President of German Finance Regulator: Blockchain has potential to fundamentally change financial markets

By Tom Braegelmann

The President of BaFin, the German Federal Financial Supervisory Authority, Felix Hufeld, delivered a keynote speech (in German) in Berlin on 7 June 2018 on the following topics

Blockchain, Smart Contracts and Dapps

with the following major statements:

Hufeld on Smart Contracts:

  • They are double-headed thingamabobs, somewhere between hype and success
  • Smart contracts have some striking weaknesses that make them susceptible to cyber attacks, among other things.
  • Their code has proven to be their Achilles’ heel in the past.
  • in addition, the code of a smart contract cannot be changed, “which considerably limits the smartness of these contracts”.
  • Smart  ontracts do not do justice to the principle known from civil law of subjecting contracts to review and evaluation.
  • An interpretation of a smart contract according to its intended meaning and purpose of a provision cannot be carried out automatically afterwards either.
  • Smart Contracts are about as smart as a “Juke Box” from the 70s, from which a fixed song sounded after insertion of a coin.
  • The contracts from the analogue world are – at least in this point – smarter. Even in the case of unforeseeable events, it is possible to come to a judgment and assessment and achieve what was really intended, even if conditions changed massively in the meantime.

Hufeld on Dapps:

  • The concept of a decentralized computer program made possible by smart  contracts could actually become revolutionary; this is also referred to as distributed apps (“Dapps”).
  • These apps are not only safe from failures of individual computers or providers, they also promote the development of a “blockchain economy”.
  • Some experts regard this economic model as a real alternative to the centralization tendencies of progressive platformization that we already see in North America or Asia, where leading Bigtechs handle banking business for millions of people in addition to traditional online services.

General statements on the potential of blockchain technology:

  • In Estonia, which was named “Most digital Country in the World” in 2015, blockchain technology is already being used in many public administration services
  • In Sweden, moreover, a pilot project has been running since last July in which this technology is used for land real estate registrations.
  • Some African countries could make a real quantum leap thanks to blockchain technology, for example concerning the documentation of property rights – which is a prerequisite, according to development aid professionals, to set real and sustainable economic growth in motion
  • Concerning the financial sector, there is the potential to turn an entire sector upside down
    • Especially because blockchain technology can make intermediaries – at least technologically – superfluous, since doing transactions without intermediary service providers saves money.
    • However, the disruptive potential of this technology extends beyond cost savings
    • Payments are automatically checked and, if necessary, instructed by computer protocols, so-called smart contracts, which digitally map contracts.
  • Non-techies can also see what opportunities blockchain technology offers to establish new standards on the financial markets.
  • However, by far the best-known representatives of blockchain technology are currently crypto tokens such as Bitcoin.
  • But to reduce the blockchain to tokens only would be fundamentally wrong.

What is BaFin currently doing?

  • Analysis and market observation
  • Hufeld said, “We must first classify the technological potential in a legally and economically sound manner, only then should we act.  However, we must not make the mistake of excessively doing to much. ”
    • “Innovations need room to develop, especially at the beginning.”
  • “However, if we identify threats to financial stability or consumer protection, we will recalibrate – whether at the level of supervisory administrative practice or in the fields of legislation and regulation.
    • “How do we deal with the tension between innovation and safety? It cannot be our approach to regulate the opportunities of a technology for fear of its risks.”
    • “Or as the former [German] Federal Science Minister Heinz Riesenhuber put it: ‘Anyone who sets up his or her life in such a way that he or she never falls on the face is only allowed to crawl on the stomach.'”
    • “That said, neither regulators nor supervisors should minimize the risks of blockchain or other phenomena of digitization.”
  • “As BaFin, however, we also need to keep an eye on consumer protection issues that arise, for example, in the initial issue of new tokens, the Initial Coins Offerings (ICOs). This form of crowdfunding has so far been an unregulated and highly speculative process, especially for private investors”.
  • “We will not be able to save every single investor from its fate, that cannot be the task of a governmental regulalatory body . Here, too, the maxim applies: We must take regulatory or supervisory action if overall financial stability would be threatened or consumers could be systematically harmed”.
  • The European Commission has published a FinTech Action Plan dealing with key regulatory issues relating to blockchain technology.