Financial innovation such as Blockchain & Regulation
Blockchain is a financial innovation which is interconnected to the existing legal and regulatory space. Extensive experience with financial innovations as in how new financial products are invented, introduced, and diffused is only one generation old. Both regulators and inventors have low experience with adopting financial innovations which are critical to the health of global economies and markets (Delimiatsis 2011).
The financial crisis in 2008 was caused by rapid innovative developments in global financial services such as over-the-counter derivatives products (Pagano & Volpin 2008). These innovations were used for credit risk modeling causing information asymmetry problems, and the increased complexity of the system made risk assessment harder and therefore, risk management more difficult (Delimiatsis 2011). The dynamic nature of financial innovations can cause their consequences to change over time. This is exemplified in the financial crisis of 2008 when regulators failed to act proactively, neither did they react swiftly in regulating new financial innovations (Marques-Ibanez & Scheicher 2009). Innovative financial products are linked inextricably to global financial markets coordination, financial markets, regulatory cooperation, and one should consider how financial innovations can lead to financial fragility and instability as seen in the financial crisis of 2007–08 (Delimatsis 2011).
Financial innovation is a dynamic, ongoing process entailing the creation and popularization of new financial instruments and technologies, markets, and institutions (Lerner & Tufano 2011). Litan (2010) argues that financial innovation has transformed how finance works. Structural changes, technological advances or new industrial structure in financial sectors has boosted globalization by increasing cross-border trade in financial services (Claessens 2010), and Allen and Gale (1994) argue that financial innovation increases welfare.
Financial innovation is a dynamic, ongoing process entailing the creation and popularization of new financial instruments and technologies, markets and institutions (Lerner & Tufano 2011). Litan (2010) argues that financial innovation has transformed how finance works. Structural changes, technological advances or new industry structure in financial sectors has boosted globalization by increasing cross-border trade in financial services (Claessens 2010), and Allen and Gale (1994) argue that financial innovation increases welfare.
Financial innovation is, in most instances, very much ahead of current regulation (Delimatsis 2011). For example Bitcoin which is the first cryptocurrency was unregulated for many years after it launched,until regulators stepped in: Bitcoin is for exampl4 unlawful such as in Dar al-lifta (2017) which is the primary Islamic legislator in Egypt has classified Bitcoin transactions as “haram” (prohibited under Islamic law), and Algeria where the financial law has prohibited the use of any cryptocurrencies (Journal Officiel 2018). Regulating innovative financial products after the fact is regarded as being counterproductive and a delaying factor for innovation, but regulators prefer to intervene when the side-effects of business innovation have become apparent. In practice agency problems, supervisory forbearance and complex products can delay regulatory intervention and regulatory intervention vis-a-vis the financial innovation can be challenging (Freixas & Parigi 2009).
In the current stage of financial development, it is argued that more is at stake when regulatory intervention affects the pace of financial innovation. When regulators create inflexible and stringent rules, this can be a disincentive for the innovator and stifles the development of innovative financial products. (Delimatsis 2011). Regulation can stifle innovation, and there is evidence that regulator intervention can cause harmful effects on financial innovation (White 1997).
Having a revolutionary change in financial services can cause tremendous systemic risky and be very costly (Tufano 1989), and financial innovation typically happens in evolutionary steps of adopting prior financial products ( Tufano 2003).
Regulation can (…) encourage innovation in globalized financial markets if it seeks to harmonize certain requirements across jurisdictions such as reporting requirements, thereby diminishing compliance costs and facilitating market access (Delimatsis 2011)
The idea sometimes put forward that more regulation may impede innovation may not hold: Better regulation may direct entrepreneurial talents to financial innovations which can enhance societal wellbeing (Delimatsis 2011).
Recent blockchain-based financial innovations have affected regulation by crossing national borders by default, and in this sense, there is a case for global coordination of financial regulations to level the playing field. In such cases, enhanced transparency, a central good-governance principle, and sharing information across borders can allow for well-meant regulatory competition and ultimately encourage innovation, while allowing for better supervision and informed investment decisions. In any event, there is a high level of learning-by-doing in this area, and we are at the beginning rather than the end of changes and innovations in the global financial architecture (Delimatsis 2011).
Requiring public disclosure of certain critical financial business information in specific contracts may ultimately have adverse effects and may even reduce market liquidity. Therefore, it seems that disclosure exclusively to the corresponding regulator or supervisory authority would be much more meaningful. Public disclosure can still be required, but perhaps in a later date so that it does not affect business decisions nor allows for misuse of disclosed information (Delimatsis 2011).
