Following President Xi’s announcements on a meeting of the Political Bureau of the CPC Central Committee, which highlighted the strategic development of Blockchain on October 24, 2020 started off with a bang as FinTech took center stage at the events surrounding WEF Davos and the China perspective being chief among topics of interest. There was much discussion surrounding the attitudes of Central Banks and national digital currencies, the future of asset digitalization in the wake of a relatively sleepy STO (Security Token Offering) market in 2019, and the potential for FinTech to do good and contribute to sustainable development.
China’s Central Bank Digital Currency in the Pipeline
President Xi publicly remarked in October that China must position itself to take a leadership role in Blockchain, unleashing the floodgates of Blockchain reform and activity that had been slowly building in China including the subsequent announcement by the People’s Bank of China (PBOC) that it is moving forward with the development and launch of its Central Bank Digital Currency (CBDC). The rest of the Blockchain world has responded in kind with countries like Thailand making CBDC announcements and the US accelerating its own plans in the area.
Central Banks issuing digital currency provides the critical channel linking physical cash settlement and digital transactions/assets, allowing seamless transfers of currency and the exchange of digital-for-physical. This is potentially the final major missing link that will enable the true integration of digital assets and physical commerce.
China has announced a two-tier system where PBOC will continue to play a core role, pushing CBDC down through the policy banks, which in turn will provide liquidity for digital transactions. In contrast with fully decentralized systems, this hybrid option potentially delivers a more measured approach, one that benefits from the many of the advantages of Blockchain technology while also effectively engaging regulators and existing financial institutions. It appears that China is now clearing out unlicensed, unregulated players in anticipation of controlled deregulation. This is an opportunity for existing mega-players, particularly third-party payment providers, to become a core conduit for China’s CBDC to popularize.
The early action is likely to be in testbeds and special economic zones and is likely to remain domestic. An open question, then, is what about international settlement? True gains in the overall efficiency of the economy will rest in how well/quickly exchanges develop for the assets that the currency serves. It could be the case that existing mega-players will take on the role of market-makers in the absence of true exchanges.
Digital Assets Adoption Driven by Tokenization
One should not discount the development of STOs as a major watershed moment for digital asset adoption. In many jurisdictions, especially in developed economies, legislation and regulation already exists for traditional assets. While ICOs (Initial Coin Offerings) and the original principles of full decentralization have slowed adoption by regulators seeking to provide investor protection, STOs are an opportunity to couch the development of digital assets in existing regulatory frameworks—think revising policies rather than writing policies from scratch. This may be just the thing many economies need to jolt them into action as it’s clear that the ability to monitor and to provide transparency is important to regulators. Thinking back to the unregulated days of credit default swaps (CDS) in 2008, it’s clear that the lack of transparency in securities and of effective monitoring contributed to both bad behavior and loss of investor confidence. We have already seen that bitcoin futures, overseen by the US Commodity and Futures Trading Commission, have begun to reduce volatility in that core digital asset.
In China, where it appears core players are ready to move forward with a digital asset ecosystem that is inclusive of appropriate regulation, sandboxes have been proposed by a number of regional authorities, notably Hangzhou and Shenzhen. Asset-backed, tokenized assets, particularly those backed by real estate, appear to be first on the to-do list and represent a relatively small revision to existing securitization and trust-fund regulation. With money laundering and investor protection important concerns, central monitoring is going to be a must. It would not be surprising to see policy in this space to mirror the two-tiered approach taken with respect to CBDC.
FinTech Empowers Sustainable Growth along the Belt and Road
There is much discussion of how FinTech developments will impact sustainability, specifically financial inclusion and long-term viable economic ecosystems. Financial inclusion is featured prominently in the 17 United Nations Sustainable Development Goals, and one area of potential impact is the use of tokenization to fractionalize infrastructure projects along the Belt and Road. These projects tend to require large capital outlays with long-term horizons, two characteristics that are the ire of financial investors. Fractionalization provides a way to split the large capex into smaller parts that may be absorbed, at least in part, by the local economy. This has a number of advantages.
Fractionalization provides for financial inclusion by reducing minimum investment size, allowing local constituencies to benefit from the resulting economic growth. At the same time, it potentially creates a new set of investable assets and much needed liquidity, providing a tool for wealth growth and preservation where few options may be available.
Furthermore, infrastructure delivers benefits to the local economy far in excess of the financial return of the project itself including local revenue generation, industrial development, and improvements in overall quality of people’s life. As such, local investors value the projects more dearly than financial investors and are generally willing to hold investments for longer horizons. Foreign investors discount the projects for their length, country risk, and other considerations, so financing locally lowers cost of capital, improves the overall shareholder structure, and reduces development risk and initial outlay for the project initiators.
Finally, Blockchain provides assurances with respect to property rights, agency concerns (since it is a direct investment rather than executed through an intermediary), and execution through the application of smart contracts. In developed countries, this might not amount to much, but it might indeed be the most important advantage of the Blockchain approach in emerging economies.
Spotlight: FinTech in Shanghai towards a Symbiosis
The Shanghai Municipal Government has joined the charge to quickly improve the environment for FinTech development in its announcement of the “Plan to Hasten the Development of the Shanghai FinTech Center”. Along with a call for increased research and development and policy/regulatory reform, the plan also calls for development a FinTech ecosystem and community, something that is consistent with the core principles underlying Blockchain and information sharing. Given its existing strength in financial services, combined with its vibrant international presence and resources, Shanghai should be well-suited to take the lead.
Also noteworthy is the call for development of FinTech applications and not just hardware support as well as the engagement of a variety of stakeholders ranging from customers, users, developers, regulators, and the traditional finance industry. The willingness of the “hard-core” FinTech players to work together with, rather than compete against, existing mega-firms in the financial system and vice versa will be critical in determining whether Shanghai will achieve its long-term goals.
Blockchain Applied in Public Health
The current health emergency surrounding COVID-19 has highlighted a potential use-case for blockchain technology as it has highlighted the need for a nation-wide (or even global) reporting system that is validated, transparent, and secure. Existing multi-layered systems unfortunately slow reporting and information aggregation. For example, a certain number of cases must “amass” in each locality before it gets noticed by the national authority and a certain amount of time elapses before information from numerous reporting entities (hospitals/clinics/etc.) can be collected. Local health units have a limited amount of information, each seeing only a part of the picture, unable to benefit from the large sample size or combined expertise that a shared information structure would provide. Even well-intentioned, mis-informed individuals can further mislead findings or exacerbate responses once the crisis is identified.
A distributed data structure could ensure faster information dissemination leading to quicker identification and call to action. Further, the transparency of such information will allow multiple actors to study information simultaneously, allowing red flags to be raised more quickly with fuller information and greater confidence. Such determinations, arrived at by consensus, would help to block mis-information in a time and situation prone to panic, and a Blockchain-based system can provide both the security and incentive opportunities to encourage good actors and reduce the influence of bad ones.
Such a system should benefit from it shared, distributed nature, encouraging a high level of collaboration between medical authorities, hospital staff, and members of the community. This kind of a hybrid chain structure delivers higher auditability than private chain while maintaining the high level of security and data throughput difficult for some public chains. Such a system would be more transparent and more flexible than the existing reporting system while being actively monitored by authorities.