Next Generation Financial Architecture. Part 4 - National BlockNet.
- 2. Next Generation Financial Architecture Page 2 of 5 Introduction For more than a century, the average cost of the financial intermediation in major economies has remained around 2%.1 Consolidation in the financial services industry has exhausted possible economies of scale and introduced inefficiency of complexity that offsets any productivity gains or technological improvements. The current financial system relies on the debt to compensate for its operational inefficiencies. Excessive leverage of the financial institutions poses a threat of collapse of the entire financial system. Reduction in costs of the financial services will reduce the need for excessive leverage. Financial architecture based on Blockchain technology with its cost of financial intermediation as low as 1bp2 offers an irresistible alternative to the current financial architecture. Objectives An important objective of the next generation financial architecture is to detect and prevent systemic and emerging threats to financial stability by fixing regulatory inconsistencies and closing supervisory gaps while reducing the cost of regulatory compliance. This can be achieved through global, decentralized, public utility that offers secure, transparent, and cost-efficient financial intermediation services. The global, public utility should be decentralized in nature, provide regulators of participating jurisdictions the ability to enforce domestic policies within their respective jurisdictions, and restrict transactions with other jurisdictions if such transactions pose a threat to their national security or violate their domestic policies. All satisfactorily identified participants of the financial markets should be able to transact using global, public utility without introducing or incurring systemic risk of the financial markets. The backbone of the next generation financial architecture should be a private BlockNet as further illustrated. 1 Thomas Philippon, 2016. The FinTech Opportunity. 2 Gideon Greenspan, 2015. Multichain Private Blockchain.
- 3. Part 4 – Private BlockNet Page 3 of 5 BlockNet BlockNet is a group of blockchains woven into a single multi-chain network. The Global BlockNet should be comprised of individual blockchains of participating jurisdictions as shown in Figure 1. Figure 1. Global BlockNet Each participating jurisdiction should control opening of identifiable accounts and issuance of domestic currency tokens. The Regulators of participating jurisdictions can restrict domestic transactions with untrusted blockchains, tokens or accounts netwide. This multi-chain framework can be further extended by replacing National blockchains with National BlockNets comprised of blockchains of regulatory agencies as shown in Figure 2. Figure 2. National BlockNet Blockchain technological limitations and level of economic activity within domain of participating agencies may dictate introduction of Agency BlockNets comprised of blockchains of covered asset classes or even at a lower granularity level.
- 4. Next Generation Financial Architecture Page 4 of 5 Identified Participants All market participants should be satisfactorily identified by relevant authorities of participating jurisdictions for prevention and detection of tax evasion, money laundering, terrorist financing, and other financial crimes. Private Blockchains must limit access to the network to authorized accounts and devices only. Enforcing identification requirement within participating jurisdiction should be done on the individual Blockchain level. Coordination across participating jurisdictions and management of connections between Blockchains would ensure proper identification of market participants throughout the entire private BlockNet. Centralization Decentralized, global utility requires some degree of centralization within Blockchain of individual participating jurisdictions as illustrated in Figure 3. Issuance of accounts and tokens within jurisdiction could either be delegated to authorized market participants with oversight by the respective regulatory body or done by the regulating agency itself. Figure 3. Centralization within jurisdiction Execution and validation of transfer and exchange transactions within and across jurisdictions must be fully decentralized. Any authorized market participant can act as a central counterparty in exchange transactions.
- 5. Part 4 – Private BlockNet Page 5 of 5 Systemic Risk There are three main features of the BlockNet that mitigate systemic risk of the financial system: 1. Issuance of security tokens into the BlockNet should be restricted to entities with immediate access to contingent capital through standard, convertible capital structure3 that is contingent on large price shocks. 2. Use of derivative should be limited to instruments with capped payoff and collateralized by the maximum payoff amount. Fully collateralized, tranched futures and options4 would ensure delivery-versus-payment settlement throughout the BlockNet. 3. Exchange of tokens on the BlockNet should be done through periodic auctions that make abuse of asymmetric information and high frequency trading uneconomical, reduce inessential trade volume, and smooth intraday volatility of the financial markets. Conclusions 1. Blockchain technology offers secure, transparent, and cost-efficient alternative to current financial architecture. 2. Private BlockNet ensures proper identification of users of the financial utility. 3. Multi-chain framework provides necessary flexibility to satisfy regulatory requirements of participating jurisdictions. 4. BlockNet removes systemic risk from the financial markets. 3 Eugene Kagansky, 2016. Next Generation Financial Architecture – Part 1 – Convertible Capital Structure 4 Eugene Kagansky, 2016. Next Generation Financial Architecture – Part 2 – Tranched Futures & Options