Blockchain technology is most notably used to facilitate cryptocurrencies and financial services. Its potential to be used for wider commercial purposes is being explored by a number of industries. This articles provides a short explanation of how blockchain systems work, why they are used and some of the legal issues.

A Short History of Blockchain

Blockchain was invented in 2008 to serve as the public transaction ledger of the cryptocurrency bitcoin. The invention of blockchain for bitcoin made it the first digital currency to solve the double-spending problem.

The double-spending problem is the potential flaw in a digital cash scheme in which the same single digital token can be spent more than once. Unlike physical cash, a digital token consists of a digital file that can be easily duplicated or falsified.

Blockchain solved this problem by making it impossible to double-spend digital goods that are being stored on blockchain, such as paying twice with bitcoins. It does this by requiring a more sophisticated system of authentication and through the innovative use of cryptography and distributed ledger technology.

Distributed ledger technology

The expression “distributed ledger technology” (DLT) is used to refer to technologies that enable secure validation, recording and sharing of data in a database. This means that copies of the database can be kept and maintained simultaneously by many people or organisations and no copy is the master or lead copy. As such, the database is said to be “distributed” or sometimes “decentralised”.

Therefore “distributed” means that the database is stored and maintained across multiple servers by multiple people, rather than one central database controlled by one person. Whilst “ledger” refers to the fact that the database is a record of many individual transactions.

The expression DLT is often used interchangeably with blockchain. However, what is referred to as blockchain is just one type of implementation of DLT. This blog will use the term blockchain interchangeably with DLT.

Trustless

Traditional ledgers can be altered retroactively but this is impossible with blockchain, since the latest block (or journal entry) contains data of the prior one. Moreover, blockchain provides irrefutable proof of any prior transaction and a clear allocation to an individual ID at any given time.

Therefore blockchain technology is often described as “trustless” in the sense that there is no need to trust (or indeed know) the counterparty to your blockchain transaction.

By cutting transaction costs and providing accessibility blockchain’s decentralised and open nature allows people to trust each other and to directly transact peer-to peer, making intermediaries and third parties obsolete.

Bitcoin – Blockchain Applied

The technologies underpinning the Bitcoin network enable each bitcoin to be represented by a unique set of public and private keys, making the holder of those keys the sole person that is able to transfer that bitcoin. Using blockchain to store the record of transactions in bitcoin means every subsequent acquirer of a bitcoin can have full confidence that the transferor in fact controls that bitcoin without the need for any third party verification or concerns that the bitcoin has been copied or already transferred to another person.

Since the introduction of the Bitcoin network in 2009, many other public blockchain networks utilising digital tokens as a method of payment (“cryptocurrencies”) have been introduced, such as Ethereum and Litecoin.

Examples in commercial situations

Marine insurance:

In May 2018, Danish shipper Maersk announced it was insuring its vessels’ hulls and machinery using the Insurwave platform, a joint venture between Ernst & Young and software provider Guardtime. Using Insurwave, Maersk provides real-time data on its fleet of vessels which providers use to rate and price insurance and reinsurance products through DLT. Endorsements and invoices are able to be issued automatically to reflect any necessary changes as the vessel’s risk profile changes over time.

Trade finance:

The “we.trade” trade finance platform (see we-trade.com) launched in July 2018 is the first commercial blockchain platform developed by a consortium of financial institutions. The platform enables corporates to conclude trade finance transactions with management, tracking and payment information made available to all relevant parties on a real-time basis and automating final payment based on the fulfilment of agreed conditions. The platform is intended to be opened up to further international financial institutions with the goal of creating a global trade platform.

Future Uses

Supply chain applications generally:

A blockchain can be built up from the moment the goods are manufactured, and indeed before manufacture, as it could chart the origin of the parts of which the goods are composed. This sort of tracking already exists, but blockchain would increase certainty and confidence.

IP rights management:

Ownership of IP rights can be stored on a blockchain, making it easier to identify when a certain right was first applied for, registered, licensed, or commercially used, and parties to whom any right has been transferred.

Internet of things:

The Internet of Things (IoT) essentially connects devices to the internet or to one another. IoT sensors facilitate the remote monitoring of patients’ well-being, stock levels and machine components, and can even allow machines to be operated remotely.

Blockchain could enable IoT devices to communicate securely with one another as to the status of a device or good.

Land registries:

Last year it was reported that Kenya, the Republic of Georgia, and Russia are test piloting projects whereby real property records will be managed on a public blockchain database. In 2018, HM Land Registry announced that it was working with R3’s Corda platform to investigate potential uses of blockchain.

Personal identity:

It has been suggested that blockchain service providers might offer individuals a service that stores securely their personal data and enables individuals to authenticate their identity (or certain identity credentials, such as being over 18) without having to disclose their personal data itself.

Construction:

The UK construction industry is highly regulated and construction projects create a significant volume of diverse data, which often needs to be shared or certified by multiple stakeholders. It follows that blockchain lends itself well to the construction industry. While there do not appear to be any current examples of the use of blockchain in the construction industry, articles (see for example medium.com: The Impact of Blockchain Technology on the Construction Industry (19 February 2017)) have explored the possibilities.

Blockchain Legal Issues

If you are looking to use blockchain within your business and/or work with businesses that do you should have an understanding of the legal issues raised by the technology.

Regulation and compliance

Depending on the application, there is likely to be a range of local, national, international and supranational law and regulation which must be catered for in any implementation of blockchain.

The key areas where specialist legal advice is likely to be required are:

  • KYC/AML checks. If the application requires customer due diligence, the methods of conducting KYC and AML checks will need to comply with relevant legislation and guidance. In a cross-border transaction context, this may require extremely complex analysis, as regulatory requirements and local custom vary from jurisdiction to jurisdiction, and the application will need to be able to meet the requirements of every relevant jurisdiction.
  • Competition law. Where the application involves a consortium or group of actual or perceived competitors, or otherwise involves the sharing of a significant data pool, competition authorities may require notification, consultation or approval. Early analysis of any potential issues under competition law is essential.
  • Tax. The tax treatment of digital tokens native to, or otherwise used on, blockchain networks remains uncertain. The blockchain application needs to be considered in the context of the business’s existing tax and financial position as well as from the end user’s personal tax perspective.
    Governing law

Which law governs, and whether to rely on the courts or arbitration, are questions which should be considered at the outset. Considerations for this should include what is customary for the particular application, where the activities and assets of the business are located, where the participants are located and where the end users are located.

IP rights

It is important to understand who will own the IP rights in any blockchain application; such rights may be created across a variety of parties.

Naturally, if the application utilises a public chain network or a third party blockchain platform, the owner(s) of the IP rights in the underlying technology (or the components of that technology) will assert their rights over such technology through the relevant terms and conditions or other agreements covering the use of that technology. In these circumstances, usual contractual assurances, such as warranty and/or indemnity protection, in respect of IP should be sought.

As within many other areas of computer programming, sample and example source code for blockchain applications is widely available on the Internet through code-sharing websites such as GitHub. Direct copying of such code for a proprietary blockchain application must be analysed so as to reduce the risk of copyright infringement claims. This will include looking at the permission or licence granted by the code author. Similarly, usage of open-source software must be carefully monitored, and the relevant licence terms of its use must be understood before incorporating open-source code into any commercial blockchain application.

Blockchain and Data protection

Completion of a full data mapping of flows, storage and usage of data is imperative to identify whether any personal data will be processed by a proposed blockchain solution. Data mapping will also be important to help establish whether any personal data is to be transmitted within or outside the network and/or between participants or other third parties. Each collection and transmission of personal data will require a lawful basis under relevant local regulation.

Technology offering opportunity

Blockchain technology has created a platform upon which businesses can look to economise and improve the reliability of online financial and commercial activity. As with most things, though, the legal issues raised by such technology should always be considered.

If you have any questions on blockchain or smart contract get in touch with one of our technology lawyers.