A Financial Conduct Authority (FCA) discussion paper is seeking views by July 17 on the potential for future development of distributed ledger technology (DLT) in the markets it regulates. The paper does not expressly define DLT, but refers to a record of activity that can be safely distributed to, and acted upon, by a network of varied participants, or a "blockchain" where records are "collated" into "blocks", and linked using a cryptographic signature.
The FCA acknowledges that the implications of DLT are not yet fully understood, and highlights its approach of "technology neutrality" - not regulating specific technology types, but only the activities they facilitate. However, it also notes that a variety of use cases, some only theoretical, has prompted it to take a closer look at DLT.
At this stage the FCA does not see a clear need to consider changes to its regulatory framework. Instead it wants to explore emerging business models and how their potential risks and opportunities operate in the context of regulatory frameworks. In particular, what new risk does DLT present to market integrity, consumer protection and competition? How can regulated firms mitigate risks? And do any of DLT's characteristics make it challenging to fit DLT solutions into the regulatory framework, despite the FCA's approach of "technology neutrality"? Further questions include:
- How will firms demonstrate appropriate outsourcing arrangements when relying on third parties (such as core developer groups of public, permissionless networks) to deliver DLT-based solutions?
- How might DLT be deployed to mitigate financial crime risks, and will regulated firms adopt such solutions?
- Where should responsibility lie in "fully decentralised", public, permissionless networks with no central point of control or regulatory nexus?
- What other examples are there of DLT providing direct and tangible benefits to consumers?
The discussion paper is aimed at both users and providers of DLT solutions in the sectors the FCA supervises. It encourages regulated firms, start-ups and technology companies to provide input where possible. It also invites the perspective of consumer groups where there is interest, and next steps might include a Summary of Responses or a Consultation Paper.
In its simplest form, blockchain is a decentralised technology or distributed ledger on which transactions are anonymously recorded. This means the transaction ledger is maintained simultaneously across a network of unrelated computers or servers called "nodes", like a spreadsheet that is duplicated thousands of times across a network of computers.
The ledger contains a continuous and complete record (the "chain") of all transactions performed which are grouped into blocks: a block is only added to the chain if the nodes, which are members in the blockchain network with high levels of computing power, reach consensus on the next "valid" block to be added to the chain.
To determine the validity of a transaction, the nodes must solve a highly complex algorithm to verify the relevant transaction (on the Bitcoin Blockchain this is known as the "Proof of Work"). Only once it has been verified can a transaction form part of a block and that block be added to the blockchain. The first node to solve the algorithm and validate the block should be rewarded - on the Bitcoin Blockchain this reward takes the form of Bitcoins and this is referred to as "mining" for Bitcoins.