Lecture 10

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Questions and Answers

What is a principle of the EU's regulatory approach to fintech?

Regulation should be integrity-enhancing and increase transparency. (correct)

Regulation should favor centralized financial systems.

Regulation should limit access to financial services for citizens.

Regulation should apply uniformly regardless of service risks.

Which of the following is NOT a key objective of the EU regulatory framework for digital finance?

Establishing a monopoly over fintech innovations. (correct)

Fostering access to financial services for citizens and businesses.

Making the Single Market more competitive.

Bringing down operational costs and increasing efficiency.

What is a challenge associated with the concept of 'technological neutrality' in the EU regulatory framework?

It creates barriers for fiat-virtual exchanges.

It complicates the identification of responsible parties in decentralized systems. (correct)

It primarily benefits centralized infrastructures.

It eliminates the need for cybersecurity protocols.

Which regulation primarily addresses stablecoins and utility tokens within the EU's framework?

Regulation on Markets in Crypto-Assets (MiCAR) Signup and view all the answers

Regarding DLT and cybersecurity, what is a key concern mentioned in the EU regulatory framework?

Insufficient infrastructure for operational resilience. Signup and view all the answers

What is the maximum market cap allowed for shares in admitted DLT securities?

€200 million Signup and view all the answers

Which of the following entities is NOT covered under the Digital Operational Resilience for the financial sector (DORAR)?

Retail businesses Signup and view all the answers

Which aspect is NOT part of the ICT risk management requirements outlined in DORAR?

Investment strategy formulation Signup and view all the answers

Which of the following definitions best describes 'ICT risk' as per the DORAR framework?

Any type of malfunction that could affect network security Signup and view all the answers

What is the maximum size of DLT securities that can be recorded in a given DLT CSD?

€2.5 billion Signup and view all the answers

Which of the following requirements is included in the ICT third-party risk management of DORAR?

Due diligence on third-party service providers Signup and view all the answers

According to the DLT framework, which type of security is explicitly excluded from being admitted?

Sovereign bonds Signup and view all the answers

What aspect does the US 'Howey Test' primarily evaluate?

The classification of assets as securities Signup and view all the answers

Which type of digital financial asset (DFA) is not classified as DLT-based?

Dematerialised securities Signup and view all the answers

What distinguishes a native token from a non-native token in the context of cryptocurrencies?

Native tokens exist independently on their own blockchain. Signup and view all the answers

Which of the following is an example of a utility token?

Filecoin (FIL) Signup and view all the answers

In the context of digital financial assets, which statement accurately describes Central Bank Digital Currency (CBDC)?

CBDC is issued and regulated by a central authority. Signup and view all the answers

What is a fundamental difference between centralized systems and decentralized systems in the context of blockchain technology?

Decentralized systems operate without a single point of failure. Signup and view all the answers

Which of the following digital financial asset types may involve use of smart contracts?

Non-native tokens Signup and view all the answers

Which of the following provides a right to a financial return as a digital financial asset?

Securities tokens Signup and view all the answers

Which mechanism is crucial for maintaining consensus in decentralized blockchain systems?

Proof of Stake Signup and view all the answers

What is a characteristic of asset-referenced tokens in the classification of digital financial assets?

They are designed to achieve stable value relative to other assets. Signup and view all the answers

What type of functionality do utility tokens typically provide?

Access to platform-specific services Signup and view all the answers

What distinguishes a distributed ledger system from a centralized system?

Transactions are verified by a majority consensus in distributed systems. Signup and view all the answers

Which feature is NOT associated with distributed ledger technology (DLT)?

Transaction erasure after validation. Signup and view all the answers

Which term refers to the process of converting physical assets into digital tokens on a blockchain?

Asset tokenization. Signup and view all the answers

In terms of regulatory frameworks, how do the EU and US approaches to crypto asset regulation primarily differ?

The EU focuses on technological innovation while the US prioritizes market protection. Signup and view all the answers

What mechanism is commonly used in blockchain systems to achieve consensus on transaction validity?

Proof of work or proof of stake. Signup and view all the answers

What is a significant advantage of using smart contracts within distributed ledger technology?

They can eliminate the need for intermediaries. Signup and view all the answers

Which of the following is true regarding the security of data in a decentralized system?

Decentralized systems have no single point of failure. Signup and view all the answers

What role does cryptography play in the functionality of a blockchain?

It enables the encryption of transaction records. Signup and view all the answers

What does the term 'trustless system' in blockchain technology imply?

Transactions can occur without a trusted intermediary. Signup and view all the answers

Which of the following best describes the permanence of transactions in a blockchain?

Once entered, they cannot be erased or altered. Signup and view all the answers

Which of the following financial instruments is NOT classified as a money-market instrument?

Options contracts Signup and view all the answers

Which type of contract specifically relates to the transfer of credit risk?

Contracts for difference Signup and view all the answers

Which of the following instruments is specifically designed to be settled in cash at the option of one party?

Futures contracts relating to commodities Signup and view all the answers

What is the key characteristic of derivative instruments that differentiate them from other financial contracts?

They involve variable returns based on underlying assets Signup and view all the answers

Which of the following is a characteristic of options, futures, and swaps related to commodities?

They can be settled in cash or physically Signup and view all the answers

What distinguishes derivatives related to climatic variables and inflation rates from other instruments?

They must be settled in cash Signup and view all the answers

Units recognized under Directive 2003/87/EC are classified as which type of instrument?

Emission allowances Signup and view all the answers

Which instruments are excluded from the definition of derivative contracts relating to commodities?

Wholesale energy products traded on OTFs Signup and view all the answers

In assessment of the legal nature of tokens, what approach is generally taken?

To compare rights to existing financial instruments Signup and view all the answers

What is a critical aspect of the rights associated with tokens in investment?

They include ownership and control Signup and view all the answers

Study Notes

DLT Securities Settlement System

A CSD (Central Securities Depository) can operate a DLT-based securities settlement system.
Transactions in DLT transferable securities are settled against payment (DvP).
There are limits on the size of admitted DLT securities:
- Shares: < €200 million market cap
- Bonds: < €500 million market cap
- Sovereign bonds are not allowed.
The total value of DLT securities recorded in a given DLT CSD cannot exceed €2.5 billion daily.
Regulation 596/2014 (MAR) applies to this system.

Digital Operational Resilience for the Financial Sector (DORAR)

DORAR applies to all regulated entities in the financial sector that use ICT risk management tools.
Regulated entities include:
- Credit institutions
- Insurance intermediaries
- Payment institutions
- Reinsurance intermediaries
- Electronic money institutions
- Investment firms
- Crypto-asset service providers
- Institutions for occupational retirement pensions
- Central securities depositories
- Central counterparties
- Trading venues
- Trade repositories
- Managers of alternative investment funds and management companies
- Data reporting service providers
- Insurance and reinsurance undertakings
- Credit rating agencies
- Statutory auditors and audit firms
- Administrators of critical benchmarks
- Crowdfunding service providers
- Securitisation repositories
- ICT third-party service providers

DORAR Key Definitions and Clusters of Requirements

DORAR aims to "build, assure and review […] operational integrity from a technological perspective".
"ICT risk" encompasses "malfunction, capacity overrun, failure, disruption, impairment, misuse, loss or other type of malicious or non-malicious event" that can compromise network and information system security.
DORAR outlines requirements for:
- ICT risk management
- ICT-related incident reporting
- Digital operational resilience testing
- ICT third-party risk
- Information sharing
- Competent authorities

The US Approach: the 'Howey Test'

The "Howey Test" is used in the US to define a "security".

Digital Financial Assets (DFAs)

DFAs are digital representations of value, stored on a computer or the internet.
They may or may not have legal tender status.
DFAs can be used as a means of exchange or for investment purposes, offering financial returns.

Non-DLT Based DFAs

E-money
Dematerialized securities
Other (digital fiat money, like non-DLT CDBC)

DLT-Based DFAs

Cryptocurrencies (Native tokens - Bitcoin, Ether, etc.)
Fork native tokens (Bitcoin Cash, Ethereum Classic, etc.)
Non-native tokens (on smart contract platforms - ERC20, BEP20, TRC20, etc.)
- Securities tokens (some stablecoins or DeFi tokens)
- Tokenized securities
- Other crypto assets (not qualifying as ‘security’)
  - Asset-referenced tokens
  - E-money tokens
  - Utility tokens
Central Bank Digital Currency (CBDC; permissioned)

The Emerging Regulatory Framework for DLT-Based Finance: EU vs US

The EU has a regulatory framework for crypto assets, DLT infrastructure, and cybersecurity.

Key Features of the EU Framework for Crypto Assets

Focus on technology-neutral, proportional, and integrity-enhancing regulations.
Objectives:
- Fostering access to financial services
- Reducing operational costs
- Increasing market competitiveness
- Balancing data sharing with data protection

Limits of 'Technological Neutrality' (EU Regulation)

Decentralized infrastructures can make it harder to identify responsible individuals or entities.
Cybersecurity is crucial to address infrastructural challenges.
Open access to data (open banking) is needed to overcome competitive concerns.

Digital Finance Action Plan (DFAP) - September 2020 (EU)

Regulation on Markets in Crypto-Assets (MiCAR)
Regulation on a pilot regime for market infrastructures based on DLT
Regulation on digital operational resilience for the financial sector (DORA).

The EU Regulatory Approach: Key Principles

EU regulatory approach: 'Keep calm and carry on!'
- Technology-neutral, proportional, and integrity-enhancing regulations.
EU regulatory objectives:
- Fostering access to financial services for citizens and businesses
- Bringing down operational costs and increasing efficiency
- Making the Single Market more competitive
- Balancing data sharing and transparency with data protection

Key Definitions for Assessing Tokens' Legal Nature (Money or Money-Like)

Money-Market Instruments
Units in Collective Investment Undertakings
Options, Futures, Swaps, Derivative Contracts (securities, currencies, interest rates, commodities, credit risk, etc.)
Emission Allowances

What is Distributed-Ledger Technology (DLT) or the Blockchain?

DLT is a distributed database of records, or public ledger of transactions, shared among participants.
Each transaction is verified by consensus of a majority of participants.
Information on the blockchain is immutable.
In a nutshell, Blockchain can be seen as a way to verify and store agreements, processes, tasks, and payments digitally.

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Description

This quiz explores the principles of DLT-based securities settlement systems and the regulations surrounding them, including the market cap limitations for different types of DLT securities. Additionally, it covers the Digital Operational Resilience for the Financial Sector (DORAR) and its implications for regulated entities in the financial industry. Test your knowledge on these important financial topics.