DP14095 Embedded supervision: how to build regulation into blockchain finance

Author(s): Raphael Auer
Publication Date: November 2019
Keyword(s): Basel III, blockchain, central bank digital currencies, cryptocurrencies, economic finality, regtech, stablecoins, tokenisation
JEL(s): D20, D40, E42, E51, F31, G12, G18, G32, G38, K22, L10, L50
Programme Areas: Financial Economics, Industrial Organization, International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14095

The spread of distributed ledger technology (DLT) in finance could help to improve the efficiency and quality of supervision. This paper makes the case for embedded supervision, ie a regulatory framework that provides for compliance in tokenised markets to be automatically monitored by reading the market's ledger, thus reducing the need for firms to actively collect, verify and deliver data. After sketching out a design for such schemes, the paper explores the conditions under which distributed ledger data might be used to monitor compliance. To this end, a decentralised market is modelled that replaces today's intermediary-based verification of legal data with blockchain-enabled data credibility based on economic consensus. The key results set out the conditions under which the market's economic consensus would be strong enough to guarantee that transactions are economically final, so that supervisors can trust the distributed ledger's data. The paper concludes with a discussion of the legislative and operational requirements that would promote low-cost supervision and a level playing field for small and large firms.