[Full Text] Financial Supervisory Service Official: "Fragmented Mainnets Pose Systemic Risks... Need for Integrated Design"

Han Se-jin, Senior Researcher at the Financial Supervisory Service, emphasized that for the tokenization of real assets (RWA) and token securities (STO) to develop into a full-fledged on-chain capital market, it is necessary to resolve the issue of fragmented mainnets among financial companies and establish a common design that allows for integration and interoperability.

Han made these remarks at a seminar held on the 28th at the National Assembly Library in Yeouido, Seoul.

He stated, "Each financial company is setting up its own blockchain, which causes money to be trapped on their own islands, and the fragmented mainnets along with weak cross-chain bridges threaten the entire financial system."

There are concerns that the cross-chain bridges used to connect the mainnets of different financial companies could increase the risks of hacking and money laundering. This leads to a phenomenon called 'liquidity isolation', where liquidity is divided among different mainnets, and if the bridges connecting them are attacked, the risks could spread throughout the financial system.

Han believes that it is necessary to consider both the option of physically integrating the mainnets and the option of enabling interoperability between different mainnets. He remarked, "While physically integrating the mainnets is good, there is a risk that a single vulnerability could collapse the entire system, and there is also a way to optimize interoperability protocols."

Below is the full text of Han's presentation.

I have worked for a large domestic telecommunications company for the past 10 years. After that, I continued my field experience and have been supervising fintech at the Financial Supervisory Service for 15 years. In the field, I witnessed firsthand that when copper wires were replaced with fiber optic cables, the increase in speed was not just about communication speed. I believe the very fabric of the world changed. The innovation in financial infrastructure led by blockchain is similar. It is not just about faster payment speeds; it is a massive tectonic shift that fundamentally changes the map of the capital market. And we are currently at the starting point of that history.

The concepts of RWA (real assets) and token securities (STO) have been well explained by Attorney Kim Tae-rim from Axiz, so I will skip that. This is not a story of the distant future. A huge market of 460 trillion won has already opened. This is the combined value of the RWA market and the market for stablecoins. A representative example is BlackRock's bid.

By tokenizing U.S. Treasury bonds and simply holding them in a wallet, interest accrues daily. It is possible to sell them for cash flow or USDC (USD Coin) at any time, 24/7. The era has come where the token itself becomes money, collateral, and a means of payment without the need for the procedures of selling stocks and transferring to a bank. The reason money has no reason to leave the blockchain is disappearing. It is growing liquidity within the on-chain and circulating by itself. The reason why the giant financial institutions on Wall Street, which manage tens of trillions and hundreds of trillions of won daily, are tokenizing assets and enduring regulatory friction to put them on on-chain rails, and why they are replacing the rails of traditional finance with blockchain, is precisely because of this.

This is a story about what the largest financial institutions in the world are doing on blockchain right now. To answer briefly, everyone is moving according to their own calculations and strategies. First, there is BlackRock, the world's largest asset management company. BlackRock is bringing cash-like assets such as Treasury bonds onto the blockchain. The goal is clear. I believe they aim to secure the most reliable and best foundational collateral position in the blockchain market. Asset custody is handled by BNY Mellon, and the two are connected through a dedicated API between blockchain and BlackRock. In simple terms, it is the process of building and expanding a massive island called BlackRock.

Next is Visa. Visa is a card network, and Visa Direct is an international remittance network. What I am referring to is Visa Direct. Visa has attached blockchain wallets to both ends of its Visa network, replacing banks at the starting and ending points. Thus, it has added a stablecoin ramp. Liquidity providers supplying liquidity between stablecoins and fiat currencies are attached to both ends of Visa. Ultimately, this strategy aims to enable remittances for customers without bank accounts. It is very innovative. However, this is still just a massive private network centered around Visa.

What about JP Morgan? They have created Kinexys, a dedicated blockchain that operates only within the bank. So when JP Morgan's institutional clients deposit tokenized Treasury bonds, they provide loans against tokenized deposits. This generates internal liquidity within JP Morgan, which is convenient. However, this is also a closed world that only works within that environment.

Finally, there is Circle, which issues the stablecoin USDC. Circle has gathered several financial companies to create a massive liquidity pool alliance called CPN, which continues to expand. However, even among these participants, they are connected through Circle's dedicated API and dedicated channels. So, it is another private network under the name of an alliance.

The four examples I have explained so far share a commonality. They can all be seen as being trapped on their own islands. However, this scene is reminiscent of what we saw in the 1980s. While there may be those born after the 1980s, we know the process that the internet went through to develop. Initially, in the late 1980s, companies like IBM, CompuServe, and AOL built their own private intranets. They kept their customers locked in their own closed networks and required them to use dedicated gateways to communicate with other networks. If a customer on the AOL network wanted to send an email to a customer on the CompuServe network, they had to use a dedicated gateway and pay exorbitant fees.

This was the early internet. Closed networks built separately by each company. And I believe that today's blockchain is exactly in the same situation. I will skip this slide.

Let me pose a question. Why has the true blockchain capital market not yet arrived? It seems to me that token securities have been introduced and operated in our country through the practical demonstrations of businesses for almost 8 to 10 years. And now it is being legislated. I believe there are four walls blocking the way forward.

The first wall is payment delays. Assets can move on the blockchain in 1 to 2 seconds. However, the money to be paid still takes 1 to 2 days through the old banking network. The item has already been transferred, but the money has not yet arrived. In this gap, payment accidents can occur, and if one place collapses, there is an inevitable risk of a chain default.

The second wall is systemic risk. Each financial company is setting up its own blockchain separately. As a result, money is trapped on their own islands. The cross-chain bridges created to forcibly connect these islands are literally bridges connecting islands. The problem is that these bridges are major targets for hackers and are easily used as conduits for money laundering, and there is no operator or standard for them.

The third barrier is the absence of standards. Currently, there is no common blueprint at the national level. Each entity is building independently. If this continues, when we try to merge everything later, we will face an enormous bill for rebuilding everything. This will be elaborated on further later.

The fourth barrier is legal constraints. Currently, token assets are treated individually, like cattle or artworks. Investments that mix multiple assets to spread risk are still limited, but the policy direction on September 4 opened the door to this aspect. What remains is, as mentioned by Attorney Kim earlier, to open the door to public offerings and to flexibly refine the issuance rules for products to fit reality.

In summary, we need to break down four barriers: payment delays, system risks, the absence of standards, and legal constraints. Only then can we transition to a true next-generation blockchain on-chain capital market where assets and money flow in real-time without obstruction.

Let me explain the first barrier in more detail. The assets at the top of the screen flow through the blockchain in one second. However, the money at the bottom is still tied to the T+2 legacy banking network.

This creates a serious dilemma. First, there are cases where the goods are sent first, but the money has not yet arrived. If stocks are transferred in one second but the money does not arrive in the other party's account two days later, it ultimately results in a payment default. In the meantime, the stocks may have already been sold to hundreds of others or combined with protocols that create liquidity through re-collateralization in the secondary market. This leads to increased leverage and a chain of defaults.

For reference, the policy direction on September 4 imposed restrictions on asset transfers to prevent this risk. This seems to be a sign of much deliberation. However, this is only a temporary measure.

Conversely, there are cases where assets are locked up until the money arrives. This is called a lock-up. Since the assets are frozen for two days, the significance of using a high-speed blockchain is entirely lost.

If we have to lock up collateral worth billions of won to prevent payment accidents and tie up cash that does not generate interest, it creates a situation where money does not circulate. There is no reason for global institutions to enter. The only reason global institutional investors would come in is due to real-time asset settlement on-chain. Without that, there is no reason for them to enter.

There is only one solution. Goods and money must be exchanged simultaneously on-chain. They must go on-chain at the same time. This is simultaneous settlement, atomic settlement. If the money does not come in, the assets should not be transferred, and if the assets are not transferred, the money should not be settled. This is the T+0 simultaneous delivery payment (DvP) mentioned in the policy direction.

To implement this, one method is to physically integrate the mainnet, but there are risks associated with that. A single vulnerability could collapse the entire system. Another method is to optimize interlocking protocols. Both require research and extensive review. The faster this research and demonstration progress, the faster regulations can advance.

Fragmented mainnets and weak cross-chain bridges are threatening the entire financial system. Now, let’s talk about the second barrier. On the left side of the screen, you can see liquidity isolation, where each financial institution has its own mainnet, trapping money on their isolated islands. If we forcibly connect these islands with bridges, it becomes the most dangerous powder keg. Many of the hacking attacks occurring now are happening at these bridges.

This is because it is where the money is locked, and the links for money laundering can be the weakest here. Customer verification (KYC), anti-money laundering (AML), and travel rules can disappear on a bridge without a responsible entity. It becomes the most dangerous powder keg.

There is also an oracle that assigns value. To send real-time information about stock market conditions or whether a bank has settled funds on-chain, a system that connects off-chain and on-chain is needed. This is called an oracle. This oracle is merely a centralized server. Of course, there are several companies abroad, such as Chainlink, but discussions on whether it is subject to financial regulatory approval have not yet been sufficiently conducted.

Nevertheless, the role of oracles is significant. The bridge references the price information from the oracle to issue or burn assets on one side or to issue new wrapped tokens on the other side. However, if there is a failure or hacking of the oracle that assigns that value, it can collapse completely. Ultimately, if the isolated islands and the leaky bridges are interlinked, it can increase the systemic risk of the entire financial system.

Now, the third barrier. To prevent astronomical reconstruction costs that will arise later, it is essential to embed regulation from the initial design stage by coding the rules into the system. On the left side, you can see a torn blueprint. If we leave it to create individual mainnets without a national standard, we will receive an enormous bill when trying to merge these networks in the future.

It is similar to when companies in the past created private intranet networks and then had to switch to a new internet standard, TCP/IP, incurring huge costs and facing system outages.

Therefore, regulations must be integrated into the system from the initial design stage. Instead of imposing sanctions after an incident occurs, core elements must be embedded in the program code in advance.

First, since financial transactions are moving capital markets almost on a nanosecond basis, we need to establish specifications for the mainnet that can guarantee the speed and performance to handle this. In other words, performance that guarantees institutional-level large-scale transaction processing speed is required.

Second, regulations regarding security must be embedded in advance to safely protect transaction information and personal data. Since it is a decentralized network rather than a centralized system, environmental integrity and security rules must be embedded in the code.

Third, mechanisms must be in place to ensure that the system does not stop even if a specific institution collapses. Single points of failure (SPOF) must be fundamentally eliminated.

Finally, the fourth is regulation and supervision. It is necessary to link the audit log of the ledger in real-time with the financial authorities' systems so that they can monitor the ledger in real-time. I believe that embedding regulation and supervision into the protocol itself is the overarching paradigm that supervision aims for in the on-chain world.

Ultimately, we must build with a proper common blueprint from the beginning to fundamentally block the enormous costs and incidents that will arise in the future. The last page discusses the fourth barrier, but since the previous speaker explained it better, I will skip it. Thank you for your attention.

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