Distributed ledger technology (DLT) and blockchain have attracted massive investment interest globally, which reflects their substantial transformative potential, especially in the financial sector. Proponents hold out a long list of useful applications of these technologies – from capital raising and trading, to deposits and lending, to property and casualty claims processing (InsurTech), to digital identity management and authentication, to regulatory technology (RegTech) such as anti-money laundering and client suitability checks.
Although Asia has taken a leading role in adoption of these new technologies, in practice they are often shrouded in uncertainty and confusion in the region. What are the differences and links between DLT, blockchain, cryptoassets, and ICOs, and what are the current regulatory practices and challenges related to these new technologies? A new report of the Asian Development Bank brings much needed clarity to these issues and offers a new analytical framework to help policymakers review and assess opportunities and challenges associated with DLT and blockchain for the financial services industry.
First, it clarifies the confusion in terminology, by distinguishing between (i) DLT (a distributed digital database that is shared, independently updated, and synchronized by consensus among the network participants), (ii) blockchain (a form of distributed ledger with each block of transaction records linked by cryptographic signatures) and (iii) their applications, such as smart contracts and cryptoassets.
Second, it argues that, although some cryptoassets can be used as a medium of exchange, they have proven to be too speculative in most cases and have largely failed to function as a store of monetary value. While the rise of cryptoassets has yet to pose systemic concerns, monitoring is nonetheless in order as cryptoassets develop, particularly given rising market integrity and consumer protection concerns. Several countries have decided to go further than that and are examining the feasibility of introducing a sovereign (generally central bank-issued) cryptoasset as an alternative settlement currency, medium of exchange, and/or store of value. However, the implementation of such a sovereign alternative is fraught with technological, legal, macroeconomic, and other policy issues, many of which remain untested nationally and unresolved as a result.
Third, the report addresses the concept of ICOs (initial coin offerings), a fundraising technique that uses digital tokens (coins) representing various rights issued and managed on a blockchain that operates on a distributed ledger. ICO tokens can confer an entitlement to a share in profits or capital gain (in which case they will typically fall under regulation as securities or possibly as a collective investment scheme). They can also confer an entitlement to cryptoassets (which may subject them to regulation as derivatives) or an entitlement to use the product or join a community to be developed with the funds raised (which will typically not fall within the purview of financial regulation and merely be subject to general consumer and commercial laws).
Fourth, the report shows that implementation of DLT and blockchain in Asia has been fraught with difficulties that highlight the existing weaknesses. Notable examples include the loss of 750,000 customer Bitcoins and 100,000 Bitcoins owned by the Japanese Mt. Gox Bitcoin exchange, and the loss of 119,756 Bitcoins by Hong Kong-based Bitfinex. Furthermore, despite the potential to improve efficiency through the new technologies, the underlying challenges (including transparency, operational and cyber risks) do not disappear entirely. This is noteworthy, since benefits of new technologies are often overstated: for example, blockchain can make data storage tamper-evident but not tamper-proof.
Finally, the report examines the feasibility of designing an efficient regulatory response to various implementations of the new technologies and recommends a functional and proportional approach to regulation, which includes the following core elements:
1. DLT should be treated as a platform technology that can be used across a wide variety of functional areas, from identity to property registration to financial infrastructure, payment, and fundraising.
2. It should be made clear how existing law applies in the context of DLT and blockchain end-uses (including rules on consumer protection, data protection, choice of law/courts, and competition frameworks). To achieve this, there should be a system of categorisation and certification encompassing the new technologies.
3. Regulators should focus on specific applications associated with the biggest risks, such as ICOs.
4. Cryptoasset intermediaries (most notably, cryptoasset exchanges) require immediate regulatory attention, as they are likely to become a major source of risk in the short term.
5. Policymakers and regulators should strive to better understand individual use cases and systems implementing DLT and blockchain, balancing the opportunities to build better financial infrastructure that could bring massive long-term benefits with the management of the many risks that will arise along the way.
Anton Didenko is a Research Fellow at the Faculty of Law, UNSW Sydney, Australia.
Ross Buckley is a KPMG Law and King & Wood Mallesons Chair of Disruptive Innovation and Scientia Professor, UNSW Sydney, Australia.
Douglas Arner is a Kerry Holdings Professor in Law and Director, Asian Institute of International Financial Law, Faculty of Law, University of Hong Kong.
Cyn-Young Park is a Director at the Regional Cooperation and Integration Division of the Economic Research and Regional Cooperation Department, Asian Development Bank.
Bo Zhao is an Economist at the Economic Research and Regional Cooperation Department, Asian Development Bank.