compliance & regulation

FINRA Reports on Potential Implications of Blockchain

; Seeks Comment

WASHINGTON, January 24, 2017 /BUSINESS WIRE/ — Distributed ledger technology (DLT), better known as blockchain, has garnered significant interest in the securities industry, with many market participants indicating a desire for increased regulatory engagement as they explore the technology and its possible applications.

In response, the Financial Industry Regulatory Authority (FINRA) today issued a report that discusses the use and implications of DLT in the securities industry. The paper also seeks comments as part of an effort to obtain feedback on any challenges associated with the use and implementation of DLT.

“Over the past couple of years, FINRA has actively engaged with market participants to monitor developments related to DLT and its potential impact in the securities industry,” says the report, from FINRA’s Office of Emerging Regulatory Issues. FINRA believes this early collaboration “will allow the industry to reap the benefits of the technology, while ensuring protection of investors and maintenance of market integrity.”

The paper, which is intended to be FINRA’s initial contribution to an ongoing dialogue with market participants about the use of DLT, provides an overview of the technology, highlights key applications and discusses implementation and regulatory considerations for broker-dealers. Among the applications addressed are those being used or tested in the equity, debt and derivatives markets, as well as shared utilities.

Excerpts from the Report

Overview of Distributed Ledger Technology

This section provides a high-level overview of DLT and its key features.8 Distributed ledger technology involves a distributed database maintained over a network of computers connected on a peer-to-peer basis, such that network participants can share and retain identical, cryptographically secured records in a decentralized manner.
The operation of DLT may involve the use of a public or private network potentially containing digitally represented assets, where the participants on the network conduct and verify transactions, and record related data on the network in an encrypted format. In this section, we clarify this process by explaining: (1) the differences between public and private networks; (2) the use of digital assets; and (3) the general process for conducting and verifying transactions and recording them on a DLT network.

Public vs. Private Network

DLT uses either a public or private network. Public networks are open networks, accessible to anyone who wishes to join, without any restrictions on membership. Any data stored on a public network is visible to all network participants, in encrypted form. The first DLT network, centered on the issuance and exchange of bitcoins, was established as a public network. This network does not have any central authority; instead it relies on the network participants to verify transactions and record data on the network, based on a certain protocol.

Over the past couple of years, FINRA has actively engaged with market participants to monitor developments related to DLT and its potential impact in the securities industry...

In contrast to public networks, private networks are permissioned networks, and only those entities that have been granted access can join them. Private networks allow the network operator to restrict access and create an environment of known, trusted parties. On private networks, permission levels may also be tiered such that different entities and individuals may have varying levels of authority to transact and view data. There is a growing desire to employ private networks, particularly in the financial services sector, as various industries start to develop commercial uses of DLT while seeking to maintain greater control over network users.

Digital Assets on a DLT Network

A DLT network frequently contains assets that are digitally represented. The digital assets may be created on the network (e.g., cryptosecurities, cryptocurrencies), or may be a digital representation on the network of a traditional asset that is stored offline (referred to as “tokenized assets”).

Assets on a DLT network, whether public or private, are cryptographically secured using a public- private key combination. A public key is the “address” where the digital asset is located on
the network. A private key is the code that gives the holder access to the asset at the address represented by the corresponding public key. The private key is designed to be retained by the asset holder or its agent to access the asset.

Read the entire report here.




FINRA, the Financial Industry Regulatory Authority, regulates all securities firms doing business in the United States. FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. FINRA touches virtually every aspect of the securities business – from registering and educating all industry participants to examining securities firms, writing rules, enforcing those rules and the federal securities laws, and informing and educating the investing public. In addition, FINRA provides surveillance and other regulatory services for equities and options markets, as well as trade reporting and other industry utilities. FINRA also administers the largest dispute resolution forum for investors and firms. For more information, please visit here.