To achieve this, DLT/blockchain technology enables decentralised ecosystems. Transactions that have been agreed upon are carried out automatically on the basis of rules set down, for example, in self-executing “contracts”, known as “smart contracts”. Another manifestation of decentralised ecosystems can be found in a new form of organisation based on governance rules set down in DLT/blockchain.

The emergence of these decentralised ecosystems is also having an impact on the financial services industry’s traditional, established value chains. One of the effects is that the industry’s previously homogeneous value chains are becoming more and more fragmented or are disappearing entirely (disintermediation). This has the potential to bring about significant and long-term changes to the financial services industry as it is today. For example, it would no longer be necessary to involve financial intermediaries such as banks to carry out financial transactions. This could mean that DLT/blockchain changes the way that financial transactions work. The disruptive nature of these technologies does not just mean that transaction costs could be reduced, however; it also offers the potential for money to be earned from new products on new markets.

Keeping in mind the risks as well as the opportunities

A technology with such a potential for disruption brings opportunities, but also risks. Financial inclusion is an area where these technologies could present considerable opportunities for improvement, in particular in the countries of the Global South. In these countries, there are many people who do not have access to a bank account but are likely to have access to some means of digital communication, such as a smartphone. But innovative forms of decentralised finance (DeFi) promise to have advantages for developed regions too, potentially making capital markets more inclusive and more efficient. Before this future potential can be realised, we face the hurdles of risks and thus regulatory challenges. For example, there are still important questions to be answered about how to ensure that IT security and data protection requirements are fully met in systems based on DLT/blockchain. An important task for supervisory authorities such as BaFin here is to ensure that the integrity and stability of the financial market is maintained even as the circumstances around it change, as they have in recent years. To BaFin, consumer protection, another statutory supervisory objective, is also of importance.

Rapid developments on the market

In January 2009, the first block of the Bitcoin blockchain was brought into being, and the Bitcoin network has been running ever since without interruption. A further milestone was reached in July 2015, when Ethereum, a decentralised software platform based on blockchain technology, made smart contracts on blockchains possible for the first time. This marked the introduction of simple computer programmes that worked around the world without interruption and without the possibility of external intervention. Smart contracts were the foundation for decentralised autonomous organisations (DAOs), which opened the doors for new forms of organisation and new ways for these to be managed.

Smart contracts gave us an early glimpse of the potential the technology could offer. Subsequently, in 2017, came the peak of initial coin offerings (ICOs), a method of raising capital by issuing cryptotokens.

Even DAOs and ICOs showed a darker side to the technology, when offerors and investors encounter each other in a segment that is assumed to be unregulated and information asymmetry is not adequately reduced through an effective set of rules. However, it also became clear that long-known IT security basics should also be complied with in DLT/blockchains. BaFin published a number of consumer warnings in this regard. The risks inherent in crypto assets, such as volatility, cyber risks and information asymmetry, are just some of the points BaFin has issued warnings about. There are also complex issues such as the question of which country’s law should be applied to cross-border virtual transfers via a blockchain.

Since the emergence of asset-referenced tokens (“stablecoins”), decentralised finance and non-fungible tokens (NFTs), i.e. digital proof of ownership for immaterial goods, the potential of DLT/blockchain and smart contracts is becoming more and more evident to those who know the market. At the same time, awareness is growing that these technologies need to be explored in-depth and analysed from the perspective of safeguarding financial stability. The traditional financial industry is increasingly interwoven with the world of crypto assets. Some credit institutions are acting as pioneers in championing the potential of DLT/blockchain and smart contracts for deployment on the market. The biggest IT companies (Big Tech companies), which are predominantly based in the USA or East Asia, are also playing an important role in the development of DLT-based solutions on the financial market.

New supervisory issues

International standard-setting bodies, such as the Bank for International Settlements (BIS) and the Financial Stability Board (FSB), are already taking a very close look at the issues raised by the developments surrounding crypto assets. It is clear to supervisory authorities and central banks around the world that they need to take action to develop robust regulatory frameworks in light of the way in which DLT/blockchain applications and crypto assets are permeating the market.

These innovations are also a key area of focus for BaFin. In 2013, BaFin was one of the first supervisory authorities in the world to carry out a supervisory classification of Bitcoin. The German legislature also took regulatory action early on, such as by addressing crypto assets and crypto custody business in the German Banking Act (Kreditwesengesetz – KWG). In addition to a number of regulatory changes, BaFin’s expertise is now also being put to use in the development of the European Union’s Regulation on Markets in Crypto-Assets – MiCA. MiCA will create a European framework for crypto assets that will ensure they are handled and regulated in a consistent manner across the EU. Even in a future shaped by DLT/blockchain and crypto assets, BaFin will continue to safeguard financial stability and consumer protection.