FINRA issued a report on Wednesday examining the uses and implications of distributed ledger technology in the securities industry. The paper provides an overview of distributed ledger technology, commonly called blockchain, and discusses the ways it could be used in the industry, as well as regulatory considerations for broker-dealers.
FINRA noted it intends the paper to be the first in a series discussing blockchain implications. It is seeking public comment on the paper until March 31.
A 2016 report by the World Economic Forum found that over $1.4 billion has been invested blockchain over the past three years, FINRA noted.
While there is debate over the speed and magnitude of disruption caused by blockchain, "most agree that the technology has the potential to bring additional efficiencies and increased transparency to the industry," FINRA wrote in the paper.
With those benefits, of course, come risks, namely to data security and privacy, FINRA found.
A distributed ledger may exist on a private or public network, according to the paper. The information on a public network is still encrypted, but anyone can access it. The lack of a centralized authority makes it an inefficient tool for financial markets, FINRA found.
Private networks have restricted access, set by an operator who may grant different levels of permission to users.
The assets on a distributed ledger may be created on the networks, such as cryptocurrencies, or digitally represented: traditional assets that are "tokenized" but stored offline. All assets in the ledger are secured by a public and private key. The public key gives the location of the asset, while the private key grants access to it.
Transactions on the ledger are verified, cryptographically hashed (meaning they are assigned a unique, non-reversible binary value) and permanently recorded with a timestamp.
(Related: But Is Bitcoin Safe?)
Rules That Could Impede Blockchain Implementation
There are a number of rules that could affect how quickly blockchain is taken up by the broker-dealer industry. Under the Securities Exchange Act of 1934, Rule 15c3-3 requires that brokers "maintain physical possession or control" over customers' securities. Rule 15c3-1 requires that they maintain a minimum level of net capital, which the SEC has said must include highly liquid assets.
FINRA Rule 4160 and Exchange Act Rule 17a-13 regarding asset verification are also roadblocks if firms can't assess which institutions hold which assets or develop processes to verify maintenance of those assets.
