The blockchain phenomenon
January 2018 | PROFESSIONAL INSIGHT | BANKING & FINANCE
Financier Worldwide Magazine
January 2018 Issue
Blockchain technology is the topic of the day. For the tech industry, it has been steadily growing for the past decade, becoming the technology which could transform virtually every industry.
It has been touted as one of the most critical disrupters since the advent of the internet in the 1990s and is one of the most actively invested sectors, next to payments infrastructure, e-wallets, mining and banking infrastructure. Blockchain technology is still in its early days, but it is clear that it is on the way to ushering in a new era of the information age.
Investment into blockchain startups is expected to surpass $3bn by the close of 2017, and as of September 2017 funding into blockchain companies was $2.4bn, up 340 percent from 2016. Twenty-five percent of that funding came from VC investment and 75 percent from ICOs. By 2024, the global blockchain market is expected to be worth $20bn.
The new blue ocean
Often thought to be synonymous with Bitcoin, blockchain technology is far more than just a platform for cryptocurrencies. It is a globally distributed platform with the potential to revolutionise every industry from banking to insurance, and from telecommunications to healthcare and manufacturing.
Blockchain technology is a decentralised database used to maintain a continuously growing list of records, called blocks. Each block has a timestamp which links to a previous block. Think of it as a distributed ledger, which records ownership and value, and allows anyone with access to view and take part in it. The network is only updated and verified through the consensus of every party involved. The entire chain is continually updated so that every ledger in the network is the same. This gives everyone the ability to prove who owns what at any given time.
Blockchain technology is emerging as a key business focus beyond cryptocurrencies. Even though it is not a household name yet and consumers do not have direct interaction with blockchain, it does create a sort of historical thread underneath every digital transaction that happens on the internet – whether that transaction relates to goods, services or private data. Legacy banks and tech giants are putting the technology in place to drive innovation and set out below are a few examples.
Blockchain has the potential to reduce bank infrastructure costs by $15-20bn a year by 2022, according to a report by Santander InnoVentures. Even though there is a significant amount of publicity about Bitcoin and enabling the digital currency movement, blockchain technology will be a significant player in the modernisation of the back-end functions of the financial and banking sectors. The value of blockchain in the financial services market is the reduction in both time and resources to settle transactions. Even though transactions are computerised, they are still modelled on legacy, paper-based systems. Migrating these systems to blockchain technology has the potential to drastically transform the sector, including, inevitably, displacing some of its players.
The term ‘smart contracts’ refers to any transaction or exchange enabled using blockchain technology, and as the technology advances we are likely to see more complex agreements being translated into code and enforced using blockchain technology. Simply put, when certain conditions are met, the respective responsibilities or obligations of each party relating to that condition are automatically triggered.
A great example is a contract that is represented in code on a blockchain, requiring party A to make a payment on completion of a milestone event by party B. Once the milestone has been met by party B, payment by party A is triggered automatically – it cannot be stopped because it has been coded onto the blockchain, so party A cannot default on its obligation to pay. Payment will be made and settled automatically by the parties’ respective banks within a few minutes of party B meeting the milestone, no matter where the parties are based. No intermediaries are required, and this self-enforcement reduces the potential for legal disputes.
According to a 2017 IBM study, a third of C-level executives are using or considering adopting blockchain technology in their organisations. The study indicated that executives hope the technology will help establish trust, accountability and transparency among their organisations and with partners.
Companies are taking a serious look at the commercial applications of blockchain technology, such as changing the way assets are stored and transferred, or how end-to-end supply chains are managed, but attention also needs to be paid to the new methods required to incorporate companies, invest and even issue, sell and transfer shares on the blockchain.
Initial coin offerings (ICO), are a new way of raising funds using blockchain technology. Cryptocurrency is exchanged for ‘tokens’ – intangible pieces of code which are traded on a blockchain, and which assign to their owner particular rights, such as voting rights. The fundraiser gets cryptocurrency with a monetary value assigned to it; the investor gets a say in the direction of the company issuing the tokens.
The legal challenges on the horizon
As with all disruptive, high-growth technological advances come legal and legislative challenges. Blockchain has potentially limitless applications, and therefore the laws and regulations that apply to online transactions and communications today will continue to apply to those done using blockchain technology.
Financial regulation will be the main sector focus as blockchain technology proliferates. The Financial Conduct Authority in the UK is already setting up focus groups to ascertain whether the current regulatory framework can apply to the various applications of blockchain technology in financial services, and, interestingly, whether current regulations might impede the development of this new technology.
The current position is that, whether financial regulations apply will have to be determined on a case-by-case basis, depending on the nature of the product traded on the blockchain.
One of the significant advantages of blockchain technology is that it is a distributed ledger, meaning no single organisation controls it. Each node in a blockchain keeps an identical copy of the ledger which is updated instantly and concurrently, meaning that nothing can be changed unless all nodes agree. This is the reason why advocates point to the accuracy of blockchain and the alleged near impossibility of mistakes and fraudulent activity, including hacking. But what happens when something does go wrong, as it inevitably will? Who is responsible and how can each party allocate liability?
This is a question that is difficult to answer, but legal experts expect liability to be dealt with using the same principles used today: each participant in the blockchain will have roles and responsibilities and liability will be apportioned accordingly and written into a smart contract, and probably a traditional legal contract to govern the smart contract, to ensure clarity and enforceability.
As blockchain technology is a globally distributed ledger, issues will start to surface on how national laws can be applied to transactions taking place on it. Do we need worldwide privacy laws to regulate the control and processing of personal data on the blockchain?
Further, in a distributed system with no centralised controlling body, it is difficult to establish which party is the data controller, the data processor or even where the parties are physically based. Consequently, questions about the application of data protection legislation to blockchain technology relate not only to jurisdictions but also to enforcement.
The EU General Data Protection Regulation, which comes into effect in May 2018, also raises questions about data subjects having codified rights to require data controllers to erase their personal data, and the obligation on data controllers to ensure that personal data is stored for no longer than is absolutely necessary. This is in direct opposition to one of the essential characteristics and advantages of blockchain – transactions are immutable, and, in the case of public blockchains, accessible by everyone.
As with most innovation, the law lags behind, but legislators and regulators are going to have to keep up with the advancement of this upending technology which appears to have the potential to impact every sector imaginable.
The end game
Eventually, blockchain will increase transaction speeds and reduce costs, and overall make the internet a safer and more trusted place.
In the short term, there will likely be a lot of teething problems while companies grapple with the new ways of doing business that blockchain can offer, and things could move in various directions as the technology scales and laws evolve to keep up with the changes.
We could see some organisations experiencing steep and potentially expensive learning curves, as the boundaries and possibilities of blockchain technology are tested and developed.
Charlie Lyons-Rothbart is an associate at JAG Shaw Baker. She can be contacted on +44 (0)203 598 3070 or by email: firstname.lastname@example.org.
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