Mark Branson: Regulators Face up to Cryptomania

2018-05-18 IMI

This article first appeared in The Bulletin published by OMFIF in May 2018. Mark Branson, Chief Executive Ofﬁcer of FINMA, the Swiss Financial Market Supervisory Authority. There is a hint of hysteria around the world of blockchain and cryptocurrencies, a heady atmosphere for ﬁnancial regulators. Regulators’ goal, without compromising on the core objectives of ﬁnancial supervision, should be to create an environment supportive of innovation. But they tend to have a natural conservative bias and only rarely communicate with the unproven next generation of market innovators. The system is stacked partly against innovation to the comfort of incumbents. That means regulators must be consciously self-critical when redressing the balance. That is why FINMA, Switzerland’s ﬁnancial markets regulator, has cleared the way for blockchain innovation. The country’s regulatory sandbox and dedicated ﬁntech licence were ideas proposed by FINMA. Financial technology, undoubtedly, holds great promise. Mobile banking is broadening access to ﬁnancial services. Roboadvising – online investment advice based on mathematical rules and algorithms – can reap the beneﬁts of artiﬁcial intelligence and machine learning at low cost. Crowdfunding is opening new channels for ﬁnancing. Then there is the blockchain, which many ﬁnancial institutions are testing. It is conceivable that parts of the ﬁnancial infrastructure will shift to this technology and render existing processes, and even some players, obsolete. Finance has beneﬁted greatly from technological advances. However, these improvements have not been passed on as lower costs to the consumers. And they have not halted the decline in the industry’s proﬁtability. Cyber and market risk For regulators, ﬁntech cannot only be about opportunity. Some of the risks associated with it are more philosophical or societal. There are questions about consumer autonomy as processes become more algorithm-based, as well as concerns about adequate privacy protection. The most obvious risk is cyber attacks. The ﬁnancial sector is the single most attractive target. Data from Melani, the Swiss reporting and analysis centre for information assurance, show that 62 out of 94 incidents reported to it targeting critical infrastructure in 2017 occurred in the ﬁnancial sector. A second important risk is the extent of outsourcing. As traditional value chains fragment, risks migrate. Many ﬁnancial institutions outsource back ofﬁce functions, increasingly across borders. The economic rationale is compelling, but should not come at the cost of stability. Data needs to be instantly accessible during a crisis and conﬁdentiality protected. Equally important is the stability of third party service providers, who are mostly non-ﬁnancial institutions. Then there is market risk. Bitcoin’s price rose 17-fold in 2017 and 64-fold in the last three years. Some see this as the biggest bubble in ﬁnancial history. For others, this is merely a short stop on the march to an anonymous and free ﬁnancial system. In my view, an anarchic, parallel monetary world is unlikely to grow to critical mass. The best way to exploit the potential of blockchain technology is to accept that innovation-friendly regulation and supervision is the best deal there will be. Categorising crypto tokens Initial coin offerings of cryptocurrencies erupted last year. Growing from a relatively unknown fundraising method used in the blockchain community, ICOs raised over $6bn in 2017 through almost 900 projects. Switzerland has become a hub for ICOs, with four of the six largest offerings in 2017 taking place there. Cryptomania is everywhere. Last year FINMA was ﬂooded with enquiries about the applicability of its regulation to ICOs. There were three basic options: anarchy, prohibition, or a third, more reasonable approach. The third option is quite simple. In assessing ICOs, FINMA looks at the economic function and purpose of the issued tokens, which are categorised into three types. Payment tokens are synonymous with cryptocurrencies and have no further functions or links to other development projects. Utility tokens are tokens which are fully functioning ways of providing digital access to an application or service. And asset tokens are tokens that are issued in fundraising processes and are functionally analogous to equities, bonds or derivatives. Payment tokens like bitcoin and newer utility tokens look like means of payment and are therefore subject to anti-money laundering controls. Asset tokens look like securities and therefore fall under securities law. There is an assortment of innovators, imitators, regulatory arbitrageurs and fraudsters in the cryptoworld. It’s the job of regulators to ensure that the innovators have the chance to thrive if their idea is worth it, that the arbitrageurs have nothing to gain, and that the fraudsters end up where all fraudsters should.

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Mark Branson: Regulators Face up to Cryptomania

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