March 29, 2016
Good afternoon, ladies and gentlemen. Thank you for your warm welcome. It is a pleasure to be here with you today.
Before I begin, let me say that my remarks reflect my own views and do not necessarily constitute the views of the Commodity Futures Trading Commission (CFTC or Commission), my fellow CFTC commissioners or the CFTC staff.
Two decades ago, as the Internet was entering a phase of rapid growth and expansion, a Republican Congress and the Clinton administration established a set of foundational principles: the Internet was to progress through human social interaction, voluntary contractual relations and free markets. Governments and regulators were not to harm the Internet’s continuing evolution. Because of this “do no harm” approach, the Internet created millions of jobs, transformed our economy forever and improved standards of living across the globe.
Today, as you know, a new technology is at hand that may offer a similarly profound tool to share networks of information. Yet, its development is at risk of being stymied by disparate and uncertain regulation.
It is time again to remind regulators to “do no harm.” That is what I want to speak to you about this afternoon.
The Emerging Technology of Distributed Ledgers
The emergence of distributed ledger technology, which all of you know is sometimes referred to simply as “DLT” or “blockchain,” may revolutionize the world of finance. In fact, the Bank of England has called DLT the “first attempt at an ‘Internet of finance.’”1 DLT has the potential to link networks of legal recordkeeping the same way the Internet connects networks of data and information. It will have profound implications for global financial markets by increasing settlement efficiency and speed, linking recordkeeping networks, reducing transaction costs and increasing market access. It will broadly impact financial markets in payments, banking, securities settlement, title recording, cyber security and trade reporting and analysis.
The potential applications of this technology are being widely imagined and explored in ways that will benefit market participants, consumers and governments alike. Distributed ledgers could allow for the confirmation and ownership transfer of virtually anything from hockey tickets and magazine subscriptions to auto repair warranties and airline loyalty rewards or apartment leases. Another potential use of DLT is better and more verifiable voting systems, whether for proxies by corporate shareholders, customer satisfaction surveys or voting for political candidates.
DLT may be able to provide regulators with visibility into the trading portfolios of swaps counterparties that they lacked during the financial crisis and that Dodd-Frank mandated. It may make possible new “smart” securities and derivatives that can value themselves in real time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.
On this point, a dramatic example of the potential benefits to regulators of blockchain technology is in the collapse of Lehman Brothers. If an accurate DLT record of all of Lehman’s transactions had been available in 2008, then Lehman’s prudential regulators could have used data mining tools, smart contracts and other analytical applications to recognize anomalies in trade activity, divergence in counterparty exposure (specifically those willing to trade with Lehman), widening credit spreads and disruptions in short term funding activity. Regulators could have reacted sooner to Lehman’s deteriorating creditworthiness.
And even if prompter and better-informed regulatory intervention would not have been enough to prevent a run on Lehman, the records held by trading counterparties (and available to regulators) would have accurately shown Lehman’s open positions. Imagine if, instead of requiring countless legal actions spanning eight years, we could have known all of Lehman’s exposures within minutes of a bankruptcy filing. Accelerated settlement of open positions and accounts would have likely taken weeks, not years.
Further, DLT may help market participants manage the enormous operational, transactional and capital complexity brought about by the legion of disparate mandates, regulations and capital requirements promulgated globally in the wake of the 2008 financial crisis.2 In fact, one study estimates that DLT could eventually allow financial institutions to save as much as $20 billion in infrastructure and operational costs each year.3
There is no doubt that DLT has sparked an incredible amount of interest within the financial industry. Not a week goes by without several news articles, opinions and reports discussing the potential benefits and challenges of the technology. Billions of dollars are being invested in dozens of new ventures and innovations.4 Development is moving rapidly, certainly faster than underlying legal and regulatory frameworks. Rules regarding DLT are currently unwritten and likely years away, leaving the industry with little clarity.5
Yet, this investment faces the danger that when regulation does come, it will come from a dozen different directions with different restrictions stifling crucial technological development before it reaches fruition.
The Need for a “Do No Harm” Regulatory Approach to Distributed Ledger Technology
I am pleased to see that the next panel will discuss the regulatory challenges facing DLT development. I believe that innovators and investors should not have to seek government’s permission, only its forbearance, to develop DLT so they can do the work necessary to address the increased operational complexity and capital consumption of modern financial market regulation.
Regulators have a choice in this regard. I believe we can either follow a regulatory path that burdens the industry with multiple onerous regulatory frameworks or one where we come together and set forth uniform principles in an effort to encourage DLT investment and innovation. I favor the latter approach.
Fortunately, there is a good model for fostering the healthy development of DLT – the U.S. approach to the early Internet. The Telecommunications Act of 19966 and the ensuing Clinton administration “Framework for Global Electronic Commerce”7 were clear: the private sector should lead. Governments and regulators should avoid undue restrictions, support a predictable, consistent and simple legal environment and respect the “bottom-up” nature of the technology and its development in a global marketplace. This model is well-recognized as the enlightened regulatory underpinning of the Internet that brought about profound changes to human society.
In February 1996, Congress recognized that “the Internet . . . ha[d] flourished, to the benefit of all Americans, with a minimum of government regulation” and thus sought to ensure that Internet-access services would remain “unfettered by Federal or State regulation.”8 The Federal Communications Commission (FCC) agreed that Internet services “should exist in a minimal regulatory environment that promotes investment and innovation”9 and accordingly issued a series of orders affirming that Internet service providers would be governed under a comparatively relaxed framework.10 The federal government also promoted an open network beyond its borders.11 The FCC worked to support new World Trade Organization agreements that privatized state-owned telecommunication companies, created independent regulators around the world, adopted a set of regulatory practices to create competition and reduced trade barriers for information-technology goods and services.12 The U.S. also engaged with the Organization for Economic Cooperation and Development to adopt a similar light-touch Internet regulation regime.
During the period of this “do no harm” regulatory framework, a massive amount of investment was made in the Internet’s infrastructure. It yielded a rapid expansion in access that supported swift deployment and mass adoption of Internet-based technologies.13 Investors deployed $90 billion into the cross-continental fiber-optic broadband network, and broadband reached homes and smaller businesses, while large businesses built their own dedicated data connections.14 The share of U.S. households with broadband services increased from four percent in 2000 to 68 percent in 2010.15 Internet-based innovations have revolutionized nearly every aspect of American life, from telecommunications to commerce, transportation and research and development.16 This robust Internet economy has created jobs, increased productivity and fostered innovation and consumer choice.17 “Do no harm” was unquestionably the right approach to development of the Internet.
Similarly, “do no harm” is the right approach for DLT. Once again, the private sector must lead and regulators must avoid impeding innovation and investment and provide a predictable, consistent and straightforward legal environment. Protracted regulatory uncertainty or an uncoordinated regulatory approach must be avoided, as should rigid application of existing rules designed for a bygone technological era.18
Regulators Must Coordinate in Their Response to DLT to Allow it to Flourish
Much like the Internet, U.S. and foreign regulators must coordinate to create a principles-based approach for DLT oversight in order to provide the flexibility, certainty and harmonization necessary for this technology to flourish.
The Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) have recently turned their attention to financial technology innovations, including DLT.19 I was encouraged to read that FSB Chairman Mark Carney recognized that regulation should not stifle emerging innovation.20 In addition, IOSCO Chairman Greg Medcraft said that IOSCO is working on international policy to drive innovation without undermining confidence in markets and that issues around DLT must be dealt with at the multilateral level, not by individual countries.21
Regulation of DLT must indeed be coordinated on a multilateral level based on the principle of “do no harm.” Just as many financial service firms are joining together in broad DLT consortiums, regulators must do the same. The FSB and IOSCO have important roles to play in coordinating DLT regulation. These organizations should put forth a set of simple governing principles flexible enough to accommodate the issues and concerns of different national regulators. Such principles would create a regulatory environment that encourages the development of DLT, just as U.S. policymakers’ enlightened framework fostered the exponential growth of the Internet.
Without such a “do no harm” approach, financial service and technology firms will be left trying to navigate a complex regulatory environment, where multiple agencies have their own rule frameworks, issues and concerns.22 The industry is already starting to express these concerns.23 Some of the issues are anti-money laundering, know-your-customer requirements, privacy and security and dispute resolution.24 A single distributed ledger may also hold multiple assets that are subject to different or simultaneous regulatory agencies’ jurisdictions and rules. This could raise questions about which agency’s jurisdiction and rules apply to the distributed ledger.25 Such dichotomy, complexity and uncertainty will undoubtedly stifle DLT innovation.
It is therefore critical for regulators to come together to adopt a principles-based approach to DLT regulation that is flexible enough so innovators do not fear unwitting infractions of an uncertain regulatory environment. Some regulators have already openly acknowledged the need for light-touch oversight. For instance, the UK’s Financial Conduct Authority (FCA) has committed to regulatory forbearance on DLT development for the foreseeable future in an effort to give innovators “space” to develop and improve the technology.26 The FCA is even going one step further and engaging in discussions with the industry to determine whether DLT could meet the FCA’s own needs.27 Similarly, a few weeks ago, Masamichi Kono, Vice Minister for International Affairs at the Japan Financial Services Agency, stated that regulators must take a “pragmatic and flexible approach” to regulation of new technologies so not to stifle innovation.28
I have no doubt that the FCA’s intention to give DLT innovators “space” to innovate will be good for DLT research and development. I also suspect that it will be good for the UK’s burgeoning FinTech industry and the jobs it creates across the Atlantic.29 U.S. lawmakers concerned about the rapid loss of jobs in the U.S. financial service industry, especially in the New York City area,30 should similarly look to provide “space” to U.S. DLT innovation and entrepreneurship and the well-paying American jobs that will surely follow.
Revisit Existing Regulation
While international regulatory coordination and the adoption of a principles-based approach are important, each regulatory agency can take steps now to ensure that its existing rules do not inhibit DLT development and adoption.
For the CFTC, one example comes to mind – recordkeeping rule 1.31.31 Rule 1.31 requires all books and records to be kept in their original form or native file format.32 Such records must be produced in a form specified by any representative of the Commission.33 Rule 1.31 also has requirements for certain records to be stored in either micrographic media or electronic storage media and other related conditions.34
The CFTC should revisit this rule and make it technologically neutral such that it can accommodate DLT and other innovations that promote efficiency, accuracy and security in recordkeeping. The CFTC should also examine and, as necessary, revise other rules that may inhibit DLT innovation. Other regulators should similarly examine their recordkeeping and other rules.
The United States’ global leadership in technological innovation of the Internet was built hand-in-hand with its enlightened “do no harm” regulatory framework. Yet, when the Internet developed in the mid-1990s, none of us could have imagined its capabilities that we take for granted today. Fortunately, policymakers had the foresight to create a regulatory environment that served as a catalyst rather than a choke point for innovation. Thanks to their forethought and restraint, Internet-based applications have revolutionized nearly every aspect of human life, created millions of jobs and increased productivity and consumer choice.
Regulators must show that same forethought and restraint now.
Today, I call on my agency, the CFTC, and other U.S. and overseas policy makers and regulatory counterparts to repeat that broad-minded approach.
I look forward to working with my fellow CFTC commissioners, U.S. lawmakers and other financial services regulators here and abroad to develop a “do no harm” framework from which to launch a new era of innovation in distributed ledger technology for the good of our markets and the people they serve.
Thank you for your time and attention.
1 Robleh Ali et al., Bank of England, Innovations in Payment Technologies and the Emergence of Digital Currencies 11 (2014), http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q3digitalcurrenciesbitcoin1.pdf; see also Tomas Hirst, The Bank of England Just Said It Thinks Bitcoin Could Be Huge, Business Insider, Sept. 11, 2014, http://www.businessinsider.com/bank-of-england-report-on-bitcoin-2014-9.
2 See, e.g., Oversight of Dodd-Frank Act Implementation, U.S. House Financial Services Committee, http://financialservices.house.gov/dodd-frank/ (last visited Mar. 2, 2016).
3 Santander InnoVentures, Oliver Wyman & Anthemis Group, The Fintech Paper 2.0: Rebooting Financial Services 15 (2015), http://santanderinnoventures.com/wp-content/uploads/2015/06/The-Fintech-2-0-Paper.pdf.
4 See Blockchain & Bitcoin 2016: A Survey of Global Leaders, Magister Advisors, http://magisteradvisors.com/blockchain-bitcoin-2016-a-survey-of-global-leaders/ (last visited Mar. 24, 2016); see also Kim S. Nash, Blockchain: Catalyst for Massive Change Across Industries, Wall St. J., Feb. 2, 2016, http://blogs.wsj.com/cio/2016/02/02/blockchain-catalyst-for-massive-change-across-industries/ (citing figure published by Magister Advisors).
5 Benjamin Elliott et al., Banks Testing Blockchain Need Clarity on Regulations, TabbForum, Feb. 26, 2016.
6 Telecommunications Act of 1996, Pub. L. No. 104-104, 110 Stat. 56 (1996).
7 See Clinton administration, Framework for Global Electronic Commerce, http://clinton4.nara.gov/WH/New/Commerce/.
8 47 U.S.C. § 230(a)–(b) (2012).
9 In re Inquiry Concerning High-Speed Access to the Internet Over Cable and Other Facilities, GN Docket No. 00-185 (F.C.C. Mar. 15, 2002).
10 See, e.g., In re Preserving the Open Internet, Notice of Proposed Rulemaking ¶ 29, GN Docket No. 09-191 (F.C.C. Oct. 22, 2009), https://apps.fcc.gov/edocs_public/attachmatch/FCC-09-93A1.pdf; see also Jeffrey A. Eisenach & Ilene Knable Gotts, Looking Ahead: The FTC’s Role in Information Technology Markets, Geo. Wash. L. Rev. 1876, 1894–95 (2015).
11 See generally Karen Kornbluh, Beyond Borders: Fighting Data Protectionism, Democracy J., Fall 2014.
13 See, e.g., John W. Mayo et al., Assessing the Economic Benefits and Costs of the FCC’s Imposition of Title II Regulation 4–5 (Aug. 2015).
15 Testimony Before the Subcomm. on Communications and Technology of the H. Comm. on Energy and Commerce, 114th Cong. 2 (Oct. 27, 2015) (statement of Robert J. Shapiro).
16 See, e.g., Editorial: Internet Regulation: Why a Light Touch is Best, Economist, May 26, 2005, http://www.economist.com/node/4009433.
17 Bob Latta, Regulation Would Stifle Internet Innovation, U.S. News & World Report, June 23, 2014, http://www.usnews.com/opinion/articles/2014/06/23/fcc-regulation-of-broadband-providers-kills-innovation.
18 Henry Engler, Blockchain Faces Maze of Regulatory Complexities, Questions and Challenges, Thomson Reuters, Feb. 23, 2016, https://blogs.thomsonreuters.com/answerson/blockchain-faces-maze-of-u-s-regulatory-complexities-questions-and-challenges/.
19 Caroline Binham, Financial Stability Board Adds Fintech to List of Worries, Fin. Times, Feb. 27, 2016; Huw Jones, Global Regulators May Propose Rules for Fintech: FSB’s Carney, Reuters, Feb. 27, 2016; Greg Medcraft, Blockchain: How We Can Harness the Benefits of this New Technology While Mitigating the Risks, MarketVoice, at 23, Jan. 2016.
26 Daniel Palmer, U.K. Financial Regulator Vows to Give Blockchain “Space” to Grow, CoinDesk, Feb. 23, 2016, http://www.coindesk.com/uk-financial-regulator-blockchain-space-grow/.
27 Id. Blockchain may provide many benefits to regulators as well, such as improving audit trail and surveillance capabilities. A light-touch approach in regulating the blockchain will allow these benefits to be realized. See Mike Ross, Blockchain Plus Smart Contracts Equals Boon for Regulators, TabbForum, Feb. 29, 2016.
28 Masamichi Kono, Japan Financial Services Agency, How Can Regulators Do Better The Next Time?, CFTC International Regulators’ Meeting, Boca Raton, FL, at 5-6, Mar. 15, 2016, http://www.fsa.go.jp/common/conference/danwa/20160315/01.pdf.
29 Through “Project Innovate,” the FCA works with businesses to introduce innovative financial products and services to the market and to help them understand the regulatory framework. The FCA plans to expand Project Innovate by implementing a regulatory sandbox that furthers UK-based financial technology development. This regulatory sandbox would include a “safe space” where businesses could test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of pilot activities. See FCA Project Innovate, https://innovate.fca.org.uk/; see Regulatory Sandbox, http://www.fca.org.uk/news/regulatory-sandbox.
30 Portia Crowe, Wall Street Jobs are Leaving New York, Business Insider, Feb. 10, 2016, http://www.businessinsider.com/where-goldman-sachs-is-outsourcing-jobs-2016-2.
31 17 C.F.R. § 1.31 (2015).
32 Id. § 1.31(a)(1).
33 Id. § 1.31(a)(2).
34 Id. § 1.31(b).
Last Updated: March 29, 2016