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Embedded Supervision: How to Build Regulation into Blockchain Finance

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Abstract

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, i.e., a regulatory framework that provides for compliance in tokenized 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 decentralized 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.

Suggested Citation

  • Auer, Raphael, 2019. "Embedded Supervision: How to Build Regulation into Blockchain Finance," Globalization Institute Working Papers 371, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddgw:371
    DOI: 10.24149/gwp371
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    References listed on IDEAS

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    1. Thomas Philippon, 2015. "Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation," American Economic Review, American Economic Association, vol. 105(4), pages 1408-1438, April.
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    More about this item

    Keywords

    tokenisation; stablecoins; asset-based tokens; cryptoassets; cryptocurrencies; regtech; suptech; regulation; supervision; Basel III; proportionality; blockchain; distributed ledger technology; central bank digital currencies; proof-of-work; proof-of-stake; permissioned DLT; economic consensus; economic finality; fintech; compliance; auditing; accounting; privacy; digitalisation; finance; banking;

    JEL classification:

    • D20 - Microeconomics - - Production and Organizations - - - General
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • K24 - Law and Economics - - Regulation and Business Law - - - Cyber Law
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • L50 - Industrial Organization - - Regulation and Industrial Policy - - - General
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General

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