2017: The Year Regulators Engage with Blockchain

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18 December 2016

New York-based Chuck Thompson is president and founder of Blockchain Consulting LLC and managing director of NextSeed, as well as a veteran of Wall Street and BigLaw. He has extensive experience in FinTech, RegTech, InsurTech and distributed ledger technology, and is a member of the Bars in Illinois and New York, and the US Supreme Court.

In this CoinDesk 2016 in Review feature, Thompson argues that the coming year will see distributed ledger tech arrive more broadly on the regulatory radar than it has before.

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In the grand scheme of things, distributed ledger or blockchain technology has not been around very long – less than a decade – and for most of that period, it has flown beneath the radar of most people, including the various regulators around the world.

That clearly changed in 2016.

In the US, the Securities and Exchange Commission (SEC) hosted a public forum to discuss, among other things, blockchain technology; J. Christopher Giancarlo, commissioner of the Commodity Futures Trading Commission (CFTC), gave numerous speeches focusing on blockchain technology; and even the Department of Health and Human Services sought white papers exploring how blockchain technology could be leveraged for healthcare purposes.

In Europe, the Bank of England launched a FinTech accelerator to, among other things, explore how blockchain could be utilized in central banking, and the Financial Stability Board (FSB) disclosed that it was working on issues relating to blockchain.

In addition, in May, the UK launched a “regulatory sandbox” whereby a FinTech company could roll out a new business, with regulatory oversight but with relaxed restrictions, to a limited number of customers on a test basis.

Other regulators, including the Hong Kong Monetary Authority, have followed that lead and developed sandboxes of their own.

There was even action among elected lawmakers and in private-public sector partnerships. A bill was proposed in the US House of Representatives that would require certain regulatory agencies to provide a similar sandbox. But, to date, no official measure has been passed.

Further, Estonia has developed an e-residency program based on blockchain technology. Georgia, Ghana and Sweden began work on projects to implement blockchain land title registries, and Singapore developed a system to eliminate invoice fraud through the use of blockchain.

Nonetheless, so far, regulators have taken a decidedly laissez-faire approach to the space. For a number of interrelated reasons, that is likely to change in 2017.

What to watch

Some regulators have already intimated that they will be more active in respect of distributed ledger technology.

In the US, the Federal Reserve recently released a research paper focusing on distributed ledger technology in which it stated, among other things, that analysis needs to be done to determine whether new laws and regulations are required to accommodate the technology.

In addition, in early December, the US Treasury Department’s Office of the Comptroller of the Currency announced that it would offer national charters for FinTech firms, opening up its proposal to public comment.

Elsewhere, South Korea’s Financial Services Commission and Switzerland’s Federal Department of Finance (FDF) have explicitly stated that they will introduce new regulation in 2017.

To be clear, regulation is not necessarily a bad thing for an industry – operating within so-called regulatory “safe harbors”, or within a licensing framework, provides companies with a certain level of comfort.

And some regulations are enabling. The FDF has made it clear that it will be attempting to reduce the barriers to entry for FinTech startups and to provide clarity as to the treatment of digital assets.

These will clearly be positive developments, at least for the Swiss.

Beyond currency

We are nearing the point at which the real-world application of blockchain is not limited to digital currencies.

As the technology moves from proof-of-concept to production of practical applications, blockchain will begin to impact more industries and affect more people. This means that more businesses – and more people – will have something (whether it be money, privacy, data or something other) to lose if and when things go awry.

Regulators do not like things to go wrong. In particular, they do not like things to go wrong in developing areas that, while unregulated at the time, are viewed by them as within the purview of their regulatory mandate.

Many regulators have the express purpose of providing transparency into the markets that they oversee. So, when things go wrong in an unregulated area that a regulator views as being opaque (such as digital currency markets), that regulator is likely to become engaged.

If 2017 is the year where real-world distributed ledger technology applications become prevalent, we can expect the regulators to begin promulgating applicable rules and regulations.

On a related note, people across the globe and in varying industries are becoming more aware of the technology (even if not its underpinnings or the enormity of its promise).

This is not to suggest that blockchain technology will sink beneath its own weight, but rather that mass awareness is likely to bring with it more concerns about the security and privacy of applications running on a blockchain.

Regulators are unlikely to sit idly if such concerns are borne out in any real-world scenario.

Trump factor

Another potential rationale for more regulatory engagement in 2017 is unique to the US, where the election of Donald Trump as the next president means that there will be some turnover in the leadership of various regulatory agencies.

For example, Mary Jo White, the chairwoman of the Securities and Exchange Commission (SEC), has announced that she will step down in January of 2017. Timothy Massad, the chairman of the CFTC, is also expected to vacate his position around the same time.

The top positions at other agencies, such as the Federal Deposit Insurance Corporation, the Federal Reserve and the Office of the Comptroller of the Currency, are also expected to turn over in 2017.

In light of Trump’s campaign platform and rhetoric, it seems likely that the new regime of regulators will be more friendly to “Wall Street” – and traditional financial institutions – than is the current regime, and it is at least feasible that this will result in a less “do no harm” regulatory model in the blockchain space.

Similarly, it is possible that the new chiefs will want to make their mark in a visible way – the blockchain space is for the most part a clean slate on which a regulator may write his or her regulatory raison d’être.

Market influences

Finally, if the oft-recited decline of blockchain into what Gartner refers to as “trough of disillusionment” materializes in 2017, it is likely to be driven (or at least accompanied) by the failure by many startups in the space to deliver on the lofty promises they made in earlier years.

The failure of those startups may exacerbate the impact of certain points mentioned earlier in this article. For example, a regulator that is more friendly to the traditional financial institutions could seize on such failures as a rationale to make it more difficult for distributed ledger technology to be utilized in the banking industry.

In conclusion, for a variety of reasons – from the election of Donald Trump to the establishment of in-production applications of blockchain – expect the regulators to be engaged in 2017.

To clarify once more, engagement by the regulators is not necessarily a bad thing, and may not result in a bunch of restrictive regulations.

Regulators have been engaging with the industry to develop a better understanding of distributed ledger technology, its promise and limitations, and the ways in which it fits – or does not fit – within existing legal and regulatory frameworks.

In many circumstances – such as with the licensing proposal issued by the Office of the Comptroller of the Currency – new regulation will benefit businesses by providing some level of regulatory certainty, eliminating overlapping clarity and reducing the cost and complexity of doing business.

Much regulatory engagement in 2017 is likely be in the form of “guiding principles”, clarifications and other pronouncements as to how certain use cases fit within existing regulatory frameworks.

In certain industries, such as the financial services industry, distributed ledger technology is essentially dead on arrival without the involvement of the regulators in its development, adaptation and rollout.

However, blockchain companies in most industries will benefit from the certainty that will be afforded when regulation arrives.

Have an opinion on blockchain in 2016? A prediction for 2017? Email editors@coindesk.com to learn how you can contribute to our series.

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