If blockchain technology lives up to its promise, it may have a revolutionary impact on businesses across every major industry, governments and even the legal profession.

This article was published on March 14, 2016 in the Banking, Commercial Contracts, Intellectual Property, Privacy, and Technology sections of Law360 under the title,"Blockchain: Preparing for Disruption Like It’s the '90s."

The conversation about blockchain technology has shifted over the last few years. Stakeholders have increasingly recognized that this peer-to-peer distributed ledger technology underlying the cryptocurrency Bitcoin has utility beyond Bitcoin, and lawyers should be paying attention.

Think of blockchain technology and other variants of peer-to-peer distributed ledger technology (collectively referred to as “blockchain technology” in this article) like operating systems for transactions over the Internet. Broadly speaking, a blockchain is a database of digital transactions that are recorded in chronological and linear order. Before a block of transactions is added to a blockchain, participants in that blockchain’s network must verify the authenticity of the transactions. Once a block is added to a blockchain, the block cannot be modified or removed.

Proponents of blockchain technology believe its main promise is that it offers a more efficient, secure and transparent mechanism for storing, tracking, trading and verifying assets and information — a mechanism that does not require the involvement of central authorities or other trusted third parties. If blockchain technology lives up to its promise, it may have a revolutionary impact on businesses across every major industry, governments and even the legal profession.

Some have compared the emergence of blockchain technology to the emergence of the Internet and e-commerce technology in the early 1990s. Much like the early 1990s, when businesses were exploring new uses for the Internet and e-commerce technology, we are seeing significant experimentation with blockchain technology. Some of the blockchain technology-related business and technical trends that we anticipate seeing over the next 12 to 18 months include:

  • development of more robust blockchain frameworks
  • continued collaboration among industry leaders and formation of new standards organizations
  • propelled growth of the Internet of Things (IoT)
  • acceleration of investments in blockchain technology startups.

We discuss each of these trends and the related legal considerations in more detail below.

New Framework: Smart Contracts

Bitcoin is the first implementation of blockchain technology as a tool of distributed consensus. Smart contracts have been called the future of blockchain technology. These contracts are one of the more complex emerging alternative applications of the earlier implementations of blockchain technology. Unlike traditional contracts, smart contracts are written in source code, recorded on a blockchain and then automatically performed and enforced without the involvement of contracting parties or central authorities.

Ethereum (http://www.ethereum.org/) is one example of a platform for smart contracts. Platforms, such as Ethereum, support built-in software programming languages that are used to write smart contracts. The following is an example of source code for a simple Ethereum smart contract that executes the transfer of tradeable cryptocurrency:

contract token {

    mapping (address => uint) public coinBalanceOf;

    event CoinTransfer(address sender, address receiver, uint amount);

  /* Initializes contract with initial supply tokens to the creator of the contract */

  function token(uint supply) {

        if (supply == 0) supply = 10000;

        coinBalanceOf[msg.sender] = supply;

    }

  /* Very simple trade function */

    function sendCoin(address receiver, uint amount) returns(bool sufficient) {

        if (coinBalanceOf[msg.sender] < amount) return false;

        coinBalanceOf[msg.sender] -= amount;

        coinBalanceOf[receiver] += amount;

        CoinTransfer(msg.sender, receiver, amount);

        return true;

    }

}

Source: https://ethereum.org/token

Outside of cryptocurrency transfers, smart contracts may also be used for, among many other applications, capital markets trading, real property and intellectual property transfers (including for digital rights management and the payment of music royalties), energy grid management, insurance claims processing, and logistics and supply chain management.

If smart contracts become mainstream, they may challenge the basic principles of contract law, contract interpretation and the application of equitable principles. Should this occur, lawmakers, regulators and courts will need to evaluate whether the fundamental differences between traditional contracts and smart contracts necessitate changes to existing contract law and/or the creation of a new body of contract law for smart contracts. In addition, the adoption of smart contracts has the potential to define a new generation of transactional lawyers who draft contracts in software programming languages on smart contract platforms.

Collaboration, Standards-Setting and Intellectual Property Strategies

Continued collaboration among industry leaders and standards-setting will be important for blockchain technology to reach critical mass in certain industries, including the heavily regulated financial services industry. In fact, many financial services experts believe collaboration and standards-setting will be the driving factor as to whether blockchain technology will be widely adopted in this industry.

One example of collaboration is the consortium of major banks headed by R3 (http://www.r3cev.com/), which is leading blockchain technology research for the financial services industry. Another example is the Linux Foundation’s Hyperledger project (http://www.hyperledger.org/), which is a cross-industry collaborative effort to advance blockchain technology by creating a cross-industry open standard. These and other open standards projects will continue to evolve as industry leaders push to promote and maintain decentralized and interoperable blockchain implementations.

Any business that participates in these collaborative efforts should consider its contributions in the context of an overall intellectual property strategy for that business. The strategy may include seeking and enforcing patents, licensing intellectual property on RAND terms as part of standards organizations and/or contributing source code to the open source community with the intent to focus on value-added services (e.g., blockchain-as-a-service).

The Internet of Things and Privacy and Security

The number of IoT devices is projected to surpass 20 billion by 2020.1 Blockchain technology is expected to foster this growth by reducing the costs associated with the large, centralized data centers that are currently required to connect the IoT. This will result in an increase in the amount of sensitive data collected and the potential for more security breaches.

Advocates of blockchain technology tout it as being privacy-preserving and inherently secure, but not everyone agrees for all use cases. Some have argued that the immutable, irrevocable and transparent characteristics of blockchains may prove problematic in use cases involving the storage or transfer of sensitive data. This is true in part because the tamper-free characteristic of blockchain technology relies on the number of peers (or “nodes”), which may include IoT devices, verifying transactions on a blockchain network. In theory, the greater the number of nodes available to verify transactions on a blockchain network, the more trusted the blockchain network. However, each additional node also increases the number of potential points of security failure. In addition, while a single transaction or series of transactions may be secure on a blockchain, it may be possible to reverse engineer data from the metadata and aggregated data collected from IoT device transactions on a blockchain. So, while blockchain technology may be a powerful mechanism for authenticating IoT devices and facilitating the transfer of data between IoT devices, the technology will not eliminate all privacy and security concerns. The nature of the potential privacy and security issues should be evaluated in the context of the specific blockchain technology implementation, the type of IoT devices operating on the relevant blockchain network, and, of course, the type of data collected and stored on that network.

Investments in Blockchain Technology Startups

Public companies and private investors have already begun to make significant capital investments in blockchain technology startups. This trend is likely to accelerate in the second half of this year and into 2017 as commercial deployments of blockchain technology become a reality. Transactional lawyers who are tasked with performing due diligence on the buy and/or sell side in connection with these investments need to understand blockchain technology and the emerging business models based on the technology. Traditional due diligence approaches may need to be adapted. For example, there will be unique issues concerning ownership of data residing on decentralized ledgers and intellectual property ownership of blockchain-as-a-service offerings operating on open source blockchain technology platforms. These and other legal issues will need to be considered in the context of the business value proposition and competitive barriers to entry.

These are some examples of the potential legal considerations associated with the mainstream use of blockchain technology. Like the early days of the Internet, lawyers need to prepare for changes that may occur as a result of the technology and perhaps be prepared to practice in a gray area of the law until lawmakers, regulators and courts determine how existing laws should be applied to the technology and/or decide to adopt new ones.