The Shanghai Stock Exchange published a research paper outlining the potential integration of blockchain technology into Chinese financial infrastructure, arguing that adopting distributed ledger technology-based replacements for existing transaction settlement models could dramatically improve efficiency.

As the fourth-largest stock exchange in the world, the Shanghai Stock Exchange (SSE) boasts a market cap of $5.01 Trillion USD as of March 2018 and is directly governed by the China Securities Regulatory Commission. The research paper, published on July 10, 2018, analyzes the potential benefits of blockchain integration into financial market infrastructure, citing a significant potential impact driven by the unique technical characteristics of distributed ledger technology.

China Eyes DLT-Based Markets

China’s regulatory attitude regarding cryptocurrencies and blockchain technology recently shifted towards a positive position, with the Blockchain Research Working Group at China’s National Internet Finance Association (NIFA) taking a proactive stance towards the development of the blockchain industry within the country.

Governed by the People’s Bank of China and State Council, NIFA functions as a self-regulatory body that promotes the development of fintech within China. NIFA Blockchain Research Working Group head Li Lihui, speaking at the 2018 Bo’Ao Forum for Asia in April, highlighted the need for innovation within the sector to prevent China from losing out in a blockchain arms race:

“While blockchain’s technological development has seen a major progress in China over last year with blockchain platforms launched by internet giants such as Baidu and Tencent, our regulatory initiative is substantially lagging behind. What we need for the future, are clear regulatory guidelines for the entire industry to follow.”

The SSE research paper is indicative of a more progressive stance from Chinese regulators, referencing the August 2016 World Economic Forum Future of Financial Infrastructure report .

The findings identify the technology behind bitcoin as likely to “profoundly alter the way banks do business worldwide” and noting the lack of discussion regarding blockchain development within China.

The report pinpoints a range of areas in which blockchain technology could potentially improve the Chinese financial landscape, noting that the technical characteristics of the blockchain are “very suitable” for the construction of the financial market infrastructure:

“A general worldwide consensus is that DLT will be a new revolution for the financial industry. The first application use cases will be over-the-counter securities issuance and trading, as well as order book post-trading settlement.”

Blockchain technology, argues the SSE report, could optimize anti-money laundering and information disclosure processes, as well as improve clearing and settlement processes to “reduce settlement time and reduce the risk of settlement failure.”

Regulatory Reform is Critical

While the report is optimistic regarding the potential benefits of blockchain technology in the Chinese financial ecosystem, the SSE concedes that there are “many obstacles” to overcome before the integration of distributed ledger technology into any Chinese stock exchange could occur.

The SSE, for example, currently incorporates a third-party intermediary for both custodial practices and for post-trading transaction settlement, which would be eliminated by the integration of a distributed ledger based solution. Before DLT can be implemented, states the report, Chinese regulators must establish a new legal framework issued in cooperation between the Chinese central government and regulators:

“Regulation should adapt to the evolving technology. We suggest regulators treat the topic of DLT as a crucial study area moving forward … in order to develop a solid regulatory framework for embracing the financial innovation.”

The future of cryptocurrency and blockchain regulation within China, however, appears to include a more permissive stance toward DLT-focused innovation. China University of Political Science and Law professor of finance emphasized the importance of liberal blockchain regulation in China during a recent interview with Chinese media outlet Dayqkl:

“Relevant legislation reflects the combination of prudential supervision and innovative promotion … We should gradually build a mature legal system for blockchain finance and digital currency regulation and I believe blockchain finance and digital currency industry have great development potential in China”