2016 Annual Report of the Financial Stability Oversight Council of the United States: Bitcoin and blockchain threaten financial stability (download the full report)

In a recent report (download the full report in PDF), the U.S. Financial Stability Oversight Council (FSOC) has identified Bitcoin and blockchain technology as a threat to financial stability.

The committee, which includes representatives from the Federal Reserve, the Securities and Exchange Commission, and the Treasury Department, is designed to identify risks and address emerging threats to U.S. financial stability.

In the report titled “Financial Innovation and Migration Activities Towards Building Distributed Ledger Systems,” it explains that “market participants have limited experience with distributed ledger technologies and may not see the operational vulnerabilities of such systems until they are deployed at scale.”

The report adds:

“As this generation of market participants uses distributed ledger systems, they may cross regulatory jurisdictions and national boundaries, and hence there will need to be a degree of coordination between regulators to effectively identify and address the risks associated with distributed ledger systems.”

Bitcoin was singled out for special mention, with the report noting that it has experienced a “devastating fall” in transaction failures and delays as transactions outpace the speed of the blockchain.

An example of a threat to Bitcoin and blockchain is the possibility of a 51% attack, a form of attack in which someone controls a majority of the network’s hash rate and can modify transaction records, preventing new transactions from being confirmed. The report states:

“While distributed ledger systems are designed to prevent a single party from reporting errors or fraud, the system is vulnerable to fraud by collusion among significant participants.”

But not everything the report says is negative, saying that digital currencies should be further developed and that steps should be taken to regulate their use in financial markets. The report states:

“Distributed ledger systems will ultimately reduce the importance of centralized intermediaries, and regulators will need to adapt to changing market structures,”

It could be worse

The report was even more pessimistic about the regulatory environment for Bitcoin and blockchain technology more broadly.

While there is the threat of a 51% attack, there is a risk that blockchain will replace existing financial transactions for the first time; yes, if used properly, it can be a faster and cheaper way to transact, but there is a reasonable assumption that some people will misuse the system, especially considering that it is still a new technology and concept in many industries.

The report does not call for a ban or severe restrictions on the development of Bitcoin and blockchain technology, which is actually a clear positive signal that the highest levels of government recognize that this technology is here to stay and there will be some risks, but the market is guided by this.