Blockchain Was Supposed to Set Us Free. So What Happened?
Threatened by the blockchain revolution, traditional financial institutions are hindering regulation that could decentralize the financial system, writes fintech regulation lawyer Saul Adereth
Last year we read a lot about the big promise of blockchain. The technology was supposed to take us from bondage to freedom–at least financially speaking. In its interim report from March 2018, the Israel Securities Authority (ISA), noted that the distributed ledger technology (the technology at the core of blockchain) has the potential to turn the financial world into a more efficient ecosystem, both locally and globally.Facts aside, as indicated by the FATF, there is one risk bigger than that of crypto-related money laundering: de-risking. It is the responsibility of the Bank of Israel to take a lead and assist the financial sector in breaking through the walls put up by banks.
Blockchain technology allows us to absolutely verify any form of money transfer and prevent double spending, simply, and without centralized organizations such as banks and other account managers.
Saul Adereth. Photo: Oren Dai
Unfortunately, in the past year, we have seen little to no progress in the promotion of a regulatory environment supporting the development of blockchain and its innovative potential. Whether it is because the buzz died down, investors moved on to other fields, startups changed strategies, or due to regulatory pressure—at the end, we are still chained to the banks.
The less talked about side of the story of distributed ledger technology is that banking institutions have marked it as having the potential to disrupt their existing financial hegemony. By moving the financial assets out of banks and into privately held digital wallets, blockchain could potentially make banks obsolete. Currently, very few blockchain-related companies keep an Israeli bank account, and funds transferred to or from known crypto exchanges are blocked by the banks.
Banks, of course, rarely admit to being threatened by blockchain. Instead, most point out legal concerns. A 5-year-old public statement by the Bank of Israel listing the risks associated with distributed virtual currencies is often evoked to bolster banks' stance against the blockchain.
This behavior, dubbed "de-risking," is a serious concern according to intergovernmental organization the Financial Action Task Force (FATF). According to the FATF, de-risking may drive financial transactions underground, create financial exclusion, and reduce transparency, thereby, quite ironically, increase money laundering and terrorist financing risks.
Banks rely on the actions, or rather the inactions, of various regulators. The ISA was one of the first regulators to acknowledge and investigate blockchain technology, and one of the first regulators in the world to implement blockchain into its systems, back in early 2018. In its interim report, the ISA said that one of its goals is to increase confidence in the finance sector while balancing the promotion of technological innovation with the protection of the public of investors.
However, it seems that the ISA is leaning towards what it deems as public protection, adopting the rhetoric of the U.S. Securities and Exchange Commission (SEC) by saying that (almost) all distributed ledger technology projects should be regulated subject to securities laws. The ISA points out some of the most basic features of blockchain technology, such as the existence of a secondary market, the recent hype that caused a surge in speculative investments, and the fact that blockchain companies openly state that over time they will upgrade, evolve, and provide newer and better products.
Another key regulator is the Bank of Israel, which authored a 2014 public statement, pointing out the lack of supervision over the trade of what is colloquially known as cryptocurrency, as well as the increased risks of fraud, money laundering, and terror financing. These suppositions were not updated in over five years. Perhaps it is time to challenge these assumptions, by looking at more advanced markets, such as Japan–by far the global leader in cryptocurrencies activity. A recent report by the Japanese police, studying all suspected incidents of money laundering in the country, indeed pointed out a 10-fold increase in the number of cases of crypto-related money laundering. But such an increase is the stuff of headlines. In fact, these crypto-related cases amounted to 1.6% of all researched money-laundering cases.
And as for the problem of fraud–a cause for concern and a major reason for the drop in the blockchain-related hype–one could only hope that better regulation and the maturity of the market will drive out all fraudulent projects and allow for real honest entrepreneurs to flourish.
Saul Adereth is a partner in the Israeli law firm Shibolet&Co, where he serves as head of blockchain and smart contracts practice and fintech regulation.