Supervise this: Regulators around the world are puzzling over how best to regulate blockchain networks. Perhaps part of the solution is to participate in them. That’s the gist of a new
working paper from the Bank of International Settlements, the so-called central bank for central banks.
Conventionally, financial institutions must collect, verify, and deliver certain information about their transactions to government authorities in order to comply with regulations designed to combat money laundering and fraud. In future blockchain-based markets, however, it should be possible for regulators to automatically collect that data directly from the shared ledger, argues
Raphael Auer, the new paper’s author and a principal economist at the BIS.
The “starting premise” of his argument, writes Auer, is that “one needs to look beyond Bitcoin and other ‘permissionless’ cryptocurrencies or crypto-assets and instead focus on a ‘permissioned’ version of the technology.” The most important distinction here is that permissionless systems allow anyone with the right hardware and an internet connection to participate in the system, pseudonymously. Permissioned systems require that these validators be identified and vetted. A permissioned system, Auer contends, would give participants something to fall back on in case they are unable to achieve a consensus automatically using the blockchain’s software.
Large bank-to-bank money transfers (called “wholesale” payments), comprise the vast majority of payments globally. Auer says distributed ledger technology has near-term potential to make them cheaper and more efficient by automating many of the processes. Meanwhile, policymakers could take advantage of the technology as well, he argues. Regulators could run the network’s software and use blockchain-based programs (smart contracts) to automatically collect relevant information.
First, though, the system must be set up so that regulators can trust the data, says Auer. That is, the economic incentives must be designed so that it is in the individual validators’ best economic interest to verify new transactions, not accept bribes to manipulate the transaction record in fraudulent ways. That will be far from straightforward. Most financial regulators around the world probably don’t have the required level of technical sophistication to make that work yet. But Auer’s argument may help shift the conversation from one that has mostly been focused on how regulators will apply traditional approaches to new blockchain-based markets, to one in which regulators can use blockchain technology to their advantage.
