A regulatory sandbox for Wall Street
Don’t let regulation delay this global solution to the weaknesses of the financial system
In the eight years since the crash, regulators have made some progress in strengthening the global financial system, but the structure is still not as robust as one might wish. In principle, new technologies—including blockchain, the idea that underlies bitcoin—could help fix some of this fragility. It’s a possibility well worth pursuing.
In what ways is the system still weak? Crucial functions—such as payments and trading—remain concentrated in large, undercapitalized banks or other central hubs; despite regulators’ efforts, losses at those institutions could still have economywide repercussions. To make matters worse, the authorities don’t yet have a clear real-time picture of what’s happening in financial markets or where risk is concentrated. Blockchain technology is capable of addressing both issues.
Finance is about trust: Institutions evolved to enable transactions with strangers. Centralized intermediaries of various kinds solved that problem, keeping track of who owns what and who owes whom. But they also create points of systemic vulnerability. Blockchain establishes trust in a new way. It creates a so-called distributed ledger, which maintains a complete history of all participants’ transactions—verified and recorded across a network of computers spread around the world. The record resides in so many places that it can’t be lost or tampered with.
Now imagine all transactions—from paychecks to derivative contracts—residing on a public distributed ledger. Everyone, including regulators, would be in a much better position to see (and to head off ) dangerous exposures. If a major bank ran into trouble, authorities wouldn’t have to worry about the impact on vital payment or ledger systems. Governments would be better able to let large institutions fail, restoring market discipline to risk-taking and allowing regulation to be much simpler.
Getting there will take some problem-solving. The question is how to make it happen. Big banks and exchanges are participating in various projects to build private blockchain systems. The spur is greater efficiency and lower costs. This kind of closed-architecture innovation, however, is unlikely to be transformative in itself. It’s aptly known as blockchain on “training wheels.” Startups are also working on public applications, which have greater potential—but regulations put them at a disadvantage. It might be enough to suffocate, or seriously delay, a technology whose most promising uses are global.
The U.K. Financial Conduct Authority has found an elegant solution: a “regulatory sandbox,” where companies can test concepts without submitting to the full compliance burden. This approach needs to go international, with different jurisdictions agreeing to allow experiments with cross-border blockchain applications. If the U.S. took the lead in this effort, others would sign up for fear of being left behind.