming transactions where instead of a centralised platform, participants each hold a complete record of transactions through peer to peer verification of transactions. This means there is no central recording system, rather each participant keeps a record of all transactions ever made. This is the same system which allows Bitcoin to operate with no central body.

How would blockchain technology be adopted at the ASX?

Instead of the ASX clearing house settling trades, trades will be settled by participants confirming transactions through the peer to peer network. The network (likely made up of brokers) will record the buyer and selling participants, the number of shares traded, price of shares, time of exchange and the exchange of funds. The ASX will still provide a centralised electronic exchange for participants to place orders, only the settlement or back office function will be sourced to the network.

The benefits?

Blockchain has great potential to cut inefficiencies in the share settlement function. As trades are settled by peer confirmation, there is no need for a clearing house, auditors to verify trades and custodians to ensure a fund has the shares they say they hold. Essentially this is cutting out the middleman in the back office which means less costs in record keeping and in turn less costs to trading on the ASX. Given the high costs in getting a third party to audit, record keep and/or verify trades these costs are substantial.

The peer confirmation of trades also means settlement can be almost instantaneous. Compare this to the current settlement period of three working days (‘T+3’) as the ASX needs to make sure the participants have the money and shares on hand to exchange. This would make shares a far more liquid investment – almost as good as having cash on hand. Higher liquidity means more investment into ASX shares.

As all participants have the full record of transactions and therefore holdings of investors there is complete transparency in the equity market. This makes it almost impossible to falsify transactions or to alter prior transactions. If a false trade occurs, participants will find inconsistencies in their full ledger and reject the trade. For example an investor would be unable to sell stock that they did not own as all participants would know exactly how much stock the investor owns now.

The challenges?

First, implementing a clearing system using blockchain will introduce a new type of fee. In the Bitcoin blockchain, miners process Bitcoin transactions by solving optimisation problems and get rewarded by newly created Bitcoins and settlement fees offered by Bitcoin users who wish to have their transactions processed.

Miners prioritise the order of transactions to be cleared based on the fees offered and the difficulty of the problems to record the transaction in a block. This is what allows a blockchain to have no centralised clearing house.

If the ASX blockchain requires investors to include transaction fees in order for their transactions to be cleared, then the ASX is transferring the cost of maintaining the back office to the investors. If this is to happen, investors will have to compete against each other to have their transactions cleared faster than those of others. Alternatively, if the new system doesn’t allow such fees and relies on brokers or other entities to clear the transactions, then the ASX is again transferring the cost of maintaining back office to those entities.

The second concern is increased transparency. Under the proposed trading system, most of positions of the market participants could be exposed to the public as the trading ID can be identified. This could disadvantage many investors such as super, managed and hedge funds. For example, a super fund typically sells a large position on a gradual basis for a prolonged time period.

In this process, it is critical not to be noticed by other traders who may take advantage of such large-scale sales. With complete transparency such as in blockchain, such a sell-off could not be applied effectively. Potentially this may make investors leave the ASX and seek more opaque venues to trade such as dark pools.

Will it work?

Clearly a direct adoption of blockchain from Bitcoin technology would not be viable for the ASX. If the ASX is able to adopt blockchain technology and address privacy, security and trade transparency concerns then this would yield great cost savings to investors.

Authors: Adrian Les, Senior Lecturer in Finance, University of Technology Sydney; KIHoon Hon,  Assistant Professor, University of Technology Sydney

MasterCard Invests in Bitcoin Venture as Cryptocurrency Debate Escalates

From Brandchannel.

As the debate over the long-term viability of bitcoin continues to swirl, major financial brands are investigating in the technology including NASDAQ, Barclays and MasterCard—the latter investing last year in bitcoin company Digital Currency Group (DCG).

Blockchain, the technology behind bitcoin, uses sophisticated cryptography and distributed ledgers to regulate, record and enable bit coin transactions. According to Business Insider, blockchain “has the potential to strip out huge amounts of administrative costs, and companies around the globe are signing up to get a piece of the action through consortiums and direct investment.”

Garry Lyons, MasterCard’s chief innovation officer, told Business Insider, “Like the rest of the world, we’re interested in seeing where blockchain technology goes, and that’s why we invested in DCG. It’s connected to 15 different others and they have their fingers in the right pies, so we’ve got the right engagement right now to see people experimenting with the underlying tech.”

It’s not just the industry that’s excited about blockchain. “It’s the world, everyone,” continued Lyons. “Even at Davos, every single tech panel I have gone to mentions blockchain, and some people call it the second coming. But while we think it’s very interesting, we don’t want to, and no one wants to, be blindsided by rushing into it.”

The rush is causing predictions of bitcoin’s imminent demise as well as its meteoric potential—with blockchain consortium R3 announcing that 11 major investment banks had made trades on an open-source alternative to bitcoin, according to International Business Times.

Lyons commented, “R3 is an interesting way of doing that because it brings several interested parties together to experiment with underlying tech. It’s a good opportunity for the banks, and there’s more chance of blockchain technology succeeding as a group than disparate parties.”

Meanwhile, bitcoin took a dive last week, losing 13 percent of its value to settle at below $365 for the first time since early December 2015 as news that Mike Hearn, a core developer of the software, was quitting and pronouncing bitcoin a failure.

Hearn’s frustration over scaling the cryptocurrency and rejection of his proposed Bitcoin XT, a version of the bitcoin core but with bigger blocks for more transactions, led to his departure. “From the start, I’ve always said the same thing: Bitcoin is an experiment and like all experiments, it can fail,” said Hearn in Venture Beat. “The now inescapable conclusion that it has failed still saddens me greatly.”

“To paraphrase Mark Twain, it would seem that reports of Bitcoin’s death are greatly exaggerated,” counters Nasdaq.com. “The network faces a huge challenge in the near future as a solution to continuing increases in popularity must be found, but that is in many ways a wonderful problem to have.”

TechCrunch noted that bitcoin is unregulated and provides anonymity, so it rapidly became a haven for drug dealers and anarchists. “Its price fluctuated wildly, allowing for crazy speculation. And, with the majority of Bitcoin being owned by the small group that started promoting it, it has been compared to a Ponzi scheme.”

In addition, the bitcoin network can process only a handful of transactions per second, reports TechCrunch, resulting in unpredictable transaction-resolution times and fees that exceed credit-card fees at peak times.

“In the beginning, Bitcoin was a noble experiment,” concludes TechCrunch. “Now, it is a distraction. It’s time to build more rational, transparent, robust, accountable systems of governance to pave the way to a more prosperous future for everyone.”

Enter block chain—perhaps the second coming, perhaps not.

What Is The Potential of Blockchain?

Yesterday we highlighted the IMF report on virtual currencies. Underlying this are blockchain technologies. Strategy&’s s+b have published a long article “A Strategist’s Guide to Blockchain” which is worth reading in full. Here is a brief extract:

The name of the technology that could make all this happen is blockchain. Originally the formal name of the tracking database underlying the digital currency bitcoin, the term is now used broadly to refer to any distributed electronic ledger that uses software algorithms to record transactions with reliability and anonymity. This technology is also sometimes referred to as distributed ledgers (its more generic name), cryptocurrencies (the electronic currencies that first engendered it), bitcoin (the most prominent of those cryptocurrencies), and decentralized verification (the key differentiating attribute of this type of system).

At its heart, blockchain is a self-sustaining, peer-to-peer database technology for managing and recording transactions with no central bank or clearinghouse involvement. Because blockchain verification is handled through algorithms and consensus among multiple computers, the system is presumed immune to tampering, fraud, or political control. It is designed to protect against domination of the network by any single computer or group of computers. Participants are relatively anonymous, identified only by pseudonyms, and every transaction can be relied upon. Moreover, because every core transaction is processed just once, in one shared electronic ledger, blockchain reduces the redundancy and delays that exist in today’s banking system.

Companies expressing interest in blockchain include HP, Microsoft, IBM, and Intel. In the financial-services sector, some large firms are forging partnerships with technology-focused startups to explore possibilities. For example, R3, a financial technology firm, announced in October 2015 that 25 banks had joined its consortium, which is attempting to develop a common crypto-technology-based platform. Participants include such influential banks as Citi, Bank of America, HSBC, Deutsche Bank, Morgan Stanley, UniCredit, Société Générale, Mitsubishi UFG Financial Group, National Australia Bank, and the Royal Bank of Canada. Another early experimenter is Nasdaq, whose CEO, Robert Greifeld, introduced Nasdaq Linq, a blockchain-based digital ledger for transferring shares of privately held companies, also in October 2015.

If experiments like these pan out, blockchain technology could become a game-changing force in any venue where trading occurs, where trust is at a premium, and where people need protection from identity theft — including the public sector (managing public records and elections), healthcare (keeping records anonymous but easily available), retail (handling large-ticket purchases such as auto leasing and real estate), and, of course, all forms of financial services. Indeed, some farsighted banks are already exploring how blockchain might transform their approaches to trading and settling, back-office operations, and investment and capital assets management. They recognize that the technology could become a differentiating factor in their own capabilities, enabling them to process transactions with more efficiency, security, privacy, reliability, and speed. It is possible that blockchain could transform transactions to the same degree that the global positioning system (GPS) transformed transportation, by making data accessible through a common electronic platform.

Blockchain could become a force anywhere trading occurs, trust is at a premium, and people need protection from identity theft.

But although the potential is immense, so is the uncertainty. Distributed ledger technologies are so new, so complex, and so prone to rapid change that it’s difficult to predict what form they will ultimately take — or even to be sure they will work. The Gartner Group declared in an August 2015 report that crypto-currency was traveling a “hype cycle”: it had passed the Peak of Inflated Expectations and was headed for the Trough of Disillusionment. Another research firm, Forrester, titled its 2015 blockchain report “Don’t Believe in Miracles,” advising enterprises to wait five to 10 years before introducing blockchain, in part because of legal restrictions.

On the other hand, some authorities advocate energetic R&D. “The distributed payment technology embodied in bitcoin has real potential,” said Andrew Haldane, chief economist of the Bank of England, in September 2015. “On the face of it, it solves a deep problem in monetary economics: how to establish trust — the essence of money — in a distributed network.”

If you are a senior executive in a financial-services firm, you may already be experimenting with distributed ledger technologies, if only to see how they fit with your strategy. You have lots of company. By 2014, more than a dozen major companies were actively exploring blockchain-related ventures and their potential effect on core practices (see Exhibit 2). For example, blockchain might streamline transaction processing by establishing a single source of truth, available to all, updated in near-real time. This could increase the speed of exchange, reduce the number of intermediaries (and the costs associated with them), improve security, digitize assets, give wider access to people who don’t have bank accounts, enable better bookkeeping, and improve regulatory compliance.

sb82-Blockchain-ex2b

The Future of Capital Markets in a Digital Economy – Blockchain Disruption

In a speech by Greg Medcraft, Chairman, Australian Securities and Investments Commission he discusses digital disruption in capital markets. He rightly identifies blockchain technology as one of the most significant disruptive elements of all.

Regulators globally are facing new challenges brought by structural change and digital disruption. There are both opportunities and challenges posed – it is about harnessing the opportunities while mitigating the risks.
I believe that the great drawcard of digital disruption is the opportunity it brings. The markets are seeing this with global investment in fintech ventures tripling to US$12.2 billion in 2014, from US$4 billion in 2013.
It is nothing new when you think about innovations like credit cards and ATMs, which were developed by banks to facilitate customer access. But now, new developments are going beyond the banking system directly to the customer.Businesses have seen the potential for new ways of directly creating and sharing value with technologically savvy investors and consumers. Examples include:

  1. peer-to-peer lending and market-place lending
  2. robo-financial or digital advice
  3. crowdfunding
  4. payments infrastructures (e.g. digital currencies, Apple Pay).
  5. In the future, we will likely see further developments in insurance priced to reflect deeper understanding of individual risk characteristics, in areas such as home, life and car insurance (such as the use of telematics by QBE’s Insurance Box).
  6. Importantly, there is much work going on globally exploring the potential of blockchain technology.

All these innovations have the potential to change the way that investors and financial consumers interact with financial products and payments. But many of these activities may not fit neatly within existing regulatory frameworks or policy. The challenge for us will be to ensure that we continue to deliver on the priorities I mentioned earlier – investor and consumer trust and confidence and fair, orderly, transparent and efficient markets – in the face of these developments.

Potential that these developments have for capital markets – To help understand what this challenge means to us, I’d like to talk in more detail about blockchain technology. This technology – if it takes off as I think it will – has the potential to fundamentally change our markets and our financial system.

What is blockchain technology? Chances are you have heard about bitcoin – the digital currency. ‘Blockchain’ is the algorithm behind bitcoin that allows it to be traded without a centralised ledger. In basic terms, it is an electronic ledger of digital events – one that’s ‘distributed’ or shared between many different parties. And it maintains a continuously growing list of data records. It has three key features:

First, it is a vehicle for transferring value and holding records – each transaction or record is evidenced by a unique data set or ‘block’ that attaches to the continuously growing blockchain.

Second, it does not involve a central authority or third-party intermediary overseeing it or deciding what goes into it. The computers that store the blockchain are decentralised and are not controlled or owned by any single entity.

Third, every block in the ledger is connected to the prior one in a digital chain algorithm. So the record of every transaction lives on the computers of anyone who has interacted with it, and is updated with each entry. The continual replication and decentralised nature makes it secure.

How can blockchain transform capital markets? – I see four reasons.

First, efficiency and speed. At present, when investors buy and sell debt and equity securities or transact derivatives, they generally rely on settlement and registration systems that take sometimes several days to settle trades. It can take even longer, sometimes, where the trade involves cross-border parties. Blockchain holds potential to automate this whole process.

Second, disintermediation. Blockchain automates trust; it eliminates the need for ‘trusted’ third-party intermediaries. In the traditional market, buyers and sellers can’t automatically trust each other, so they use intermediaries to help give them the comfort they need. With blockchain, the decentralised ledger offers this trust. Investors can deal with each other and with issuers in private markets directly.

Third, reduced transaction costs. By eliminating the need to use settlement and registration systems and other intermediaries, there is significant potential to reduce transaction costs for investors and issuers. A June report backed by Santander InnoVentures, the Spanish bank’s fintech investment fund, estimated that blockchain could save lenders up to $20 billion annually in settlement, regulatory, and crossborder payment costs.

Fourth, improved market access. Because of the global nature of blockchain, global markets have the potential to become even more easily accessible to investors and issuers; therefore making it easier for investors and for issuers to invest in and issue debt and equity securities.

Naturally, harnessing this potential will depend on the integrity, capacity and stability of blockchain technology and processes. It will also depend on industry’s willingness to invest in, and make use of, new ways of settling and registering transactions. The potential is, nonetheless, enormous. Industry is seeing that potential and is looking to see how it and the markets might benefit.

Blockchain developments – Let me touch on four areas where the benefits of blockchain are being explored:

The first is in share, loan and derivative trades. A series of start-ups are looking to use blockchain to execute and settle securities and derivative trades.

The second is in private equity transactions. The US stock exchange, NASDAQ, is experimenting with using blockchain technology as a way of recording private equity transactions. In doing so, it hopes to provide ‘extensive integrity, audit ability, governance and transfer of ownership capabilities’.

The third is in government bond trades. A US firm is developing a way to use blockchain to record and settle short-term government bond trades on a distributed ledger.

The fourth is in money transfer. In Mexico City a firm has developed an app that lets migrants send money via the blockchain to Mexico and withdraw cash from ATMs.

How regulators are responding – I have talked about the opportunities blockchain offers. But, as I have said, these opportunities can also threaten our strategic priorities of investor trust and confidence and fair, orderly, transparent and efficient markets.  Right now, we don’t know exactly how blockchain or other disruptive technologies will evolve. But, for now, it is fair to say that they will. Blockchain potentially has profound implications for our markets and for how we regulate. As regulators and policymakers, we need to ensure what we do is about harnessing the opportunities and the broader economic benefits – not standing in the way of innovation and development. At the same time, we need to mitigate the risks these developments pose to our objectives. We also need to ensure those who benefit from the technology trust it. And, at the end of the day, we are working to ensure that investors and issuers can continue to have trust and confidence in the market.

How ASIC is responding to digital disruption? – ASIC’s role in ensuring that we harness the opportunities while mitigating the risks covers five key areas:

First, education. We are supporting investors and financial consumers in understanding the opportunities and the risks of participating in the digital economy. For example, our MoneySmart website, which last year received over 5 million visits.

Second, guidance. We are engaging with and providing guidance to industry in these areas. I want to mention two particular activities:
– The first is our cyber resilience work. We have undertaken significant work in the area of cyber resilience. Cyber resilience is the ability to prepare for,
respond to and recover from a cyber attack. In March this year, we published guidance for businesses to help in their efforts to improve cyber resilience and manage their cyber risks.
– The second is our Innovation Hub – we launched this last year. Much innovation in financial services comes from start-ups and from outside the regulated sector. The Innovation Hub is designed to make it quicker and easier for innovative start-ups and fintech businesses to navigate the regulatory system we administer. The Innovation Hub – which also includes our new industry-led Digital Finance Advisory Committee – also provides us with important information about the developments that are on the horizon, and how they might fit into the current regulatory framework.

Third, surveillance. We monitor the market and understand how investors use technology and financial products and the risks that arise. We undertake continual scans of the landscape, including developments overseas, to better understand new developments, the pace of change and emerging risks that may be posed by structural change driven by digital disruption. In the case of blockchain, there is a need for regulators to focus on and understand a number of issues, including:
– how blockchain security might be compromised
– who should be accountable for the services that make the blockchain technology work
– how transactions using blockchain can be reported to and used by the relevant regulator.

Fourth, enforcement. Of course, where we detect misconduct by our gatekeepers, we will take action. Our challenge here will be to understand how regulatory action can be taken where a transaction entered into here or overseas is recorded in the blockchain.

Fifth, policy advice. Ensuring the right regulation is in place to protect investors and keep them confident and informed, while also not interfering with innovation.

We also need to ensure that rules are globally consistent and regulators can rely on each other in supervision and enforcement with such developments. We will continue to review the current regulatory framework, analyse how new developments, such as blockchain, may fit into the framework and identify where changes may be required.

How IOSCO is responding – IOSCO too has a key role to play in this area, especially in ensuring that there is a global strategy in place and that cooperation between regulators is in place – in order to meet the challenge of addressing issues arising from cross-border transactions. IOSCO’s work plan this year in this area includes the following four priorities:

The first is working to identify and understand risks flowing from digital disruption to business models. In fact, the IOSCO Board will be holding a stakeholder
roundtable next month in Toronto to discuss financial technology developments and regulatory responses.

The second is in the international policy space. This is about designing regulatory toolkits and responses that are flexible, creative, and provide incentives for financial technology innovation that drive growth without undermining investor and financial consumer trust and confidence in our markets.An example of this is work we are considering on crowdfunding.

The third is in the area of cyber resilience. We are working with the Committee for Payments and Market Infrastructures to develop guidance that will help strengthen the cyber resilience of financial market intermediaries.
We expect this guidance to be finalised next year.

The fourth is on strengthening cooperation. We are working on enhancements to IOSCO’s Multilateral Memorandum of Understanding – or MMOU – to deal with the new technological environment in which we are operating.
The MMOU is a cooperation arrangement that enables 105 regulators to share information to combat cross-border fraud and misconduct. These enhancements will make it easier for us to take action in relation to cross-border transactions.