The start of the new decade has seen a surprising renaissance period for cryptocurrencies. In the fervour surrounding the once shunned currency, Bitcoin has nearly tripled in value due to the commercial reevaluation of its utility. This desire to push cryptocurrencies to the mainstream can be seen by the fact that Paypal, and now Mastercard and Visa, will start implementing cryptocurrencies into their network. However, often overlooked in the discussion of cryptocurrencies, which could not just contribute to the commercial world, but fundamentally invert it, is that of the boundless potential for blockchain and its “Distributed Ledger Technology”. This automated and decentralised method of transaction that cryptocurrencies utilise has seen a dramatic increase in innovation and implementation by itself. Indeed, one of the core reasons for the Bank of England pursuing the issuance of a Central Bank Digital Currency is that it will encourage more innovation in blockchain. This technology is still in its early stages, but providing regulation for it has been an arduous process, with an explosion of innovation in the industry overwhelming regulators. For example, in America, the astronomic rise in blockchain innovation over the past year has led to what commentators are calling a proverbial “DDos attack” on financial regulators. This is coupled with the fact that this field is very alien and complex for courts and regulatory bodies, illustrated by the British courts only recently confirming cryptocurrencies to be property in AA v Persons Unknown , setting a clear question as to if, and to what extent, legal regulation is required. In light of recent media proclamations that, due to Brexit, Britain has the potential to become a “world centre” for financial technology, it is thus very important to illustrate both the potential for blockchain technology and the legal regulation that might be implemented for any innovative developments.
Chain, keep us together
Blockchain’s usefulness comes from the fact that any transaction performed is subsequently recorded by a signature. This signature is not a traditional one but a code referred to as a “hash”. In a traditional transaction, these hashes would be recorded with a singular recording method and subsequently validated by the responsible parties, but the hashes that are created through Distributed Ledger Technology are stored in a “node”. This is a programme that all participants individually access, and which validates the transaction for each individual. Consequently, the transaction is decentralised, as the process is neither transferred nor copied but occurs on each node independent of one another. This automation and decentralisation allows for a decrease in error, especially reducing human error, subsequently increasing the efficiency of a transaction. It is also transparent as nodes are visible to all participants and the hashes are fixed and unchangeable due to being individually verified in the same way, meaning one party cannot claim a transaction has a different outcome. Importantly, but undoubtedly controversial, is that it operates with some level of anonymity and flexibility, allowing parties to facilitate transactions outside of any given legal jurisdiction.
It is not difficult to see the benefits such technology can bring to a variety of sectors. Currently, there are novel blockchain implementations in surprising areas, for example, the immutable data chain can be used by advertising companies to target their audiences better, or efficient methods of establishing funds for property acquisition could be used in real estate markets. In this regard, the utilisation of blockchain can be used not just in piecemeal implementation but in large-scale strategies. Indeed, the European Commission has recently argued for blockchain technology to be used in transnational environmental strategies regarding greenhouse gas emissions. Such ideas are still in their infancy but a good illustrator of what is possible is Walmart, which at present have one of the largest utilisations of blockchain technology. For Walmart, both suppliers and consumers issuing information about food products create excess information to validate manually, quickly. By using a blockchain system of validation at each stage, from the food’s creation to its issuance to the public, Walmart can trace contaminated food to its source within 2.2 seconds, instead of the typical 7 days manually.
However, undoubtedly “decentralised finance” or DeFi is one of the most significant utilisations and the most expediently growing area of blockchain technology. DeFi will allow the public to enter financial transactions without the need for traditional financial intermediaries such as banks. For example, it can create auction markets in which monetary sums are lent and given if collateral is provided, but without any of the traditional documentation and limitations on the loans given. Hence, a transaction is successfully completed without the requisite integrity of, for example, an investor in a traditional financial setting. DeFi loans can be granted regardless of typical requirements such as a suitable credit score for the applicant, opening the door for investment in small-scale businesses. However, they can also come with significant downsides, such as a significant monetary collateral amount required for an applicant, and a lack of the centralised insurance and certainty in the platform, which banks typically benefit from. Regardless, the transparency and the lack of oversight or regulation in transactions gives DeFi the potential to vastly alter the financial sector.
Smart Contracts: The Lessons Learnt From Being The New Kid on The Block
One of the core blockchain infrastructures that enable such strides in the field with regards to innovation is smart contracts. It is thus the blockchain mechanism that has attracted the most discourse from academics. Currently, as there are no laws or court cases which deal with regulating blockchain, this discourse is vital for any speculation on what action regulators will take in the future. Smart contracts utilise a blockchain to self-execute terms- for example, where a traditional contract would just stipulate “if x happens then y will follow”, smart contracts automatically implement the arrangements for when “if x happens then execute y”. This automated system allows the infrastructure for blockchain’s innovation by enabling automatic execution of transactions, for example in an auction-based DeFi system by automatically executing the numerous requisite contracts between the vendor and purchaser.
However, their novelty compared to traditional contracts puts them at odds with legal systems and raises significant legal questions. From the perspective of contractual interpretation, the England and Wales Law Commission has argued that the intention of the parties, despite being stored in code, can still be warped if someone besides a contractual party provides the code for the blockchain. This thus makes it difficult for the courts to ascertain where the contractual obligation starts and ends. Furthermore, the Law Commission has queried if interpretation should be from the perspective of a reasonable person or a reasonable person with the requisite knowledge of code. The courts grappling with the precise place of programming and code in the legal system is not uncommon, but what the Law Commission demonstrates is that in the sizable alteration of pre-existing legal areas, such as contract law, the coding aspect of blockchain can raise significant legal questions as to blockchain’s validity.
The European Union’s Blockchain Observatory And Forum in their report on smart contracts highlight further novel regulatory issues with blockchain. Their core issue is that there is the potential for complete anonymity in both the creators of the smart contract and parties in a transaction using blockchain. Consequently, when a smart contract’s usage breaches British law it will be difficult to allocate liability to the creator or user and file a lawsuit against them. Another interesting point raised is that a smart contract is immutable in the code, meaning that it is difficult to update it for any complexities encountered, for example when there is a contractual term that breaches British law.
However, regulation is not impossible. In America, there is a call for a quality assurance mechanism, where a decentralised regulatory agency checks the code for any potential problems, and clearly identifies and faithfully copies all the developers and code involved by way of a “forensic node”. This would enable regulators to ascertain liability and also provide methods in which developers can update their code to mitigate any difficulties. Some countries could learn a lot from this, for example, Britain who already uses a similar decentralised regulatory infrastructure for regulating some Financial Technology in their “sandboxes”. Thus, while regulation in this area is complex and will invariably take time, it is still possible.
The potential for blockchain technology is immense and comes with many clear benefits for the commercial arena in areas such as finance, environmental regulation, media and real estate. However, such drastic developments in pre-existing legal areas create a need for regulation but have created difficulties because of the legal complexity of the code that blockchain utilises. This is true not only because of the complexities of legally interpreting code but also in the rigidity and anonymity of blockchain. Regulation should thus attempt innovative methods of decentralised regulation by allocating substantial oversight in developing blockchain technology.