Systemic risk in the financial world has increased in recent years due to the interconnected nature of global financial markets. Could the blockchain make a difference in reducing risk associated with failure of global players?
Lehman Brothers and Systemic Risk
The collapse of Lehman Brothers in 2008 shook global financial markets. It reduced investor confidence in banks and contributed to recessions across the world. Interbank lending froze as banks did not have the confidence to place even overnight deposits in their fellow banks. When the fortunes of firms can change in a matter of days, financial statements which are a year old are not helpful in evaluating a firm's financial position.
Blockchain: Real-Time Information
How could the blockchain help? If financial assets (mortgages, bonds, shares) are stored on a blockchain, it would help provide real-time information about a firm's net asset holdings. This information can be used by investors to assess the financial position of a firm and take quick decisions. In the absence of this information, risk-averse investors might shun all firms in times of uncertainty.
Useful Tool For Regulators
Real-time information could help regulators assess the financial health of financial institutions which are systemically important, and suggest remedial action if required. Regulators would also be able to assess the impact of the closure of a firm on the financial system. An orderly closure of firms would be possible and no financial institution would be considered “too big to fail”.
While the blockchain provides a tool for real time monitoring of complex systems, its effective use depends on the capability of the organizations involved. Mt.Gox couldn't reconcile its total bitcoin balance (a rather simple task) and failed to detect the leakage of bitcoins from its reserves for a period of several months. Its disorderly collapse sent shockwaves through the Bitcoin ecosystem and left thousands of investors in the lurch. An incapable regulator who monitors financial institutions' position on a real-time basis using the blockchain would be ineffective.