Blockchain has the potential to remake the internet landscape. Are we ignoring the legal and regulatory risks?

Satoshi Nakamoto[1] is a name that most people associate with the development of Bitcoin, the famous crypto-currency payment system that promises to make direct peer to peer payments between individuals without the use of an intermediary.  While Bitcoin has yet to displace traditional payment mechanisms as means of transacting, the underlying infrastructure of Bitcoin, the Blockchain, may prove to be Nakamoto’s most enduring invention.  It is this underlying internet infrastructure that is said to be ushering in what some commentators have referred to as the Internet of Value as distinct from the first iteration of the Internet, the Internet of Information.[2]

 

The Blockchain is a sophisticated network of computers running the highest level of cryptography that distributes a ledger along a public network.  The network is important from an operational perspective because it eliminates the “double spend” problem in peer to peer transactions involving digital currencies.  The double spend problem occurs since it is impossible under the current Internet infrastructure to transfer money from one party to another and ensuring that the payor no longer has the money given to the payee without the use of a trusted intermediary.  In other words, under the status quo, whenever you send someone something over the internet, be it a digital asset in the form of a file, or attachment for instance, you can only send them a copy.  This new technology allows you to send something to a party over a peer to peer network while ensuring that one party no longer has a copy on their own device.

 

How is this accomplished?  The Blockchain consists of a record of transactions that is encrypted to protect anonymity but is publically available and can be reviewed to verify the authenticity of previous transactions.  These records are maintained by numerous computers that act as nodes on the Internet.  Unlike conventional repositories of information where information is kept in a central location, the distributed nature of the ledger makes the system more secure as numerous copies are available which makes the system more difficult to hack.  The system is set up such that every ten minutes, transactions are archived in a block and sent out through the network for verification.  Computers along the network compete for the right to verify this batch of transactions by answering a randomly generated mathematical problem.  The first computer to successfully answer this question, has the right to verify the authenticity of the transaction.  Once this is done, the block of transactions is time stamped and linked to the previous transactions so that there is a permanent online record of all previous transactions since the beginning of the Blockchain.  The changes that occur to the record are then sent to the other computers on the network who then update their version of the ledger and the [group of super] computer[s] that won the competition is given the right to mint a Bitcoin as compensation for its efforts.  The fact that all records are publically accessible and time stamped makes the system much more difficult to hack then current systems, since a hacker would have to alter the entire chain rather than the individual block to be effective as the other computers on the network act as a check against hacking.  Moreover, transactions cannot be reversed after they have been time stamped adding yet another layer of protection.

 

The implications for this technology extend far beyond the payments realm.  The technology can also serve as an important repository of public records as all transactions can be independently verified.  As such, diverse proposals have been made to use the Blockchain to maintain land registries, patent filings, birth certificates, as a means of delivering foreign aid and even as a means of changing how democracy itself works, just to name a few examples.[3]  Moreover, the technology also has a component built in that allows for the execution of “smart contracts.”  These are not legal contracts per se (although they can be incorporated into legal agreements by reference) however they are still quite significant legally speaking.  Smart Contracts can control real-world valuable property and can enforce a functional implementation of a particular requirement and can show proof that certain conditions are met or not met.[4]  William Mougayar gives the example of a car payment, which if not made on time results in a digital lock being placed on the vehicle until payment is received.  Don Tapscott gives an example in IP law where a music performer could sell an MP3 file directly to consumers.  They could use a smart contract implementation in the Blockchain to specify a royalty rate regime built into the price of the track.  So, for instance, if the track was downloaded by an ordinary consumer, they could listen to the track for free or pay a few micro cents for it.  If the track was sold to a movie producer who wanted to use it in their film, the track would have a built in royalty regime that would enforce itself based on when and how it is used.[5]

 

As with any new and wide ranging technology, the developers behind it essentially see the sky as the limit.  And with any technology that is at an embryonic stage, there is an aversion to regulation which might stifle technological progress.  However, the lack of regulation poses significant challenges which developers have yet to address.  Two such challenges immediately stand out:

 

  • While the technology manages to eliminate the role (and costs) of having intermediaries, it also makes it difficult to regulate by not having an intermediary [such as wire services, credit card issuers, securities depositories, land registry offices, etc.] well versed in best practices and whose activities can be subject to regulatory oversight;

 

  • Smart Contracts although not traditional contracts in a legal sense [and more appropriately described as a transaction protocol], they still have a number of legal issues that must be resolved if we are to avoid classical consumer protection problems.

 

Beginning first with intermediaries, while it is true that there are transactions costs associated with transacting with an intermediary, there are also numerous benefits that flow to consumers through these intermediaries.  In 1999, faced with the question of why it was that the emerging models of e-money had failed to capture significant market share from credit card companies (a trend that continues to this day), Jane Kaufman Winn stated that this was due to the high levels of protection for consumers that are mandated for consumers who use the credit card system.[6]  Indeed, while the Blockchain allows for consumers to pay businesses directly without the use of the outdated payment infrastructure that underlies credit card systems (which is said to still use 1970’s mainframes) and does so in a more economically efficient manner, what consumers will be losing out on are the dispute resolution mechanisms that are inherent in these systems.  Thus, while Blockchain may do a wonderful job of bringing business and consumers together to facilitate a transaction anywhere in the world, the question that remains to be answered is what happens in the event of a dispute?  Currently a consumer who has a dispute with a merchant can rely on the fact that the credit card issuer can intervene on their behalf, and in situations where warranted initiate a charge back against the merchant.  No chargebacks are possible in the Blockchain.  As a result, a payment through the Blockchain is more analogous to a payment in cash, which brings with it substantial risks to consumers beyond simply certifying the authenticity of the payment.

 

Moreover, while the distributed nature of public Blockchains provides for an additional layer of security against hacking, this in itself is not without risks.  For example, unlike an intermediary where regulators can enforce compliance against a domestic entity, with a ledger that is distributed across many jurisdictions, how will regulators find a way to ensure compliance with anti-money laundering legislation?  The same is true of consumer protection laws, privacy laws or any other type of transactional based legislation.

 

With respect to the smart contracts feature, questions need to be answered relating to bargaining power in enforcing terms.  While Tapscott’s example of giving musicians the power to have a greater share of the fruits of their labours is very admirable, Mougayar’s example regarding self – locking vehicles demonstrates how a significant power imbalance vis-à-vis bargaining power can have very serious consequences.  What about other terms that a consumer might find harsh?  Is it not hard to imagine circumstances where consumers could be made worse off than before?  What about the role of freely given consent in these types of transactions and would there be an obligation as there is in  consumer contracts to point out onerous terms to consumers before they give their consent?  Indeed, it may be rather difficult to spot onerous terms and conditions outright when they are buried in computer code that can self-execute without any human interaction.  In other words, while smart contracts may offer more freedom for some, it may restrict freedom for others (particularly those dealing with parties that have a disproportionate amount of bargaining power) and a balancing may be required to ensure a more just outcome.  This is an issue that is more pressing considering that it is also possible to build in dispute resolution procedures in these smart contracts.  Will these dispute resolution mechanisms end up hindering access to justice for consumers in much the same way that arbitration clauses are used against consumer interests for instance?

 

Undoubtedly, some of these issues can be mitigated through the use of a closed Blockchain that is regulated rather than a public one that is technologically neutral.  Ultimately, it remains to be seen just how pervasive and widespread the technology proves to be.

 

Blockchain technology is a marvellous development that has a tremendous potential to provide for a different kind of Internet than has previously been envisioned.  However, it would be unfortunate if developers of these technologies did not avail themselves of input from legal minds who can help highlight previous experiences and allow for negative effects to be mitigated at the design stage.[7]  Moreover, the legal community itself must face the challenges posed by the emergence of this new technology.  It needs to understand how law is being made through this technology as a result of the technical standards being implemented here that can affect individual legal rights and obligations, and assess what role jurists can play, if any, in guiding its development.  With any luck, an interaction between law and technology can help avoid the mistakes of the past while allowing society to take full advantage of the potential offered by this dynamic and exciting new technology.

 

 

[1] It should be pointed out that the name is considered by some to be a pseudonym as Nakamoto has chosen to remain out of the public eye.  Speculation abounds as to which individual / entities may be the real Nakamoto.  See Don Tapscott and Alex Tapscott.  The Blockchain Revolution.  Toronto:  Portfolio, 2016 at 5.

[2] See generally, Don Tapscott “How the Blockchain is Changing Money and Business.”  Online:  YouTube Ted Talks < https://www.youtube.com/watch?v=Pl8OlkkwRpc >  (date accessed:  January 11, 2017).

[3] Tapscott supra note 3.

[4] William Mougayar.  The Business Blockchain:  Promise, Practice, and Application of the Next Internet Technology.  Hoboken NJ:  John Wiley and Sons, 2016 at 42.

[5] Tapscott supra note 3 citing the example of the performer Imogen Heap.

[6] Jane Kaufman Winn.  “Clash of the Titans:  Regulating the Competition Between Established and Emerging Payment Systems.”  (1999) Vol. 14 Berkeley Tech Law Journal 675.

[7] For example, privacy by design concepts have helped make privacy regulations more responsive to consumer concerns.  See Muharem Kianieff.  “The Evolution of Consumer Privacy Law:  What Privacy by Design Can Learn From Commercial Law and Standardization.” 10 Canadian Journal of Internet Law and Technology 1 – 28, (2012).

 

Muharem Kianieff
Associate Professor
University of Windsor, Faculty of Law

 

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