Ensuring the Lawful Use of Digital Signatures for Business Transactions in United Kingdom

How to eSign a document: digital signature lawfulness for Business Transaction Management in United Kingdom

it is my pleasure now to introduce you shane economic advisor and head of research at the bank of international settlements who will be speaking on decentralization in digital finance possibilities and limits without further ado the floor is yours very good to have you here just to set the stage you know we can think of uh money uh in uh in the classical theory of money as a record-keeping device it's um it's a record of goods sold and services rendered in the past and there is in fact a very famous paper by narayana koch lakota that has an analysis of money as a giant ledger uh that records the complete history of all transactions so we have a sense of who is what to whom now in that kind of approach lugging around the huge ledger was more uh uh a a theoretical construct uh it was there partly to show uh how much more elegant money is as a convention because you wouldn't need such a complete ledger uh to record uh who owes what to whom but the irony of course is that the advances in cryptography and computing has actually made that kind of ledger feasible technically and that's where we have uh blockchain technology so let's go to the next slide right so what is the rationale for for this kind of uh um universal ledger and what is the the rationale behind blockchain well the idea is that blockchain um really um brings governance benefits in the sense that it gives the kind of checks and balances that are going to promote the integrity of the system without having to rely on um a a central authority a central trusted authority you know like the central bank and without the need for intermediaries like like commercial banks and the idea is that we can update the ledger through consensus by giving incentives for to the to the validators the miners to update the ledger in such a way that will bring that will stick to the unique true path of of transactions now it's a really ingenious idea and and the governance benefits are clearly very are are clearly very large but the question is um what are the costs of going in this direction and what are the trade-offs that are involved and i'd like to say um uh i'd like to take a couple of uh results from a working paper uh that i've written with some with some colleagues uh on um in exploring some of the some of the detailed trade-offs here let's go to the next slide so one way of posing the trade-off is in fact to go to vitalik buterin's so-called trilemma the scalability trilemma and the idea is that there are three possible objectives that that we could envisage one is the decentralization agenda that i've just talked about but the other objective is to have security to form that consensus in a secure way so that it's a there's a robust and self-sustaining arrangement but at the same time there's a third objective which is to be able to do this at scale uh so that we can take advantage of the of the technology for the underlying economic reasons now uh the terence trilemma um is the is the idea that we can achieve two of these um at one time but it's difficult to actually get all three so for instance if we wanted something which is decentralized and secure you know having one chain and doing everything on chain would be one way of doing that but then you would not be able to secure the scalability if we go to the next slide you can have a decentralized system but then scale things up by for example uh dividing up the con dividing up the computation and the validation to many different subcommittees so called sharding and be able to scale it up but perhaps uh it's it's uh it's unproven how secure that would be uh and how different that would be from doing everything on chain and finally if we go to the next slide we get to the to the other uh edge of the triangle which is if you like the traditional uh financial system where uh you have security and it's scalable but clearly uh we are moving away from the decentralization agenda so um if we go to the next slide the the trade-off if you like the uh the choice is between the these decentralization benefits um but there is going to be um a price to be paid possibly because of the uh of the choices entailed by the trilemma now if we go to the next slide let me just outline two different notions of scalability here so one is the physical notion of scalability which is about the time needed to reach consensus so this is about the computation and the technical capacity of the system this is mostly about the laws of physics but um if you think about how this kind of system would work as a self-sustaining arrangement we also have to think about the underlying incentives of the participants and this is much more about the laws of economics and here it's about the incentive compatibility of the validators and how self-sustaining these arrangements would be as a robust equilibrium in a in a game theoretic sense so um if we go to the next slide a very popular way of overcoming the physical limits would be to subdivide the problem into different units circle sharding but i think the the um the economic incentives that would be underlying this kind of system uh would still need to be looked at because um the one thing that we do know about the uh about the bitcoin blockchain and the bitcoin protocol about uh hitching the block onto the longest chain is that if you think about this as a game theoretic problem following the bitcoin protocol is in fact an equilibrium of game and it's a pretty uh robust equilibrium we have yet to really fully understand what the what the economics of this kind of system might be and one thing we do know is that in any kind of system where you need to rely on incentives you have to give sufficient rewards to the people who are involved to provide a public good and what's the public good the public good is a clean and reconciled ledger that everyone can coordinate on and to the extent that you know that doesn't come for free you have to provide incentives and um so so the thing to look out for the telltale sign of a well-functioning system a robust equilibrium would be whether the insiders are getting a lot of rent uh in order to uh to sustain the system so let me give you three examples so the first one if you go to the next slide is this very interesting paper by igor makarov and antoinette shaw that they've written and i highly recommend this uh this paper what they've done is to use the public nature of the bitcoin blockchain and have mapped out the whole uh the economics of the underlying relationships and what they find are really quite fascinating results the first result they find is that bitcoin transactions are mostly tied to investments rather than uh for monetary exchange so here are some numbers they find that 90 of transactions are basically a noise designed to mask the user identity so uh having many many addresses that you pass the payment through in order to mask your true identity and among the real transactions that are identified with economic actors uh 75 percent are those linked to exchanges online wallets and so on and indeed this kind of finding is very consistent with the working paper that we put out by rafael auer and his co-author which finds that if you look at the survey evidence the holders of bitcoin are not uh if you like you know people in hoodies in dark basements they're actually you know normal people young male well educated and they do not distrust traditional finance but they are clearly in it for the for the investments and the other thing that emerges is that far from dispensing with intermediaries uh new types of intermediaries emerge and in the case of bitcoin it's the exchanges um and they are the focal nodes in the bitcoin network and they act as investment vehicles holding customer assets uh in custody in these cold wallets so by the fact that they're in cold wallets these customers are not taking part in the governance they're not taking part in the decentralized you know consensus but instead they're using it much more like a like a mutual fund so if you click to the next couple of sides let me just skip those i had a couple of charts on the size of these cold wallets but i will skip those uh for the benefits of time and let me go to the second example which is the example uh of minor extractable value so we're talking about rent so where would the rents be if you're a validator well in the in the ethereum blockchain um you know there is this thing called a minor extractable value and it's a measure of the profit that a miner or a validator can make uh by um you know through the ability to uh to uh to hitch the block onto the onto the next uh onto the chain and for example if a validator spots an arbitrage opportunity so there are some transactions that are uh waiting to be validated the evaluator can see these transactions and can put in an order you know in view of those transactions and therefore benefit from from that information and this is a very interesting corner of the literature right now where there are some quite substantial numbers um and this is just one chart from from one source which gives a lower bound to this minor extractable value and it's getting pretty substantial if we go to the next example on the next slide another way that we can gauge the rents that are accruing to the insiders would be just to see what are the transactions costs in these d5 platforms and compared to um uh the traditional exchanges they're still very large uh for example if you look at the right hand panel uh we're talking about uh you know transactions uh where one transaction would take tens of dollars or indeed um in you know at the peak of these uh these charts we're talking about transactions costs for for one traction for one transaction which exceed uh 100 so what um uh if we go to the next slide let me just give you a very potted summary and i will um and i will wrap up so what this paper does um is to look at the problem uh from an economic perspective we say let's let's uh think about an economic problem in a standard monetary economic setting and then solve the problem of the incentives faced by the validators and the validators bear a small cost and the cost varies slightly between the validators but they are engaged in a public good contribution game and the public good as i said earlier is a clean and reconciled ledger that everyone benefits from but because of the slight differences in cost if you actually solve that kind of game using global game techniques what we know is that coordination has to be has to overcome a great deal of these uh incentive problems and you can overcome them by giving large payoffs to the validators in other words large rents that accrue to the validators it's really a feature and not a bug and um i think one of the things that comes through uh from from this uh from this kind of uh analysis let's uh fast forward three slides please and let's go to the key takeaways and i can and i can wrap up i think one of the things that really comes up from this kind of analysis is that technology can certainly take us a long way but it is not everything and uh in particular there is a very important role for the incentives of the participants that are going to be key so when we look at these new um ethereum based you know new versions of blockchains that are coming up and they're based on proof-of-stake rather than proof-of-work and what that means is that the entrenched positions of the insiders and the rents that are crude to the insiders if anything uh get worse because uh the way that you become a validator is to have a large stake and the and that large state gives you tremendous rent as a validator and because of this very uh unequal distribution of the stakes what it means is that you have a tremendous advantage and uh ability to to collect those rents and um one of the things that really comes up from the from the analysis in in our economic model is that yes there is a trade-off uh under some configurations the decentralized ledger does very well and that's the optimal arrangement but in some other occasions uh on and but in most uh parameter settings in fact the centralized ledger actually does best unless there is a uh governance weakness there's a weakness in the rule of law there's a weakness in contract enforcement etc which necessitate a decentralized ledger and there's a crucial parameter here which is we vote on the correct ledger and we we update the ledger through super majority voting and a crucial parameter is what is the super majority threshold that will allow you to validate a particular block and that choice turns out to be really really important of course the the strongest rule would be unanimity where everyone has to agree in order for you to hitch the latest block but it turns out that unanimity just isn't feasible uh it will not get you that these are the decentralized consensus you have to relax that so there is going to be uh trade-offs in the way that we arrange the um uh the super the super the super majority of voting threshold um but the parameters of the problem really matter a lot so what we do here is we we we try and uh find a mapping between the underlying features of the problem and the and the exact design of the of the consensus mechanism so let me conclude and i'll go to the final slide which is the next one so i think this given the importance of the rents that have to agree that have to accrue to the insiders i think it does raise a very interesting question which is clearly um during the early stages when there are inflows this is enough to sustain high rents because there are new people coming in and the enthusiasm is is going to give it momentum the question really is what happens when the system matures so when the system is mature enough and the profits begin to get squeezed and the rents begin to get squeezed out is there sufficient rent in the system to provide the glue to keep the decentralized consensus going and i think this is where a theoretical investigation can really can really help so lucretia let me let me conclude there thank you very much it's a intriguing presentation and uh you know getting a little bit further from your paper okay so for the general audience uh can you tell us a little bit more given the fact that you are sitting in the bar yes how do you think about how regulation should then evolve you know in relation to you know your uh your your points on uh you know governance of this decentralized system so is what is the policy agenda in particular in your institution since you're you know talking from from the from the bis thanks for christian for that very uh important question i think that you know there are probably um two or three possibly three uh strands that we can uh that we can approach that question from uh on the one hand there is the there is the consumer protection point uh are there applicable rules uh that uh um would be approp that would be appropriate to apply in these contexts uh i mean that's the too you know for the purpose of consumer protection and the market integrity another type of question would be uh what are the financial stability consequences especially when there are points of contact with the mainstream financial system and and there there would be additional um you know considerations that might uh might come in i think on the governance point i mean that's a very broad issue and uh um these issues are so new that i don't think we have any an existing framework to really put these questions uh um to really uh you know pigeonhole these questions under but uh the bis you know also um hosts the the committee on payments and market infrastructures the the cpmi um and the principles of financial market infrastructure clearly you know will also have a bearing on uh on on these uh on these new exchanges on these new platforms as infrastructures so um i mean needless to say uh you know these are very new issues that uh that we need to uh understand better and to then um and then to you know apply uh to the extent that we have uh rules that apply but if we find that there are gaps uh and the gaps are sufficient that you know they they really do miss something very substantial and i think there is a case for you know going back to the drawing board and rethinking some of the principles uh from the ground up okay thank you so i have a question from ana tana pablova um you know who oh actually the first comment is this is was an excellent presentation so that and then she asked you uh what do you think is going to be the future of central bank digital currencies since once introduced is this going to crowd out bitcoin and other cryptocurrencies what is your view on that well anna i think uh on the bitcoin question you know as i said in my presentation this uh this new paper by makarov and shaw i think shows uh um very clearly that bitcoin is not really used for monetary exchange it is primarily uh something that is held you know as an asset so probably uh you know that the um the points of contact between cryptocurrencies and and uh central bank digital currencies will be pretty minimal um i think the cbdc discussion i think uh you know draws on uh you know very strong um you know imperatives for for policymakers and they rise from uh the the centrality of data uh in the digital economy uh you know on the one hand it gives rise to issues of closed networks market power data silos and so on and having an open architecture would be a very important imperative and cbdc's may have an important role to play so that's one the other side would be um how do we make sure that we uh you know guard against uh illicit activities anti-money laundering how to ensure anti-money laundering kyc and guard against ransomware attacks and so on and some notion of digital id is going to be crucial for that and in that respect you know cbdc's have uh very much more in common with the conventional financial system but having said all that of course as soon as we get to digital ids we have to think about data privacy and how do we ensure a data governance framework that's going to ensure that only the absolutely necessary information is used by either the private sector or indeed the public sector to perform their roles i think here we we have a lot of very good experience already in the way that the conventional financial system through this retail financial system uh the these retail fast payment systems have worked and in particular the uh the application programming interfaces that are associated with um you know the the payment in the payment initiation services or account um information services where you can actually check your balances in all your accounts through one app or indeed initiate the payment from another account at another bank through the app of your you know main bank so that kind of you know technology has been around ever since the 1970s you know this is public key cryptography uh actually it's also the uh the technology used in in bitcoin um but the technology is is already there and i suppose if you have already a well-functioning retail fast payment system you are i would say 70 of the way there towards having a cbdc already and it would be a very marginal step towards that um so i think it's more that the discussion with of what would cbdc's do in a debate about big text coming into payment systems what if the big tech is also a stable coin um how would that affect the integrity of the monetary system would that lead to possible fragmentation etc and i think that's the kind of debate where the cbdc's would be more central well with this very optimistic note i think you know we are running out of time so thank you very much for for the presentation