The Financial Stability Oversight Council (FSOC) recently published its Annual Report, providing insight into its perspective on market developments and emerging threats. The FSOC, which includes representatives from the Treasury Department, the Federal Reserve, the Commodity Futures Trading Commission and the Securities and Exchange Commission, recognized that distributed ledger systems offer opportunities to lower transaction costs and improve efficiencies. However, the FSOC also acknowledged that certain risks are inherent, and therefore careful regulatory coordination is necessary.

In its 2015 Annual Report, the FSOC noted that given their limited connections to broader financial infrastructure, digital currencies did “not appear to pose financial stability concerns.” This year, however, the FSOC Annual Report devoted more attention to distributed ledgers and the innovations they enable, reflecting a greater concern with the potential risks such systems may pose.  The 2016 Annual Report recognized the potential benefits of distributed ledger systems, including increased efficiency, accuracy, and transparency in settling transactions. It also noted that distributed ledgers may reduce risk by eliminating the use of third parties and “by improving the speed and accuracy of settling systems.”  Despite these innovations, the regulatory body cautioned that distributed ledgers also pose potential dangers and must be monitored for “risks and uncertainties.” The Annual Report points to limited experience and operational vulnerabilities such as recent Bitcoin trade confirmation delays and failures caused by the blockchain’s inability to keep up with the speed at which transactions have been submitted as an example of a problem that would be difficult or impossible to predict until it occurred.

Because distributed ledgers systems may revolutionize traditional market trading infrastructure, the FSOC cautioned that regulators must “adapt to changing market structure” by familiarizing themselves with the new technology.  Lastly, since the set of market participants that make use of distributed ledger systems span regulatory jurisdictions and natural boundaries, the report called for “coordination among regulators” to adequately identify and address risks associated with distributed ledger systems.