Bank of England Considers Future Regulatory Oversight of Ethereum, Public Blockchains – Ledger Insights

This week, the Bank of England published a blog post summarizing its analysis of the governance of public blockchains. It asks how to govern a blockchain that is becoming a critical part of financial infrastructure. The focus was on permissionless blockchains and, for now, Ethereum, although it notes that it does not consider the blockchain critical. Yet.

“In the traditional financial system, critical financial infrastructure is regulated to deliver an appropriate level of responsibility, accountability and control,” the blog post said. “So, it’s a question of what appropriate regulatory oversight of a blockchain might entail, should it become a more critical part of the infrastructure of the financial system.”

It pointed to the Ethereum merger, a very risky move from Proof of Work to Proof of Stake to secure the network. Frankly, it is difficult to criticize the transition on a technical or process level, and one has to question whether conventional institutions could have handled it better.

However, that is not what the bank is worried about. It wants to know what would have happened if something went wrong. Who would take responsibility and would be responsible for the financial loss? We would risk an answer to the loss: the token holders.

The bank also mentioned that the UK wants to extend liability to critical third parties involved in the financial sector, such as cloud hosting companies.

Many in the crypto world are concerned that the move from Proof of Work to Proof of Stake makes the network more vulnerable to oversight.

On the flip side, the Basel Committee on Banking Supervision also has concerns about permissionless blockchains. Digital securities are treated (more or less) in the same way as conventional securities for Basel III risk assessments. These lower risk cryptoassets are classified in ‘Group 1’ compared to cryptocurrencies which fall under ‘Group 2’ with higher risk.

Last week, the Basel Committee published the final version of the crypto-asset rules. It says, “The Committee will continue to reflect on whether the risks posed by cryptoassets using permissionless blockchains can be sufficiently mitigated to allow inclusion in Group 1 and, if so, what adjustments to the classification conditions would be necessary.”

The SWIFT example

Based on the bank’s blog post, we will point to other networks that have been free of supervision. And how there may also be new permitted blockchain networks that also become powerful and are not directly regulated.

Take the example of SWIFT. It is not a payment system and is therefore not covered by conventional payment rules. You read that right. At a technical level, SWIFT simply transfers messages over the network. It does not actually make any payments. As a result, until 1998, it had a free pass from regulators. At the time, central banks concluded that it was too large and important and therefore needed to be monitored by central banks as a “critical service provider”.

And that is how the bank would view Ethereum if it became critical.

How architecture affects regulatory oversight

As a side observation, the choice of how a blockchain network is structured is critical to its ability to grow unfettered by regulation.

Take the example of Fnality, the approved payment network supported by 17 financial institutions. The chosen path is to have an omnibus central bank account, where the shareholder banks deposit money which is then tokenized for payments in the chain. This choice is a result of the goal of creating a single liquidity pool that a bank can use for multiple applications and platforms.

However, as a result, Fnality must obtain approval from each central bank in any jurisdiction in which it plans to operate. It is a slow painful process. It has already been designated as a systemic payment provider in the UK, and the Bank of England delayed its planned launch in 2022.

In contrast, Singapore’s Portior, where JP Morgan is one of four founding shareholders, does not have a central bank account. Instead, it is the network operator where the banks have nodes. So it is far more like SWIFT. As a result, Partior will be able to expand relatively quickly.

That is not to say that the Partior route is better than the Fnality route. They both target interbank payments, but with different priorities. And in both cases, if something went wrong, the legal liability would be clearer compared to Ethereum.