Adrian Shedden is a senior associate at independent UK law firm Burges Salmon and head of the firm’s Fintech team
For the uninitiated, the Blockchain is, in practical terms, a distributed ledger that maintains a public and multi-validated record of data and data transmissions. Created as a means of facilitating transactions using the cryptocurrency, Bitcoin, blockchain technology is now used to transmit and record the transfer of ownership of data, currency and, increasingly, even non-digital assets – in essence, the storage and transfer of value.
When fully utilised and developed, it offers the possibility of automation, scalability and increased security to existing transactions involving the transfer of value. It also provides a “paper-trail” or more accurately, a “chain”, that is capable of certifying the current ownership, or perhaps more interestingly, the ultimate source, of that value, through a network of corroborating references.
We summarise the technology, its significance in financial services terms, its potential more broadly and a short analysis of the key legal and regulatory risks that are presented by Blockchain in its present and potential future state.
As a distributed ledger, Blockchain acts as a shared public record of transactions in which each new transaction is validated by users and then stored as blocks on the chain. Every new block includes a SHA-256 hash of the previous transaction and, therefore, the validity of each new transaction (and, therefore, the Blockchain as a whole) is dependent on the validity of the previous transaction. This allows every user to see the history of all transactions and which, thereby, creates a system that is incredibly difficult to corrupt without an almost impossible amount of computing power, not to mention energy.
The problem that Blockchain originally sought to address was essentially one of trust. It developed a way of creating digital property without the need for a central trusted third party to record the ownership and transfer of that digital property and it did so by distributing the central ledger of transactions amongst the user base – allowing users to transact (pseudonymously) with each other in the knowledge that the transaction would be secure and effective and would be witnessed by every user of the chain.
The result of this is potentially revolutionary for any kind of transaction, real or virtual, which involves a transfer of value or which relies on a trusted third party for verification purposes. Taxation is an obvious example. A national tax authority in any country could utilise blockchain technology to record the accrual and payment of tax liabilities autonomously and with a level of speed and sophistication that is not possible in any practical sense under existing self-reporting systems. This in turn brings the cost of the service down and those savings could, depending on policy positions, be passed on to taxpayers.
Tax (and indeed the transfer of value) is not the only obvious example of the potential uses of blockchain technology. One could easily see how a system that creates an arena of trust without the need for a trusted third party could be applied to the registration of transactions involving land (thereby automating many of the registration services of the Land Registry in the UK) or licences over intellectual property; in each case with no sacrifice being made against the security. Indeed, there are so many options for the use of a technology of this nature that Blockchain has the potential to be "like email for money" to decontextualize a recent quote by Blythe Masters, CEO of Digital Asset Holdings, LLC.
Other potential applications for blockchain technology that are often cited include:
- The ability to store/record smart contracts (i.e. contracts drafted/interpreted as computer
code which have the ability to self-verify their own conditions, self-execute by releasing payments and remain tamper proof by virtue of being stored on the Blockchain and, thereby, creating unparalleled, or even unintended, legal certainty though that is for another article)
- Use as a means of creating and archiving any record of data including that needs to be verifiable at some future date, which in practice could revolutionise company audits or the monitoring of compliance with regulatory obligations by companies and individuals
- Use as a means of validating the provenance of goods. For example, a supermarket shopper could conceivably validate the journey of say, their organic produce, from its source to the shelf
- The evolution of payments systems such as BACS, Chaps or Faster Payments
At a national level, work is already being undertaken to explore the potential applications for the technology including the recent House of Lords Economic Affairs Committee's inquiry into distributed ledger or blockchain technology. Skeptical as the tone may have been, the inquiry elicited comments from Dr Ben Broadbent, Deputy Governor, Monetary Policy, Bank of England who confirmed that the Bank of England is currently looking at blockchain technology to develop a central bank issued digital currency (the Bank of England has recently published a statistic in “Staff Working Paper No. 605: The macroeconomics of central bank issued digital currencies“; that a central digital bank currency issuance of 30% of GDP, against government bonds, could permanently raise GDP by as much as 3%).
LEGAL AND REGULATORY ISSUES
In the current world, the main legal and regulatory issue around the use of Blockchain solutions is the inability of current law and regulation to keep up with the development of novel applications/business models. In a financial services context, a business developing a novel financial use for blockchain technology could find itself caught in the purview of the Financial Conduct Authority’s regulatory regime, which more than likely doesn’t foresee or cater for the proposed product/business (as was the case with the sudden development of crowdfunding platforms).
Fortunately the Financial Conduct Authority and, as discussed above, the Bank of England are taking proactive steps to engage with and support the developments in this area as evidenced by the launch of Project Innovate, the development of a FinTech Accelerator and the engagement with all members of the community in the recent Call for Input: Supporting the development and adoption of RegTech. The result of this has already been the provision of proportionate and appropriate regulation in developing areas.
Anonymity / Pseudonymity
One of the great virtues of the operation of the Blockchain as applied to Bitcoin is the ability of the payer and payee to remain, if not completely anonymous, then at least pseudonymous. The issues this poses for criminal law enforcement have been well established, but there will also be a reckoning from a civil law and regulatory perspective with the increased adoption of blockchain solutions by large institutions, particularly in the financial sector where such businesses are required by law to "know your customer" for anti-money laundering purposes.
It seems inevitable that smart contracts will be one of the realised practical applications of blockchain technology – especially as these create the potential for greater legal certainty and automatic enforceability and execution. However, such contracts would be stored and verified on a Blockchain accessed and accessible by every user of the Blockchain. In practice, consideration will need to be given to any confidentiality clauses contained in such contracts and the applicability/enforceability of those clauses against the users of the Blockchain who aren’t the intended recipient of such contract.
Despite the above, it is probably fair to say that the only certainty we have at the minute regarding the effect of blockchain technology and applications both generally and in a specific legal and regulatory context is that nothing is certain and everything is to play for.