US Financial Stability Oversight Council acknowledges Bitcoin in their 2016 Annual Report

One of the most powerful finance councils in the U.S. government met on Tuesday, where they approved and released their 2016 annual reportthat highlights threats against the U.S. financial system.

The official report is from the Financial Stability Oversight Council (FSOC), which is made up of the heads of the major finance-related government departments, and led by the Treasury Department. It serves to identify risks and respond to emerging threats to the stability of the U.S. financial system.

"The Council’s annual report is a vital vehicle to publicly highlight potential threats to financial stability and is another example of how Wall Street Reform has improved coordination among financial regulators,” explained Treasury Secretary Jacob J. Lew in a recent statement.

“In this year’s annual report, the Council outlines potential threats on the horizon and offers an important roadmap to help guide the Council’s focus in the coming years."
— – Jacob J. Lew,  United States Secretary of the Treasury

On page 127, listed under the chapter on “Potential Emerging Threats and Vulnerabilities,” in a section titled: “Financial Innovation and Migration of Activities,” the whole page is dedicated to Distributed Ledger Systems, including Bitcoin.

This is the first year that Bitcoin, blockchains, or distributed ledgers have ever been mentioned in an FSOC annual report. Although their treatment of distributed ledger technology is far more positive than negative, the authors of the report did have a few concerns; mostly about the nature of such a borderless system. “Since the set of market participants which makes use of a distributed ledger system may well span regulatory jurisdictions or national boundaries,” the report said, “a considerable degree of coordination among regulators may be required to effectively identify and address risks associated with distributed ledger systems.”

In fact, the report is far more concerned with risks against systems based on distributed ledger technology than it is with risks against citizens or businesses from those systems. For instance, the one paragraph that mentions Bitcoin is concerned with vulnerabilities in Bitcoin’s system that might break Bitcoin, instead of a way for Bitcoin to harm users or disrupt the existing financial system.

“In recent months, Bitcoin trade confirmation delays have increased dramatically and some trade failures have occurred as the speed with which new Bitcoin transactions are submitted has exceeded the speed with which they can be added to the blockchain.”
— – FSOC 2016 annual report

The delays that the report refers to are most likely the subject of the ongoing block size debate, which will be resolved in time as developers come up with better solutions in an open source environment. Mentioning them could simply be part of their practice to note every little risk, in the FSOC’s role as the responsible council for overseeing banks to stop them from becoming systemic threats.

One other example that they gave of a threat to Bitcoin and similar systems is the possibility of a 51% attack. “Although distributed ledger systems are designed to prevent reporting errors or fraud by a single party,” the report concluded, “some systems may be vulnerable to fraud executed through collusion among a significant fraction of participants in the system.” There was no mention of the fact that such collusion in the Bitcoin system is far more difficult than any other system due to the strength of Bitcoin’s mining network.

The FSOC was created out of the Dodd-Frank Consumer Protection Act in 2010, primarily to protect Americans from another banking crisis like the one in 2008. Ironically, this was also the reason that Satoshi Nakamoto hinted at for creating Bitcoin.

The FSOC has met frequently since its inception to deliver threat reports and oversight to congress, and of course to publish these annual reports each year for anyone in the government and the finance industry to use as a resource.

The council is permanently composed of 15 of the most powerful financial offices in Washington DC. For the annual report, all ten of the voting members must vote to pass the final draft. The seats that have a vote on it are:

1. the Secretary of the Treasury (Chairperson)
2. the Chairman of the Board of Governors of the Federal Reserve System
3. the Comptroller of the Currency
4. the Director of the Bureau of Consumer Financial Protection
5. the Chairman of the Securities and Exchange Commission
6. the Chairperson of the Federal Deposit Insurance Corporation
7. the Chairperson of the Commodity Futures Trading Commission
8. the Director of the Federal Housing Finance Agency
9. the Chairman of the National Credit Union Administration
10. an independent member with insurance expertise who is appointed by the President

There was a small mention of changes that regulators would need to make in response to Bitcoin and blockchain systems, although it is apparent that FSOC is only in the beginning stages of investigating them. “Distributed ledger systems have the potential to change the way some asset classes are traded and settled,” the report explained. “Financial regulators have often worked with those market infrastructures and firms which facilitate trading and settlement, such as exchanges, dealers, and clearinghouses, to monitor markets and, in some cases, regulate market activity,” it said, listing the potential middlemen that Bitcoin and blockchains are just starting to unseat.

“To the extent that distributed ledger systems ultimately reduce the importance of these types of more centralized intermediaries, regulators will need to adapt to the changing market structure.”
— – FSOC 2016 annual report