The Future of Blockchain in Financial Services

In your own words, what is distributed ledger and blockchain technology?

Brandon Caruana: People often use the word blockchain as if it is a brand-new technology, when in fact the technology is just an innovative way of combining old technologies that have been around for decades.

The first part of this ‘new’ technology is peer-to-peer (P2P) networking. P2P is simply when nodes on a network cut out an intermediary or a central authority (server) for communication between two end points. In a network, such as the

internet, with billions of devices (nodes), a P2P network can allow data communication to bypass a central server. Some of

the first applications to use P2P network communication were Napster and Skype and more recently, Dropbox and BBC iPlayer use P2P networking to stream content directly between their users.

The other central piece of blockchain is cryptography (thus the term cryptocurrency or cryptoasset). Cryptography is a mathematically provable way to cipher (scramble) and decipher (unscramble) data. Hidden behind the scenes, cryptography is the core of our modern economy enabling all global electronic based trade. An everyday example of this trade activity is when you buy a new product from Amazon, cryptography protects your personal information (credit card number, name, address) as it travels across the internet to be processed by Amazon.

Combining P2P networking and cryptography has given the global economy a new way of securely executing geographically dispersed trade, it is a new form of trust. The combination of these technologies has created a global immutable database that replaces the need for intermediaries or central authorities. This database is what we know as a blockchain, a chain of unalterable events that append onto previous events and combine to provide a secure, publicly accessible ledger. In short, the most important innovative feature of a blockchain is a new way to mathematically prove (cryptographically provable) trust directly between any two or more (P2P) end points (people, companies or computers).

Bitcoin was the first, and currently most well-known implementation of this new P2P, cryptographically secure trust system. New innovations since have included introducing the concept of a globally distributed computational network, taking the trust to new heights by introducing programmable agreements (smart contracts). Now any asset (capital, currency, real estate) can be cryptographically represented and traded based on a programmable set of rules and conditions. Think of buying a car, if it was a cryptographic asset that could prove it had all of its oil changes and proper maintenance, the buyer would trust the car’s history and the trade between the car and currency could be fully automated.

Does the blockchain have the capability to disrupt and establish a new model of trust?

Andrew Schofield: In short, there is true potential for disruption. While financial services customers now have mobile and web applications for services that they would traditionally get in a bank branch, the underlying technology is decades old.

The opportunity of blockchain and P2P transactions and the promise of trustless value transfers really does threaten financial services as trusted intermediaries in a significant way.

The concept of a distributed ledger technology might not just impact the financial services sector but also the accounting profession, because the idea of a single source of truth that is immutable and that everybody has access to is a very big departure from the way existing financial institutions work.

Now institutions maintain a set of books and records on their existing legacy systems. There is significant potential to revamp these systems. The challenge for existing financial institutions is to maintain relevance and not be cut out entirely in a peer-to-peer world.

Jun Hasegawa: The blockchain has already affected the financial services industry and will continue to do so. But rather than disrupting, it is currently still harmonizing with existing industries.

We are in a phase that is comparable to the mainstream adoption of the internet in the 1990s, when everyone started to create content but the internet infrastructure itself and internet speeds were not able to support all the transactions and services.

It was, at that time, not really disrupting industries but this changed in the 2000s, when the disruptive power of the internet was unleashed.

For financial services today we are on the cusp of change, where decentralised public networks, like our own OMG network, can bridge legacy financial systems with blockchain technology to help alleviate performance problems, remove friction and ease capital flow bottlenecks.

We hear a lot of debate about public and private blockchains. Why does it matter?

Brandon Caruana: There is a very limited use case for a private blockchain. As soon as there is no need for consensus algorithms and public transparency, one might as well use a traditional database, it’s faster, easier to manage and much more scalable.

There are, of course, some fringe examples of successful private blockchain deployments between a small number of trustless entities that need a semi-private immutable record for a specific trading purpose, but the real billion and trillion dollar opportunity for financial markets is an open public blockchain. The Cayman Islands is in a unique position to capitalize on this changing economic landscape and position itself as a software-based innovation island, and I am excited to see the methodical and measured approach our Government and regulators have already taken in monitoring and testing out guidelines for our jurisdiction in order to attract some of the best-structured fintech companies and other scalable start-ups.

But in order to fully achieve this, the way to go forward is to create a walled garden but in the public sphere, like Omise is doing by adding side chains outside of the main (Ethereum) blockchain. For example, by building a global platform for open financial services Omise is helping to enable transparent, P2P transactions in real-time and facilitate self-sovereign financial services across geographies, asset classes and applications.

Jude Scott: When we look at the general economy and layer global financial services on top of that, we need to go to a permissioned environment at the top level. Because you need certainty as to who the parties are that are transacting, you need certainty that a transaction is actually happening. When you are talking about high value transactions you need to have legal recourse. So, if there is failure of the transaction, if there is fraud, you have the ability to address that.

I believe that regarding blockchain and virtual assets in global financial services the lack of effective anti-money laundering (AML) solutions has been one of the barriers that are holding back this amazing technology from being fully implemented. In Cayman we are working on a certified digital AML platform, which we believe can effectively address that.

The second barrier is taxation but solving the AML piece is the first step to be able to properly tax the right transactions.

Another factor, I believe, is there has to be faster implementation of digital fiat currencies. We are still working in an environment that is primarily based on regulated banking and there has been a real resistance to seek to use cryptocurrencies through that system even with new technology. As a result, the ability to settle the transactions with digital currencies, working through the current system is generally not available.

What Cayman is working to develop is a trusted, digital regulatory framework which can provide AML protections that work in the general economy but also have an enhanced piece for global financial services transactions. And then you have an environment that regulators, global policing authorities and tax authorities can trust.

What does Cayman need to do to adapt to this technology with the right level of regulation?

Jude Scott: I think we have been doing all the right things so far. I think we recognise our important role as a premier global financial hub, that leadership role. We have been investing our time evaluating the technology, understanding the risk, looking at what other countries are doing, looking at best practices.

Considering the way that we currently regulate through regulated transactions and regulated intermediaries, we have always been of the view that the sound principles of regulation need to evolve to be able to be built upfront into the new technology. Because when blockchain technology is fully deployed in global financial services, there are not going to be any intermediaries in the P2P transactions.

We believe that one of the core unlocking mechanisms is dealing with the issue of how to incorporate AML into the technology. Once you are dealing with the AML issue it allows you to move either to open or closed environments, it allows you to efficiently use digital exchanges, create digital assets that can be trusted, having fund-issued tokens that can be traded in secondary markets.

I think we have been smart not to jump and plant the flag too quickly but learn and build it like we built the rest of our industry.

Is there a danger of overregulating, for example in response to the recently issued guidance by the Financial Action Task Force (FATF) on how to regulate virtual asset service providers?

Melissa Lim: I don’t think we are overregulated. Cayman has maintained its leading offshore position because it has complied with the highest international standards. It is in our interest to continue that and ensure that we follow FATF’s guidance. Obviously there needs to be a balance and regulation may seem onerous at times, but it also breeds additional innovation. Because of the FATF’s guidance, programmers out there are trying to develop software to comply with such AML standards.

I agree with Jude, it is great that we did not jump in quickly with new legislation. But I think it is about time that we now do so because we have had no legislation specifically dealing with digital assets. We have had input from Cayman Finance to the government, the government has set up a legislative drafting subcommittee for digital assets and such subcommittee is working with CIMA and the government towards legislation for digital assets. The market is looking for that guidance.

Brandon Caruana: We cannot stifle innovation for the matter of studying what everyone else is doing. For example, one of the things that is so powerful about Omise is that they are not only dealing with national governments at the regulatory level but also interfacing with bodies like the World Bank, World Economic Forum (where they are a member of the Global Blockchain Council convened by the WEF), the Bank of Thailand, Thailand E-Payment Trade Association (TEPA), Paladion Networks, the ETDA, Japanese Cabinet Office for Japan Regulatory Sandbox, JFSA (Japan Financial Services Agency), the MFSA (Malta Financial Services Authority), and they are also collaborating with UNICEF Innovation to promote the use of blockchain technology to solve development issues. Additionally, OmiseGO has recently onboarded Ms. Tipsuda Thavaramara as their Regulations and Compliance Advisor. Tipsuda was previously with the Thailand SEC Deputy Secretary General in charge of Policy, Markets and Intermediaries, and Investment Management.

Here is a company that is spring-boarding integration with regulators and technology, fully understanding the interface between the two and trying to get the momentum going, rather than letting study and analysis hold them up.

Melissa Lim: In that context, I think it is helpful that the Cayman Islands Monetary Authority (CIMA) and the Ministry of Financial Services have indicated publicly that they want to introduce a regulatory sandbox, which has worked really well in the UK, in order to encourage tech companies to come on island and work with the regulator with a restricted license. These companies will have the oversight of CIMA but they can test out new things as well.

What is the impact of new technologies, like Facebook’s announcement of Libra, for the offshore industry in general?

Andrew Scholfield: All of these announcements point towards a world where you have that transfer of value on a P2P basis on the internet. That is going to create a more globally connected world. A jurisdiction like Cayman, that does have very strong historical track record of both regulatory compliance and creating a business-friendly environment, can be very well positioned to take advantage of that.

As we move towards a more decentralised world, more and more businesses will look to jurisdictions like Cayman to domicile their interests and to operate a more global business rather than being tied to one onshore jurisdiction.

I think Cayman positioning itself as a domicile of choice for businesses that are looking to, for instance, disrupt the payments industry can only be viewed as positive.

Melissa Lim: From a legal perspective, if you look at offshore banking and onshore banking and how to make payments more efficiently, we are looking at smart contracts. There is talk of Cayman updating the Electronic Transactions Law to expressly recognising the concepts of blockchain and smart contracts in order to give greater certainty to smart contracts. I suspect that in the future lawyers will probably need to learn some coding in order to be able to code the smart contracts onto the blockchain protocol. Cayman is also considering using DLT for share registers, aviation registers and shipping registers.

What is happening at the moment in Cayman in terms of blockchain and crypto?

Melissa Lim: Cayman has a lot to offer because we are a traditional offshore investment funds industry. There is just so much investment in blockchain projects and Cayman features in many of these projects.

We are setting up crypto funds and venture capital funds investing into blockchain projects. We are setting up joint ventures with big players wanting to invest into blockchain projects. We are setting up Cayman entities in offshore structures that are engaging in proprietary crypto trading or advising companies on crypto trading. We are working on security token offerings (STOs). Clients are also looking at tokenising real estate, art and other tangible assets or intangible assets like shares in a Cayman company`2.

Basically, anything that involves the digital asset space, we are seeing.

Jun, you looked at the Cayman Islands as a place to do business. Where do you think the jurisdiction fits in with this technology?

Jun Hasegawa: Omise is looking to expand into key global financial centers. Our priorities and criteria to evaluate these jurisdictions are based on transparent and stable regulatory frameworks, access to top caliber professionals, and a collaborative environment to grow the business. As the sixth-largest financial centre in the world and home to over $2 trillion in institutional capital, Cayman is in a very special position to channel capital on the investment side.

Security token offerings is another area in which the jurisdiction is well-placed, and we have done a lot of work with PLCs and large financial companies on security tokens and bond issues.

Property companies are also trying to create new real estate investment trusts (REITs) but specifically for property security tokens.

What can Cayman do outside of financial services to bring tech companies to the islands and diversify the local economy?

Jude Scott: It is a very natural fit. As a starting point it is always great to have an anchor for the platform. Originally the financial services industry was built on banking. Now banking is just one of six key sectors.

When we look at technology, we already have incredible use cases here in Cayman for converting the virtual assets that are being invested into by our funds or converting the insurance contracts that are established by our reinsurance and captive insurance companies. There are other examples around special purpose vehicles (SPVs) and the ability to track collateral.

We will continue to attract talent into the jurisdiction to build solutions for that. This creates new opportunities. Since we are a tax neutral jurisdiction, all of this technology is built in an environment that does not charge income or capital gains taxes, while enabling better tax collection by other countries through the automatic exchange of tax information for investors from their jurisdiction.

Jun Hasegawa: One of our company priorities is addressing the fundamental need for a scalable network in order to capitalise on all the potential of a tokenised economy. We already mentioned REITs, bonds, payments, STOs, everything that needs scalability. We also live in a mobile world with a very large population of underbanked, people who lack access to basic financial services (savings, lending, payments etc.) and in a tokenized economy, individuals could transact freely over permissionless networks with strong ownership rights and privacy.

At Omise, our vision is Payment for Everyone, but payments are broken. Networks are fragmented, access is limited, and counterparty risk is high. With the advent of cryptocurrencies and the broader blockchain technologies there now exists the means by which we can re-think these assumptions. There is currently an opportunity, and a need to rebuild financial services that is accessible and open to all, and pricing is both fair and transparent. And that is something we are specialized in and we look forward to bringing our resources to Cayman to help in whichever way we can.

Note: Following the roundtable, Omise Holdings was featured in the July 2019: Thailand Economic Monitor – Harnessing Fintech and Financial Inclusion published by the World Bank. OmiseGO was also part of the “Blockchain in depth: No more hype” panel at the recent Bank of Thailand Fintech Fair 2019 on 18-19 July 2019. Ms. Tipsuda Thavaramara, OmiseGO Regulations and Compliance Advisor and former Thailand SEC Deputy Secretary for Policy, Markets and Intermediaries, and Investment Management joined OmiseGO’s July Ask Me Anything (AMA) video. Watch it here.

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Michael Klein
Michael Klein Editor Compass Media Ltd. PO Box 1365, Grand Cayman, KY1-1108, Cayman Islands T: 345-326-1720C: 345-815-0064 E: [email protected] Michael is a financial journalist and copywriter.  In the past he has been responsible for the Risk Management and Corporate Finance sections of a British monthly Corporate Treasury publication.  He has written various financial handbooks, notably on European Banking and Cash Management and the Debt Capital Markets.   In addition he has worked as a copywriter for banks and investment funds and served as corporate communications consultant to US and European blue chip companies.   Michael holds an MA in Political Science and International Law from the University of Bonn in Germany. 

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