Blockchain Technology and the Law

Opportunities and Risks

Muharem Kianieff

• Editorial: Informa Law from Routledge
• Año: 2019
• ISBN:
  9781351039208
• Edición: 1
• Categoría: Law
• Categoría: Law Theory & Practice

Blockchain Technology and the Law: Opportunities and Risks is one of the first texts to offer a critical analysis of Blockchain and the legal and economic challenges faced by this new technology. This book will offer those who are unfamiliar with Blockchain an introduction as to how the technology works and will demonstrate how a legal framework that governs it can be used to ensure that it can be successfully deployed.

Discussions included in this book:

- an introduction to smart contracts, and their potential, from a commercial and consumer law perspective, to change the nature of transactions between parties;

- the impact that Blockchain has already had on financial services, and the possible consumer risks and macro-economic issues that may arise in the future;

- the challenges that are facing global securities regulators with the development of Initial Coin Offerings and the ongoing risks that they pose to the investing public;

- the risk of significant privacy breaches due to the online public nature of Blockchain; and

- the future of Blockchain technology.

Of interest to academics, policy-makers, technology developers and legal practitioners, this book will provide a thorough examination of Blockchain technology in relation to the law from a comparative perspective with a focus on the United Kingdom, Canada and the United States.

Chapter 1

Introduction

Most will agree that 2008 was a momentous year in financial history. What most consumers associate with that year is the massive global financial crisis that tested the resolve of politicians and policy-makers alike. But in financial technology (fintech) circles, the year is also important for the release of a White Paper that paved the way for the development of Bitcoin and Blockchain technology. Created by an author under the presumed pseudonym of Satoshi Nakamoto,¹ the paper would have widespread repercussions not only for the world of electronic payments, but also for commercial relations and the way that we conceive of the Internet generally. Ten years later, some lessons have been learned regarding shielding consumers from considerable financial risks, both on the macro level with respect to global financial policies, and on the micro level with respect to some of the developments in crypto currencies that have followed.

Since the White Paper first appeared, a new level of excitement has surrounded the development of these fintech products that promoters declare, are poised to revolutionise modern-day finance and commerce. This level of euphoria, both in the world of technological development and in the world of business, has not been seen since the days of the dot-com bubble in the early twenty-first century. As such, developers and entrepreneurs alike have attempted to reimagine the new uses to which the technology behind the Blockchain can be deployed in order to extend its applications to achieving new-found efficiencies and to finding new ways of exploiting economically the technological advances being made by Blockchain to change the way that information is stored and used online.

As such, now would be a good time to take stock and consider how developments in Blockchain technology can be viewed in the context of the evolution of payment mechanisms generally with a view to examining which factors, if any, can serve as accurate predictors of the probability that an emerging product could displace an existing payment technology. The rapid pace of capital deployment in this area would seem to suggest that the technology will have some staying power well into the future. However, the inner workings of the technology have proven to be somewhat of a mystery for legal observers who hitherto have taken a wait-and-see approach to engaging with the emerging legal landscape behind the technology. Indeed, since much of the development behind Blockchain is being driven at such a rapid pace, numerous participants from software developers, financiers, regulators and lawyers, to name a few, have made their contributions in isolation from one another, and it is submitted, without sufficient collaboration with counterparts in other disciplines to enable the technology to evolve in a manner that does not repeat the mistakes of the past.

The most important group that is vital to the success of Blockchain is one that was not mentioned above – namely consumers (and their advocates). This is a group that has not fully engaged with the Blockchain on a mass level, and they in fact are the most vulnerable to the risks posed by it. They will determine whether or not this technology will ultimately succeed. As such, any efforts to ensure that the technology reaches a critical mass and is scalable across a wide range of applications, must take consumer interests into account in order to avoid incidents that will undermine consumer confidence and hinder the uptake of Blockchain. As a result, the ultimate success or failure of Blockchain will depend upon whether consumers find the technology to offer enough of a value proposition (taken as a whole when the benefits and risks are considered) that would warrant moving to new Blockchain-based payment mechanisms and away from conventional (what will be referred to as ‘legacy’) technologies.

To be sure, these existing legacy technologies do have a significant advantage over the nascent ones by virtue of the fact that consumers have a familiarity with them and understand how they work. Moreover, it is submitted that one of the main reasons why these products have developed in the manner that they have can be attributed to one factor in particular: the presence of an intermediary that is subject to regulation by authorities and can be looked to by consumers in the event of a dispute. These regulations did not arise by accident, but rather were in response to various incidents that put pressure on political representatives (particularly those in the United States) to take action and introduce regulations that were intended to increase consumer protections. These regulations in turn have built up public confidence in these payment mechanisms that have allowed them, in part, to assume the dominant position that they occupy today.

It will be argued that a similar approach must followed in order to make Blockchain successful in meeting the expectations that consumers will have for it. Otherwise, one risks repeating several historical events that brought turmoil to the marketplace, put individual savings at risk and threatened to impose huge transaction costs on payment processing that had a negative impact on economic growth generally.

Obviously, it is crucial to any understanding of the risks posed by a disruptive technology such as Blockchain to comprehend how it is applied, and what uses the technology can be put to. Moreover, these new disruptions on a technical level have an impact on existing legal conceptions that we have relied upon over the years the world over and the response that regulators take now will have huge repercussions on future technological developments and their business applications. In deciding which course to take, policy-makers must understand how the technology works. Moreover, they need to familiarise themselves with the risks entailed by this technology and also anticipate new risks that may arise.

This book then has two purposes. First it will describe the operation and ongoing legal issues that confront the developers of the Blockchain. Second, it will then analyse the development of Blockchain against the backdrop of previous historical innovations over the last half-century or so, in various jurisdictions, with a view to understanding how some of the challenges and solutions posed by those products can help guide us to avoiding mistakes from the past, while leveraging this knowledge to in order to mitigate some of the risks involved in using this technology. As such, no discussion of proposals to regulate Blockchain is complete without some discussion of what types of policy have proven to be the most conducive to previous innovations in payment technologies with a view to ensuring that the transition (if any) to these new products and concepts is free of turbulence for consumers and businesses alike.

At this juncture, it may be appropriate to remember that one of the guiding principles that will ultimately determine the success or failure of any payment product is the answer to the question whether the proposed technology will help to increase economic efficiency. In 1998, the United States American Bar Association (ABA) established a task force to produce a report on stored-value cards. These cards were the precursors to what today are referred to as ‘chip cards’ in North American parlance (that is to say, they featured a microprocessor embedded in the card itself, that today is used as a security device to authenticate transactions). At that time, stored-value cards were seen as a method for providing consumers with a means of storing a cash equivalent on the microchips found in their bank cards which could then be transferred in the peer-to-peer or peer-to-business context. Although the technology failed to generate much excitement among consumers, one of the factors that the task force emphasised in its report was that the more efficient a payment system becomes, the lower transaction costs become, which in turn leads to greater economic growth for the economy as a whole.² To put it more succinctly: the more efficient the payment system, the greater the benefits to the economy.

As such, those markets where, say, a Blockchain-based crypto currency can help to lower transaction costs for all economic actors, are the markets in which the technology is likely to see the greatest benefit. Conversely, however, in the event that the technology introduces new risks or imposes costs that were not previously incurred, this will increase transaction costs and bring down not only the currency in question, but the economy as a whole. For the purposes of brevity, the aforementioned phenomenon will be referred to as the ‘Transactions Costs’ rule.

At this time, it may be helpful to state what this book is not. The book is not meant to be an all-encompassing treatise on the various laws and regulations that are currently affecting the development of new crypto currencies and other Blockchain-dependent applications. It is not a how-to guide for those seeking to establish businesses that leverage the Blockchain, nor is it meant to be a compendium of all of the legal issues and regulations that could potentially affect would-be entrepreneurs who seek to operate in this space. Rather, this book is intended to be a step back from some of the recent euphoria that has surrounded some of the new launches of crypto currencies and to examine the Blockchain from a theoretical perspective that offers a critical assessment of the potential for the Blockchain to provide advancements in commercial transactions, warts and all.

By examining how previous cases that have leveraged paradigm-shifting technologies in commercial areas have affected consumer rights and expectations, we can identify from the outset those issues that Blockchain advocates and developers will need to address if they wish to grow consumer confidence in this area. The theoretical approach envisaged will help focus attention on many of the macro level issues that have heretofore not been addressed. It can be argued that one of the main factors that is holding Blockchain back at the moment is one of its promoted virtues – namely the lack of a trusted intermediary that can be looked to in order to facilitate transactions. While this has the effect of lowering transaction costs in some jurisdictions, there is a countervailing cost that is scarcely mentioned. This is the fact that intermediaries can prove to be a valuable asset for consumers to assist in mediating disputes with merchants and can also prove to be a useful point of contact for governments that are interested in regulating payment services. These are factors that have favored legacy products in the past, and as will be seen below, the dual roles played by intermediaries have helped to facilitate both the rule of law and consumer acceptance of new payment mechanisms. It should be noted that this results not only in a direct reduction in transaction costs, but an indirect reduction as well since the legal certainties that result also help to increase consumer goodwill. As such, one of the predictors for the success for these emerging products that attempt to leverage Blockchain technology is how well these products can adapt to providing consumers and regulators alike with the legal guarantees they seek in order to access products that meet their expectations.

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1 William Mougayar, The Business Blockchain: Promise, Practice and Application of the Next Internet Technology (John Wiley and Sons 2016) at 42.

2 American Bar Association Task Force on Stored Value Cards, ‘A Commercial Lawyer’s Take on the Electronic Purse: An Analysis of Commercial Law Issues Associated with Stored-Value Cards and Electronic Money’ (1997) 52 Business Lawyer 653.

Chapter 2

Overview of Blockchain and the trust problem

As mentioned in Chapter 1, the origins of Blockchain can be found in the development of the digital currency, Bitcoin, as outlined in Nakamoto’s 2008 White Paper. In this piece, Nakamoto was developing a new form of payment through digital means. This on its own is not particularly ground-breaking as digital currencies were nothing new at that time. In fact, many of the earliest of them (such as Digicash, for instance) can trace their origins as far back as 1989.¹ Like Digicash, Bitcoin relies on cryptography (described by one commentator as ‘the science of scrambling and unscrambling messages so they cannot be read by unintended eyes’)² in order to maintain user anonymity.³

Where Bitcoin departs from previous efforts lies in its ability to move beyond attempts to create a ‘cryptocurrency’ by resolving what has been termed the ‘double spend problem’.⁴ What is meant by this is the notion that given the fact that a cryptocurrency consists of computer code, there is no way to verify that a unit of cryptocurrency in the hands of one individual has not already been used by another and thereby exhausted whatever value were to remain in the monetary unit. That is to say, there is no way to ensure that digital money has not been spent twice, which would thereby cause one of the transactions in question to be voided.⁵

One of the reasons why this problem has existed since the early days of the internet lies in the manner in which information is exchanged between parties. From the late 1990s until the late 2000s, the only manner in which information could be sent between parties was, to use the analogy of Don Tapscott, as ‘copies’. That is to say, an individual wishing to send a photograph to another individual via email could do so only by sending a copy of the original file that resided on their computer. There would be no way in which one could send the original to the recipient in such a manner that the sender would no longer have the original in a peer-to-peer fashion.⁶ Rather, one would have to rely on the trusted and true method commonly found in commercial relations by employing the services of a trusted intermediary whom both parties to a transaction trust, and who then takes and transfers an asset from one party to another on its own proprietary database.

From the outset, this was not an option for Nakamoto and his fellow developers. What one notices when reading the history of the innovations in this technology, is a decidedly libertarian bent in the beliefs that manifests itself in the principles that underlie Bitcoin and Blockchain. At its core, Bitcoin is a technology that seeks to eliminate the use of any and all intermediaries between parties. Many of the original parties who developed the technology were influenced by the libertarian politics popular in California (home of ‘silicon valley’ and where the majority of innovations in computer technology takes place) during the 1970s and ’80s that viewed government with suspicion.⁷ These suspicions were driven primarily by the fear that advances in digital technology would enable governmental authorities to harvest data about private citizens and thereby making the data vulnerable to capture by nefarious actors.⁸ Naturally, the decision to keep transactions anonymous requires that information to...