SPEECHES & TESTIMONY

Remarks of Daniel Gorfine Regarding DLT and the Next Generation of Computing Infrastructure, Finovate, NYC

September 27, 2018

Good morning and thank you for the opportunity to kick off Day 4 at Finovate.  I am Chief Innovation Officer and Director of LabCFTC at the U.S. Commodity Futures Trading Commission (CFTC).  My remarks presented here reflect my own views and do not necessarily reflect the opinions or views of the Chairman, Commissioners, or the Commission.

Today, I am going to spend the first portion of my remarks talking a bit about how it is that someone from the CFTC – an Agency long associated with agricultural products like wheat, corn, and oil – is standing here before you to talk about things like FinTech, DLT, and Crypto.  The second portion of my talk will go into more detail as to how innovation – and in particular DLT – impacts the CFTC and our markets.  And then I will conclude with a few additional thoughts regarding possible future states impacted by this technological innovation and questions and challenges that will likely emerge.

From Farms to FinTech

Stepping back, the mission of the CFTC is to foster open, transparent, competitive, and financially sound markets.[1]  The agency oversees markets vital to supporting the transfer of risk between market participants and by extension to the stability and reliability of real-world economic activity, ranging from the production and provision of gasoline for our cars, to the availability of credit for our purchases, and the offering of produce in our grocery stores.[2]

So as I posed a moment ago how do we now find ourselves here making the jump from traditional commodities and risk transfer to FinTech topics like DLT and bitcoin?

The answer is that our financial markets are fast-evolving due to technology-driven innovation and this has changed the way market participants interact and engage in economic activity.   longer do market participants rely on face to face interactions and telephones.  Instead, markets have become increasingly electronic, digital, and interconnected.  This new world in turn creates new market and regulatory opportunities, challenges, and risks.

I would argue that much of this dynamic and what makes “this time different” – at least from a regulatory perspective – derives from three identifiable threads around FinTech innovation.

The first centers on speed, both in terms of innovation and subsequent adoption.  The speed phenomenon is the result of the profound impact that increased computing power and lower computing costs have had in the development of new business models and products.  Additionally, the internet and mobile technologies have rapidly sped the adoption of these new models and products.  This means that markets and regulators are faced with a constant barrage of innovations and not much time to grasp their implications before inter-connected computers and devices permit their ready adoption.

The second is that innovation largely seeks to either disintermediate traditional gatekeepers or change the way they operate.  Current financial regulatory frameworks are centered on the intermediaries or gatekeepers that manage the access to our markets or financial services activity.  To the extent that innovators are seeking to disintermediate or substantially transform traditional models in order to increase efficiencies, regulators will need to proactively identify how rules and regulations conform or will need to change.

And the third is that new technologies and the Internet have reduced barriers to entering new businesses and driven convergence across historically distinct sectors of the economy.  More specifically, traditional financial institutions, telecom providers, technology companies, and startups are increasingly competing for the same set of users or customers with the same general set of financial services or activities.  This dynamic can drive rapid innovation and competition, which can benefit consumer and end-users, but put strain on regulatory frameworks that typically focus on the actor to be regulated rather than the activity.

Additionally, an important consequence of the increasing complexity of technology-driven business models is that it requires significantly more focus on technological literacy at all levels of leadership, including within business and government.  It is simply not enough to all agree to high level platitudes that items like cybersecurity are of great importance – instead it is imperative that we have deep understanding of the details of security protection in order to avoid bad outcomes.  Indeed, I would suggest that a key emerging risk in our markets is a potential lack of required literacy in the face of increasingly technology-driven business models and processes.

LabCFTC: Building a 21st Century Regulator

Given these market dynamics, and related emerging regulatory challenges, we believe thoughtful 21st century regulatory approaches are needed.  This is why last summer, CFTC Chairman Chris Giancarlo announced with bipartisan Commission support the launch of LabCFTC.[3]

LabCFTC is the CFTC’s effort to help create a replicable model for regulatory engagement and modernization.  The mission of LabCFTC is to facilitate market-enhancing innovation, inform policy, and ensure we have the technological and regulatory tools and understanding to keep pace with changes to our markets.

The building blocks of the effort are engagement, testing and experimentation, education, and collaboration.  Through this approach, we can gain a better understanding of emerging risks, technologies, and trends, modernize our regulatory tools and operations, engage with innovators early in the development of new business models, and support better informed policymaking that facilitates market-enhancing innovation.

The effort seeks to involve both internal and external stakeholders through three primary work streams.

First, ‘Guide Point’ provides a dedicated point of contact for FinTech innovators to engage with the CFTC, learn about the CFTC’s regulatory framework, and obtain feedback.  Such feedback and discourse may provide innovators with valuable information that can help them save time and resources, or allow for the identification of potential friction or uncertainty in existing rules.

Second, ‘CFTC 2.0’ fosters the testing, understanding, and potential adoption of new technologies that can improve markets or make the Commission a more effective and efficient regulator.  We recently crowdsourced ideas for future innovation competitions,[4] which may involve, for example, novel ways to visualize CFTC published data, developing market surveillance tools, making our rules more readily machine-readable, or building a more dynamic, digital, and “smart” notice-and-comment platform.

Finally, ‘DigitalReg’ is designed to support the Commission’s effort to build a 21st century regulator and regulatory approach. Internally, DigitalReg serves as a CFTC-wide resource to help inform the Commission and staff on Fintech-related developments.  Externally, DigitalReg acts as a hub to help the Commission collaborate with other U.S. and international regulatory authorities in order to share best practices around FinTech engagement.  We were accordingly pleased earlier this year to enter into a CFTC-first FinTech cooperation arrangement with the UK’s Financial Conduct Authority (FCA),[5] and just a few weeks ago we entered a similar arrangement with the Monetary Authority of Singapore (MAS).[6]  Going forward, we are keen to continue ongoing constructive engagement with many other of our domestic and international regulatory peers.

DLT, Blockchain, and Digital Assets

Now shifting to the topics of primary focus today: DLT, blockchain, and digital assets[7] have been prominent areas of engagement and exploration for the CFTC over the past year.  When LabCFTC views the space, we are interested both in private or permissioned ledger networks (also sometimes considered “blockchain-inspired” technologies) that can be deployed by market participants to improve market infrastructure and in public blockchains that require use of a virtual currency to incentivize participation in maintaining the ledger system.

Developments across this spectrum have society re-thinking the nature of money, how people transact, and how we can more efficiently engage in regulatory, economic, and market activity.

On the private or permissioned side of the spectrum, new innovations hold promise in improving clearing and settlement processes,[8] decreasing execution risks, enhancing supply-chain management and transparency, powering smart contract systems, facilitating regulatory reporting and compliance, and even transforming information capture, delivery, and analytics capabilities.  Indeed, as we have seen firsthand through LabCFTC, there are many proof-of-concept and pilot projects underway across a range of potential applications.[9]

For example, with respect to capital markets infrastructure, DLT systems may replace outdated databases and reduce unnecessary and costly manual processes.  In the context of supply chains, we are seeing the ability to track food and agricultural products from farm to table, or the movement of commodities from inception to final delivery.  Smart contracts may further be able to incorporate compliance provisions into regulated economic transactions, and automate many types of economic activities.  And in the context of regulatory reporting, DLT platforms may also hold promise in permitting real-time and standardized reporting of trade data to the regulator without the need for current bespoke, batch-and-send systems.

In many respects, DLT-based or inspired systems may ultimately serve to upgrade our existing computing infrastructure in a range of sectors and applications.  I will have more to say on this later in my remarks.

To be clear, however, this area of innovation is quite distinct from the realm of public distributed ledgers and virtual currencies, and has its own unique set of challenges including around security, scalability, and broader adoption.[10]

On the public distributed ledger side of the spectrum, it may be helpful to level-set.  Virtual currencies are a digital representation of value and may function as a medium of exchange, a unit of account, and/or a store of value.  Virtual currencies generally run on a decentralized peer-to-peer network of computers, which rely on certain network participants to validate and log transactions on a permanent public distributed ledger visible to all.  The virtual currency serves as the required incentive for miners or validators.[11]

Proponents note that these virtual ecosystems unlock digital scarcity, enable the efficient transfer of ownership, and power the execution of relatively autonomous application platforms all without the need for a trusted, central party that was traditionally needed to verify that each party to a transaction has – and does – what it promises.[12]

In addition to providing new ways to transact over the internet, these advancements could allow for decentralized platforms or applications that provide consumers with desired goods and services absent a central gatekeeper.[13]  Additionally, decentralized systems could help counter rising concerns about the power wielded by centralized platforms that through their scale gain widespread access to -- and control over -- data and information.[14]  Some further note the potential inspiration that virtual currencies may provide Central Banks in the future creation of digital fiat currencies.[15]

Many, however, appropriately worry that virtual currencies and tokens are prone to fraud, manias, and bubbles driven by misunderstandings and myths regarding their scalability, utility, and intrinsic value.[16]  Indeed, over time bad actors have commonly invoked the concept of innovation in order to engage in fraudulent activities that target the general public.[17]  Additionally, as we are frequently reminded,[18] concerns regarding the use of cryptocurrencies to facilitate illegal activity are well-founded and require government efforts to ensure that Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements are effectively applied.

With recent hype around virtual coins and tokens there has also been a proliferation of so-called “Initial Coin Offerings” or ICOs, which frequently refers to the sale of virtual tokens to the public that are intended to raise capital for a venture and may bear the hallmarks of a securities offering.[19]  Our colleagues at the Securities and Exchange Commission (SEC) have been thoughtfully addressing related challenges,[20] and providing additional clarity to the marketplace.[21]  And from the CFTC’s perspective, given the potential to tokenize a broad range of economic assets, it is important to remind the public that digital assets can also be derivatives or commodities, depending on their terms and how they are structured.

Given the potential and challenges of this space, CFTC Chairman Giancarlo has made clear that the proper response by regulators and policymakers is not to dismiss the entire movement as misguided or foolish, but rather to take the time to learn, facilitate the promise, and guard against risks and bad actors.[22]

As part of this effort, LabCFTC published its first FinTech primer on the topic of virtual currencies in October 2017.[23]  The goal of the primer was to help educate the public about potential use-cases of the technology, CFTC jurisdictional considerations, and relevant risks, including around investment speculation, cybersecurity, and platform operations.

After the self-certification and launch of bitcoin futures in December 2017, LabCFTC was then able to continue providing support to the Commission and operating divisions based on our engagement and study of DLT and virtual currencies.

The Next Generation of Computing Infrastructure

What strikes me about DLT and blockchain more broadly, however, is that it likely stands for the proposition that we are about to witness the upgrading of our technology infrastructure, or what is frequently referred to as back-office systems, to accommodate the next generation of computing and networks.  That’s a bold statement, but let me unpack it a bit.

Today, most back office computing systems – whether at a bank, a utility company, or a manufacturer – rely on largely bespoke databases that have been bubbled-gummed and scotch-taped over to work for their current business purpose.  These systems, however, do not agree on standardized data fields or formats, and nor do they communicate well with each other.  So, we end up with siloed and messy data, which does not lend itself to the potential of next generation data analytics and machine learning platforms.

At the most basic level, what Satoshi Nakomoto and Bitcoin have done is make thinking about back-office ledger and database systems the in-thing to do.  And the incredibly helpful byproduct of this development is that people are being forced to think about data standardization and platform interoperability.  If many adopters agree to particular data formats and standards, and use a common DLT-based or inspired system, then the data that is produced will be clean, accessible, and consumable.  This means data analytics and machine learning tools can use the data to yield high value-add predictions and insights.

In addition, economic transactions and activities will become more efficient and transparent given the ability to automate processes reliant on standardized data and shared transaction ledgers.  For example, one could imagine a future state where real-time weather data flows through thousands of interconnected systems, including smart insurance contracts, commodity pricing models, a power grid looking to calibrate anticipated energy demand, and even a digital speed limit on a highway that increases or decreases based on weather and road conditions.

My example above may have you thinking, well, this isn’t so revolutionary – after all, isn’t this the benefit that the Internet and mobile connectivity has always promised?  The answer is: Yes!

But, until people started thinking about adopting common systems and standards, the Internet could not guarantee complete and seamless inter-connectivity.  It is possible that now is the start of a process where DLT-based or inspired systems allow the Internet to fulfill more of its promise.  And this development will likely be coupled with continued advances in machine learning that will benefit from routine access to increasingly standardized and consumable data provided through DLT systems.

That said, there will be major barriers to overcome.  For starters, recent reports note delays and disillusionment with many current DLT pilot projects.[24]  And this is not entirely surprising – coming out of a clear hype cycle folks are now having to grapple with real and difficult questions.

How do we, for example, solve for the collective action problem in that DLT systems only yield real benefit when many market participants adopt a common systems and standards?  How do we avoid inadvertently stifling innovation by prematurely dictating those standards?  How do we justify the upfront investment cost to upgrade to new systems, especially when the current bespoke systems seem to work well enough?  How do we handle governance and liability issues with increasingly automated systems – who owns them and has ultimate responsibility if things go wrong?  How do we ensure that these new technologies are compliant with emerging privacy laws?  And how do we ensure the systems are safe and able to defend against malicious cyber-attacks?

These are just a few of the questions that need to be asked and answered.  And, I suppose all of you will be doing exactly that during the course of the day.  I, for one, look forward to learning more from all of you, and thank you again for allowing me to help kick start our day.


[1] See CFTC Mission Statement, Commodity Futures Trading Commission http://www.cftc.gov/About/MissionResponsibilities/index.htm (last visited July 16, 2018). 

[2] Many of my introductory remarks here derive from my prior publication: See Daniel Gorfine,  FinTech Innovation: Building a 21st Century Regulator, Georgetown University Law Center Institute for International Economic Law (IIEL), Issue Brief 11/2017 (November 2017), https://www.law.georgetown.edu/iiel/wp-content/uploads/sites/8/2018/01/LabCFTC-Chris-Brummer-Dan-Gorfine-IIEL-Issue-Brief-November-2017-Accessible.pdf; see generally, Bruce Tuckman, Derivatives: Understanding Their Usefulness and Their Role in the Financial Crisis, J. of Applied Corp. Fin. Vol 28, No. 1 (Winter 2016).

[3] Address of J. Christopher Giancarlo to the New York FinTech Innovation Lab, “LabCFTC: Engaging Innovators in Digital Financial Markets,” (May 17, 2017) Commodity Futures Trading Commission,  http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-23. 

[4] CFTC Asks Innovators for Competition Ideas to Advance FinTech Solutions, (Apr. 24, 2018) Commodity Futures Trading Commission, https://cftc.gov/PressRoom/PressReleases/7717-18.

[5] US CFTC and UK FCA Sign Arrangement to Collaborate on FinTech Innovation, Commodity Futures Trading Commission, (Feb. 19, 2018)  https://www.cftc.gov/PressRoom/PressReleases/pr7698-18.

[6] US Commodity Futures Trading Commission and Monetary Authority of Singapore Sign Arrangement to Cooperate on FinTech Innovation, Commodity Futures Trading Commission, (Sept. 13, 2018) https://www.cftc.gov/PressRoom/PressReleases/7784-18.  

[7] ‘Digital assets’ is a broad category that includes ‘virtual currencies’ or ‘cryptocurrencies.’ For purposes of this speech and consistent with CFTC past use, I use the term ‘virtual currencies.’

[8] See Alexis Collomb & Klara Sok, Blockchain and Distributed Ledger Technology (DLT): What Impact on the Financial Sector?, DIGIWORLD ECONOMIC JOURNAL COMMUNICATIONS & STRATEGIES (July 1, 2016).

[9] Nikhilesh De, Hitachi and Mizuho Strike Deal for Blockchain Supply Chain, COINDESK (September 25, 2017), https://www.coindesk.com/hitachi-mizuho-strike-deal-blockchain-supply-chain/.

[10] A CFTC Primer on Virtual Currencies., Commodities Future Trading Commission, (Oct. 17, 2017), http://www.cftc.gov/idc/groups/public/documents/file/labcftc_primercurrencies100417.pdf (hereinafter “LabCFTC Primer”).

[11] See generally LabCFTC Primer.

[12] See Jerry Brito, Executive Director, Coin Center before the New Jersey Assembly Financial Institutions and Insurance Committee Hearing on digital Currency, CoinCenter(Feb. 5, 2015) https://coincenter.org/wp-content/uploads/2015/02/NewJerseyLegislatureWrittenTestimony.pdf.

[13] Steven Johnson,  Beyond the Bitcoin Bubble, New York Times, (Jan. 16, 2018) https://www.nytimes.com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html.

[14] Yuval N. Harari, “Why Technology Favors Tyranny,” The Atlantic, (2018), https://www.theatlantic.com/magazine/archive/2018/10/yuval-noah-harari-technology-tyranny/568330/.

[15] Qin Chen, Next Stop in the Cryptocurrency Craze: A Government-Backed Coin, Consumer News and Business Channel, (Dec. 29, 2017) https://www.cnbc.com/2017/11/29/federal-reserve-starting-to-think-about-its-own-digital-currency-dudley-says.html.

[16] CFTC Customer Advisory: Use Caution When Buying Digital Coins or Tokens, Commodity Futures Trading Commission, (July 16, 2018), https://www.cftc.gov/PressRoom/PressReleases/; see also Shane Shifflett & Coulter Jones, Buyer Beware: Hundreds of Bitcoin Wannabes Show Hallmarks of Fraud, Wall Street Journal (May 17, 2018) https://www.wsj.com/articles/buyer-beware-hundreds-of-bitcoin-wannabes-show-hallmarks-of-fraud-1526573115; Angela Monaghan, Bitcoin Biggest Bubble in History, says Economist who Predicted 2008 Crash, The Guardian, (Feb. 2, 2018) https://www.theguardian.com/technology/2018/feb/02/bitcoin-biggest-bubble-in-history-says-economist-who-predicted-2008-crash. 

[17] CFTC Charges Nicholas Gelfman and Gelfman Blueprint, Inc. with Fraudulent Solicitation, Misappropriation, and Issuing False Account Statements in Bitcoin Ponzi Scheme, Commodities Futures Trading Commission (Sept. 21, 2017) https://www.cftc.gov/PressRoom/PressReleases/pr7614-17.

[18] Gabriel T. Rubin, How Bitcoin Fueled Russian Hacks, Wall Street Journal (July 13, 2018), https://www.wsj.com/articles/how-bitcoin-fueled-alleged-russian-hacks-1531517907.

[19] Jay Clayton  & J. Christopher Giancarlo, Regulators Are Looking at Cryptocurrency,  Wall Street Journal, (Jan. 24, 2018). https://www.wsj.com/articles/regulators-are-looking-at-cryptocurrency-1516836363.

[20] The SEC Has an Opportunity You Won’t Want to Miss: Act Now!, Securities and Exchange Commission (May 16, 2016), https://www.sec.gov/news/press-release/2018-88; see also Pre-ICO Sale is Live, Howeycoins (2018), available at https://www.howeycoins.com/index.html;  Investor Bulletin: Initial Coin Offerings, Securities and Exchange Commission (July 25, 2017). https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings.

[21] William Hinman, Director of the Division of Corporation Finance, Director Digital Asset Transactions: When Howey Met Gary (Plastic), Yahoo Finance All Markets Summit: Crypto, San Francisco, CA, Securities and Exchange Commission (June 14, 2018) https://www.sec.gov/news/speech/speech-hinman-061418.

[22] Written Testimony of Chairman J. Christopher Giancarlo before the Senate Banking Committee, Washington, D.C., Commodity Futures Trading Commission (Feb. 6, 2018) https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo37; see also Testimony of Chairman J. Christopher Giancarlo before the Senate Committee On Appropriations Subcommittee on Financial Services and General Government, Washington, D.C. Commodity Futures Trading Commission (June 5, 2018) https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo47.

[23] CFTC’s LabCFTC Releases Primer on Virtual Currencies Commodity Futures Trading Commission (Oct. 17, 2017), https://www.cftc.gov/PressRoom/PressReleases/7631-17.

[24] Michael del Castillo, Reality Check: ASX Delays DLT Launch Amid User Concerns, Forbes (Sept. 4, 2018).  https://www.forbes.com/sites/michaeldelcastillo/2018/09/04/reality-check-asx-delays-dlt-launch-amid-user-concerns/#6adea5412371