DLT, the next step towards the digital transformation?
DLT is a technology that has been used for many years. Its potential has been emphasised in 2008, through the development of the blockchain (which is a particular type of DLT) on which the crypto-currency commonly referred to as Bitcoin still relies. Nowadays, the DLT is seen as the next step towards the digital transformation and even considered by some as potentially revolutionary as many practical applications have been identified or developed in various sectors, notably the financial sectors.
Both the legislator and the financial sector are taking up the challenge of integrating the DLT in a fast-moving environment. Important legal uncertainties around the potential use of DLT or DLT applications have been or might be cleared in the years to come with a view to allow the uptake of DLT, both on National level e.g. with the Blockchain Laws 1 and 21 and on European levels with the European Commission’s ambitious digital finance package2.
Understanding the opportunities without overlooking risks
In this context, over the past few years, the CSSF has been increasingly solicited by financial and non-financial institutions, incumbents and start-ups, wishing to present a large diversity of applications and use-cases of DLT, in various sectors.
Whereas some institutions have an advanced understanding of the risks inherent with this technology, others, which do not necessarily have all the technical skills required for its implementation, may tend to overlook them.
“As regulators, our job is to ensure the safety and soundness of the financial sector. Regarding financial, we need to balance prudent risk-based supervision with proactive support for positive innovation,” says Cécile Gellenoncourt, Head of Department, Supervision of Information Systems and support PFS.
She specifies: “We apply a principle of technology neutrality and acknowledge that innovative processes and technologies can contribute to the improvement of the provision of financial services.” Thus, when properly used, a DLT, like other technologies, can provide benefits for the financial sector. At the same time, the DLT entails specific risks that must be understood, mitigated and monitored.
Guidance by the CSSF
The CSSF has published a non-binding document in the form of a “white paper” aimed at guiding interested professionals in the conduct of their due diligence process related to the DLT and its use in the provision of services in the Luxembourg financial sector.
This white paper is the result of fruitful collaboration between our ICT risks supervision and financial innovation teams and a panel of external contributors.
According to Cécile Gellenoncourt: “We have to underline that the document does not purport to provide all the technical explanations on the functioning of a DLT, as extensive literature is already available, but to ensure that both risks and advantages are adequately and appropriately taken into consideration by the financial sector.” To that extent, the document first recalls the key common characteristics and different types of DLTs and then presents the main actors and roles identified in a DLT project along with use-case examples. Finally, the main part emphasises some of the main risks related to the DLT, both in terms of governance and technical risks, by proposing key questions and recommendations for professionals to consider when performing their risk analysis and due diligence processes.
The document can be downloaded HERE