Introduction

Hi, good morning everyone. I am a Japanese financial regulator at JFSA. My goal is to promote financial innovations and still ensure the financial stability and various regulatory goals. I have nearly 10 years experience as a regulator. I don't have a strong background in technology, so I hope I can rely on the other stakeholders on this. I am now in Washington DC doing research on blockchain and governance policy. Based on these experiences, I would like to talk about the pain points from a regulatory perspective and then I would like to propose a multi-stakeholder approach for this ecosystem.

Financial regulation

Some of you might not be familiar with regulation. These are the very fundamental goals for regulators: financial stability maintenance, protecting investors and consumers, and preventing financial crimes. This is very important because this is in the public interest. How can we ensure achieving these goals by working together?

Conventional regulatory approach

A regulator might not be necessary in the near future, if these goals can be achieved by other means than financial regulations. The fundamental approach that is conventional is: first, identify risks and regulatory needs for some topics. Then, if the needs and risks are enough, then we enter into the process of establisihng regulations and statutory laws. Then finally, we do enforcement which is usually entity-based and targets banks or something.

The question is, how can we apply this kind of approach to decentralized finance? Or should we change some of our procedures?

Financial stability

Today's discussion topic is financial stability. What kind of factors could effect financial stability? You know, financial stability is a very broad concept. There's no clear definition. If the system is stable, then we can probably make a financial transaction. The idea is to prevent financial crisis. The factor is such that there might be liquidity shortages, excessive risk taking, interconnectedness between systems, operational errors or problems, then credit crunch or political instability. All of these factors can negatively effect financial stability.

Policy development after the crisis: we developed macroprudential tools, OTC derivatives reforms, etc. But were these effective? The question is, how can we apply the existing framework to decentralized financial systems?

Blockchain-based finance

Blockchain-based finance is decentralized, autonomous, globalized, immutable, permissionless and anonymized system. These are features that the traditional financial system generally doesn't have.

Financial stability implications of decentralized financial system

I tried to sort out the issues by category of risk.

Market risks: the strength is that it could improve transparency of financial transactions, which could enable regulators to do real-time market monitoring and it would be helpful to identify source of risk and amount of risk. But on the other hand, it could have a negative impact due to volatile crypto asset markets, market integrity issues, or outdated monitoring tools.

Credit risks: The decentralized networks can help mitigate counterparty risk, and could reduce maturiy mismatch, and offer better credit assessment. But on the negatives, it could impact cyclicality, or it could cause some impact on monetary policy.

Operation risk: It could reduce human errors, at the cost of unclear responsibility like between developers and miners.

((There are a number of other risks from the slide.))

Regulator's pain points

There's a limitatoin on regulation because these are entity-based regulators. There's monitoring challenges, difficulties in recovery and resolution through effective intervention, and a lack of technical understanding. Most regulators lack technical understanding. Regulation alone may not be enough to achieve regulatory goals when the financial system becomes highly decentralized.

How can we achieve the financial regulatory goals in the public interest, even in a decentralized financial system?

Lessons from the internet

I think we can take some lessons from the development of internet governance. Most of you will be familiar. Before the internet, telecommunication authorities sufficiently regulated intermedaries just like financial regulators regulate banks. But the internet made the traditional approach difficult due to its global and distributed nature similar to the blockchain. Some regulators tried to control the Internet by replacing ICANN (administrator of TCP/IP and DNS) with regulated organizations through a series of United Nation discussions in early 2000s. This attempt failed and they accepted the concept of Multi-stakeholder governance instead.

Some of the issues in cyberspace cannot be solved solely by a regulator. As an example, a regulator tried to crack down on P2P file trading because it was infeasible to crackdown on everyone. Then there was some successful experience working together with regulators and stakeholders.

So maybe we can apply this concept to the blockchain. Law/regulation can be imposed on ecosystem participants such as minors. Market intervention too incentivize players. Government can join social activities to form desirable social norms. The government can translate law into code ("code as law").

This is from "De Filippi and Wright - Blockchain and the Law" 2018. Use the Laurence Lessig Code, 1997 graph for "classic governance model for cyberspace"- market, norm, law, and architecture.

Acknowledgement

This kind of concept is not only for us, but also for the global regulatory community. We are gradually admitting that there are limitations on traditional approaches, and we have to change our mindset to a multi-stakeholder application. As long as the objectives are considered in the design of applications and protocols, then we think that could help. We need a dialogue with all the stakeholders.

Our idea

What we want is to further develop this concept. We want to develop architectures/codes that comply with law/reuglation, align with norms, and is competitive in the market. This was published last month:

"Call for multi-stakeholder communication to establish a governance mechanism for the emerging blockchain-based financial ecosystem"

Developing such architecture requires multi-stakeholder cooperation. Regulators should give impetus or incentive to develop multi-stakeholder governance, rather than hindering innovation and communication among stakeholders.

Easy?

There's a lack of harmonization among stakeholders in the blockchain-based financial system. The lack of harmonization is an issue, especially when it comes to the relationship between open-source engineers and regulators. Some engineers might view regulators as enemies, and maybe sometimes vice-versa. We have to bridge the gap between stakeholders.

Healthy governance

The reason for this workshop in many countries is to help figure out multi-stakeholder discussions. Our ultimate goal is to achieve healthy governance through the introduction of code as law and market mechanisms. The regulator should play just one part of the role in the entire ecosystem, in joint with the other stakeholders. Joint work is necessary.

Our journey so far

This is a repetition, but our journey so far is that we had the FSB report on decentralized financial technologies, a June 2019 G20 finance ministers and central bank governors meeting in Fukuoaka, and then there are other workshops listed.

Blockchain global governance conferences

In March in Tokyo there will be a two-day workshop, one is a pane ldiscussion and the other is a day of unconference-style discussions. The participants will include academia, engineers, authorities and central banks, industry experts, etc.

Issues for discussion

Some of the discussion topics can include: privacy vs traceability: are these incompatible values? What are the appropriate KYC/AML requirements? What about standardization and interoperability? Should we wait for organic development for interoperability between blockchains? What about better incentive design to encourage good/bad behavior? What about backdoors and the technical neutrality of regulation? Architecture design ideal for engineers and regulators.

Maybe a regulator can operate a node on the blockchain and record transaction information themselves. This might take some time to change the regulatory mindset, but we should join the discussion and achieve regulatory goals that we want in the discussion together.

These transcripts are sponsored by Blockchain Commons.