Defining blockchain

Some call it a means of digital disruption, others a mere hype. In simplified terms, blockchain is a distributed ledger where peer-to-peer transactions effected with the use of Bitcoin, Ethereum or a similar protocol for transferring value and data are verified, recorded and stored in the form of “blocks”. The ledger is made up of a chain of blocks (blockchain), where each new block is created and timestamped every several minutes. Crucially, each new block must be compatible with the previous block. The compatibility requirement serves verification purposes and promotes trust among the users that no one has manipulated the system to the detriment of other users. This is known as the “network consensus”. Given its peer-to-peer nature, blockchain exists thanks to the users of the underlying protocol (e.g. Bitcoin users). In such a way, blockchain is the underlying technology for executing peer-to-peer digital transactions. The idea behind the blockchain technology is to eliminate a third-party intermediary, be it a bank, another financial institution or even a public official. What for? Mainly for the sake of speed, security and reduced transaction costs.

The year of blockchain…

Recent economic and political events along with growing attempts at implementing this technological novelty not only in the private sphere but also in the public sector bring the questions about blockchain yet again to light. Events which took place in 2016 include the adoption of a regulatory framework in Japan for cryptocurrencies based on the blockchain technology, presence of the blockchain issue in the public services sector and even the development of the blockchain technology as a policy initiative in the context of the upcoming autumn US presidential elections. In 2016, we could witness the rise and fall of the largest crowdfunding campaign organised by means of DAO, a decentralised autonomous organisation built on blockchain and powered by “smart contracts”. Blockchain has raised significant interest among business stakeholders, but it is now also being scrutinised by the EU financial markets regulator, the European Securities and Markets Authority (ESMA). Last but not least, it seems that blockchain technology will form one of the essential building blocks of the envisaged EU Digital Single Market.

…in more detail

In May 2016, two years after the collapse of Mt. Gox, the Tokyo-based bitcoin exchange reported to have caused the largest bitcoin loss in history (the equivalent of approximately USD 480 million), Japanese parliament passed a bill on regulation of cryptocurrencies. Bitcoin along with other cryptocurrencies have been formally allowed for use in transactions and payments. Not surprisingly, the Japanese bill is also said to aim at regulating cryptocurrency exchange operators by making them subject to state registration and supervision.

The DAO, or decentralised autonomous organisation, was a digital fundraising campaign built on the Ethereum blockchain and run by so-called “smart contracts”. This automated fundraising campaign, launched in April 2016 and hacked less than two months afterwards, is reported to have raised the equivalent of over USD 150 million in the ether cryptocurrency from more than 11,000 contributors. The smart contracts that run the digital decentralised autonomous organisations are protocols enabling conclusion of digital contracts recorded on blockchain which makes the transaction process faster, cheaper and devoid of a third-party intermediary. Although the DAO multi-million-dollar hack may have cast some doubt on the safety and reliability of smart contracts, it seems that fintech companies keep on outperforming each other in improving smart contract technology.

Venture capital investors are expressing a growing interest in the blockchain startups. Global venture capital investment in such businesses is reported to already exceed USD 1.1 billion. It is also no secret that many prominent financial institutions such as Citibank, UBS, Barclays and Goldman Sachs keep looking into the potential of blockchain technology.

There are countries that have been officially testing the blockchain technology with a view to using it in the public sector. Sweden is reported to be carrying out blockchain tests for the purposes of its land registry. If testing proves successful, real estate transactions along with applicable registration formalities in Sweden might be switched to blockchain in the next future. In the UK an IT startup named Credits has been awarded a framework agreement to supply the blockchain technology to UK public sector bodies.

The European Securities and Markets Authority (ESMA), the EU-wide financial markets watchdog, is keeping a close eye on the blockchain technology. Initial challenges listed so far, besides the technical issues, include regulatory, governance and privacy aspects. Further findings of ESMA especially in terms of a potential future regulatory framework for blockchain are to be expected. From the EU perspective, blockchain technology will in all likelihood play a significant role in the development of the so-called Digital Single Market, which is one of the key objectives for EU growth according to the current European Commission’s Europe 2020 Strategy.

Blockchain is even reported to have been listed among Hillary Clinton’s policy initiatives in the 2016 US presidential campaign. Besides her support for technological development and high-tech education, Clinton is said to have voiced the need for implementation of public service blockchain applications.

The internet of value and Polish private law

If blockchain is (or is supposed to be), as digital visionary Don Tapscott in his 2016 book “Blockchain Revolution” puts it, the “internet of value” (as opposed to the familiar internet of information), then we may be tempted to approach the legal analysis of blockchain exactly from the angle of value. Although in the world of blockchain value can be attributed to anything that is capable of being expressed in digital code, for the ease of process let us take cryptocurrency – the bitcoin. In this context, we refer to bitcoin in the sense of a cryptocurrency unit as opposed to the Bitcoin protocol.

Looking from the private law perspective, it would make sense to first position bitcoin among the legal notions available under Polish law. Under the Polish Civil Code the basic notion of property comprises the right of ownership and other property rights. The classical sense of the ownership right, as set forth in the Polish Civil Code, is that the owner may use, profit from and dispose of a thing to which he has the ownership title to the exclusion of third persons. Literally, the subject of the ownership right is things. Things, in turn, are for the purposes of the Polish Civil Code only material, i.e. tangible, objects. Bitcoins exist in the virtual world and have no tangible form. Therefore, by way of elimination, what a bitcoin most definitively is not is a thing under the Polish Civil Code. Given its value-based nature, bitcoin is an asset, so it should be considered as a property item. If a bitcoin is not a thing, but it is a property item, then this leads to the conclusion that we should include bitcoin among the property rights.

Under private law property rights may in general be subject to transfers and/or encumbrance. Although the issue of blockchain and cryptocurrencies remains virtually untouched by Polish case law and legal doctrine, it has been rightly argued that private contracts whose subject matter is bitcoin cannot be held invalid just for this reason, as there are no legal grounds for invalidity in such a case (see K. Zacharzewski, Praktyczne znaczenie bitcoina na wybranych obszarach prawa prywatnego, “Monitor Prawniczy” 4/2015, p. 190). In fact, it seems that bitcoins can be the subject matter of various civil law contracts such as sale, loan and exchange (see K. Zacharzewski, op. cit., p. 187, 188).

The classification of bitcoins as property rights implies the applicability of various other provisions of private law. From the family law perspective, bitcoin can fall within the scope of matrimonial property or remain a spouse’s individual property pursuant to general provisions of the Polish Family Code (see K. Zacharzewski, op. cit., p. 189). Bitcoins, like other property rights, can be the subject matter of a contractual property regime effected by the spouses before a notary public. Another example is that bitcoins, just like other property rights, should be included in the inheritance pursuant to general provisions of inheritance law. On top of this, it has even been argued that there are no legal obstacles to making an in-kind contribution to a commercial company in the form of bitcoins (see K. Zacharzewski, op. cit., p. 192).

Blockchain in the (blind) eyes of public law

Blockchains still seem to operate outside an explicit public regulatory framework in the EU reality. Neither Polish nor EU lawmakers have provided for comprehensive regulation or actually legally defined blockchain and defined the multitude of questions that arise in connection with it up to now.

Setting aside blockchains and moving back to virtual cryptocurrencies, from the Polish law perspective it seems that virtual cryptocurrencies do not strictly fall under any particular notion under public law. To put it bluntly, virtual cryptocurrencies are not a universally accepted legal tender in Poland within the meaning of the Polish Foreign Exchange Act. Nor can they be understood as the Polish currency or foreign currency. Such a stance was formally expressed by the Polish Ministry of Finance in its statement dated 28 May 2015 (file no. FN7.054.9.2015).

Attempts to categorise virtual cryptocurrencies as electronic money or a financial instrument would also be rather doubtful since bitcoins are not money and do not have an issuer in the legal sense. Instead, bitcoins are created by Bitcoin users called “miners” in the process of “bitcoin mining” which, in simplified terms, is the process of creating the chain of blocks (blockchain) for the purposes of verification of the blockchain transactions by means of algorithm. In its 2015 statement referred to above, the Polish Ministry of Finance explicitly argued that virtual cryptocurrencies do not fall within the scope of the Polish Payment Services Act, nor can they be regarded as any of the financial instruments under the Polish Act on Trading in Financial Instruments.

Taxes are always certain

The field of law that has approached the issue of blockchain and cryptocurrencies is tax law. On the EU level, in a recent ruling passed by the Court of Justice of the EU on 22 October 2015 in the Hedqvist case (C-264/14), the Court of Justice stated that services consisting of exchange of bitcoin units for traditional currencies are exempt from VAT within the meaning of the 2006/112/EC VAT Directive. In the case at issue, Mr Hedqvist, a Swedish entrepreneur, provided the relevant exchange services to his clients in return for payment of a sum equal to the difference between the price paid by the operator to purchase the currency and the price at which the entrepreneur sold the currency to his clients. The Court of Justice ruled among other things that although the aforesaid exchange services constitute the supply of services for consideration within the meaning of the VAT Directive, transactions effected in provision of such services are exempt from VAT under the VAT Directive.

On the Polish state level, the issue of blockchain and bitcoin has been addressed in the context of private income tax. In particular, as shown in recent administrative court rulings dated 11 September 2015 and 16 December 2015 (file nos. III SA/Wa 3374/14 and I SA/Gd 1551/15, respectively), revenue obtained from sales of bitcoin virtual currency should be considered as revenue from property rights and is subject to taxation under the Polish Personal Income Tax Act.

It seems that the famous quote by Benjamin Franklin, who is said to believe that only two things in life are certain, one of them being taxes, does not go out of date. At least partially.

So what is the future of blockchain?

The dynamics of current developments in the IT/fintech sector bring to mind questions about the promises and perils of the upcoming digital disruption. It already seems pretty clear that blockchain technology may bring about a genuine breathrough in the way transactions are performed and payments made. But blockchain technology can be much more than that. Blockchain can potentially record anything that can be associated with value: it can record our documents, consents or statements for regulatory and banking purposes; it can store our university diplomas, medical records; it can even potentially record votes in public elections. Blockchain technology can allow us to eliminate the third-party intermediary from a wide range of our day-to-day activities. Nevertheless, the blockchain technology can entail significant risks, such as financial or data loss caused by lack of transparency, cryptocurrency exchange exposure or as a result of hacking.

There are plenty of questions that still need to be addressed, such as anti-money laundering, data protection and payment services issues, all these in particular in the context of recent changes in EU legislation. An analysis of all these issues at once would, however, exceed the scope of this article.

Finally, to finish off with a Polish touch to the blockchain, it is worth mentioning the new policy guidelines of the Polish Ministry of Digital Affairs as of June 2016 – “From paper to digital Poland". These seek to provide legal, regulatory and economic solutions to facilitate the use of virtual cryptocurrencies and enable the application of blockchain technology to promote innovative projects and ensure transaction security both in business and the public sector. It may not be long until we find out if the world of blockchain will be the norm in the future.