In February, Michael Hsu, the acting head of the Office of the Comptroller of the Currency (OCC), announced plans for new rules on operational resilience for large banks, highlighting the critical need to address vulnerabilities, including those posed by third-party service providers. However, notably absent from his discussion were the implications of using permissioned networks by major banks to tokenize real-world assets and liabilities, a blind spot that could expose the global financial system to significant risks.

The Tokenization Trend and Regulatory Response As Hsu pointed out, top custodian banks now oversee over $108 trillion in assets, with a growing trend towards tokenization. This process involves digitizing real-world assets and liabilities on blockchain networks. Regulators, including the Federal Reserve and the Hong Kong Securities & Finance Commission, have acknowledged this trend and are cautiously exploring regulatory frameworks to govern tokenization activities.

The Rise of Permissioned Networks While traditional financial institutions embrace tokenization, they largely favor permissioned networks over permissionless blockchains. The Basel Committee on Banking Supervision’s decision to retain high capital requirements for crypto-assets held on permissionless blockchains reflects regulatory preference for permissioned networks, controlled by banks.

The Unified Ledger Vision and Regulatory Scrutiny Hyun Song Shin of the Bank for International Settlements envisions a unified ledger for global central banking. However, the absence of blockchain technology raises questions about the feasibility and resilience of such a system. Hsu’s skepticism about the necessity of blockchains in tokenization underscores the need for a deeper understanding of the implications of different technological approaches.

The Importance of Decentralization Regulators often overlook the fundamental feature of blockchain technology: decentralization. Truly decentralized blockchains, like Bitcoin, offer unparalleled operational resilience against cyberattacks. In contrast, permissioned networks and centralized protocols present concentrated attack vectors, making them susceptible to large-scale cyber threats.

The Call for Blockchain Resilience Encouraging the use of permissioned networks over permissionless blockchains may inadvertently expose the financial system to unprecedented cybersecurity risks. As trillions of dollars’ worth of real-world assets and liabilities are tokenized, the need for blockchain resilience becomes increasingly urgent. Without proper safeguards, the financial industry risks facing the largest bank heist in history.

In conclusion, regulators must reevaluate their approach to tokenization and prioritize the adoption of blockchain technology to ensure the operational resilience and security of the global financial system.

By Impact Lab