By: Iohann Le Frapper, group general counsel of Pierre Fabre and previously chair of the global board of directors of the Association of Corporate Counsel, and Dario de Martino, M&A and private equity partner and co-chair of Blockchain Practice at Morrison & Foerster LLP
Blockchain technology has been heralded as the great disrupter. From transforming a corporation’s supply chain to securing intellectual property rights or transferring anything of value such as intangible or real estate assets, blockchain technology’s uses are numerous and have now moved beyond pilot/proof-of-concept stages to actual commercial use cases.
On May 23, 2019, Iohann Le Frapper, group general counsel at Pierre Fabre Group, and Dario de Martino, partner at Morrison & Foerster LLP and co-chair of the firm’s blockchain group, spoke at a roundtable discussion during the ACC Global GC Summit in London, to assist general counsel understand this exciting new technology and the challenges to address in several industries. The speakers focused on cutting through the hype surrounding blockchain technology and delved into where blockchain is ready for adoption at a corporate level (e.g., in supply chain management and compliance).
Their most important conclusion was that by understanding the legal, technical, and business issues underpinning the adoption of blockchain technology, GCs can take a leading role in contributing to more agile business operations, digital transformation, and the related paperless cost-efficiencies.
For those who might have missed the event, the following provides an overview of the discussion with select updates to reflect the timeliness of a rapidly evolving market. This overview has been compiled into a three-part series, each addressing the big questions that GCs need to be prepared to answer.
What is blockchain for someone with no computer science background?
Blockchain technology became popular in late 2009 with the rise of Bitcoin, perhaps the most notorious application of the technology. Fundamentally, blockchain is an umbrella term that refers to a data structure that makes it possible to create a tamper-proof, distributed, peer-to-peer system of ledgers containing immutable, time-stamped, and cryptographically connected blocks of data.
In practice, this means that data can be written only once onto a ledger which is then read-only for every user. However, many of the most used blockchain protocols, for example, the Bitcoin or Ethereum networks, maintain and update these distributed ledgers in a decentralized manner, which stands in contrast to traditional networks reliant on a trusted, centralized data repository. In structuring the network this way, these mechanisms function to remove the need for a trusted third party to handle and store the transaction data.
Instead, the data are distributed so that every user has access to the same information at the same time. In order to update that ledger’s distributed information, the network employs pre-defined consensus mechanisms and military-grade cryptography to prevent malicious actors from going back and retroactively editing or tampering with the information previously recorded on it.
What is the difference between a public and private blockchain?
Depending on the objectives of a given project, blockchains can be structured so that they are public, private, or a hybrid. Public blockchains are large distributed networks based on open-source code that are developed and maintained by an online and dedicated community of users. Some of the most well-known public blockchains include Bitcoin, Ethereum, and Stellar.
In these networks, there are no restrictions on who can participate, so anybody can read transaction records, write data, and in certain networks such as Bitcoin’s, validate transactions with a practice known as “mining,” in exchange for cryptocurrency or another digital token reward. In public networks, this decentralizing feature of blockchain comes with significant resource and processing drawbacks.
Many blockchain-enabled platforms run very slowly and have interoperability and scalability issues, and they tend to require massive amounts of energy to function. For example, the Bitcoin network requires the expenditure of about 50 terawatt hours per year — equivalent to the energy needs of the entire country of Singapore.
When other cryptocurrencies based on similar validation models are factored in, it turns out that it takes roughly the same amount of energy to mine one dollar’s worth of precious metals like gold as it does to mine one dollar’s worth of virtual currency. While networks such as Ethereum are moving away from energy-intensive consensus and validation models, the process remains slow and the need for a more eco-friendly deployment of blockchain networks will be more and more pressing in light of growing climate change concerns and the corporate responsibility of corporations.
Private or permissioned blockchains are more centralized than their public counterparts. Some well-known permissioned blockchain protocols include IBM’s Hyperledger and R3’s Corda. These private blockchains are still large distributed networks, but they operate under the leadership of a known entity. This entity determines the role that individuals can play within the network and how they are rewarded for participation, including who may act as a transaction validator on such networks.
Moreover, while many of these permissioned networks are open-source, the required consensus mechanisms are much more energy efficient, since the leader can essentially dictate who validates what per node on the network. As such, many large industry players are looking primarily at the private or permissioned models for their enterprise-level needs.
Before embarking on a pilot project involving a private blockchain network, GCs should consider several potential critical issues such as:
- Governance of the network, including decision-making processes, the rights of consortium founders and promoters versus those of the newcomers;
- Understanding IP rights, including patent rights relating to the network platform that may be owned by one promoter or licensed to promoters by a technology partner;
- Whether there are any competition law issues involved; attention should be paid to whether consortium members belonging to the same industry set up a blockchain project with the purpose or effect of prohibiting some of their competitors from joining such consortium or subject such membership access to unfair and onerous terms;
- Management and sharing of network-related data; and
- Management of cybersecurity and data privacy in light of the GDPR.
What is the difference between cryptocurrencies and blockchain?
The most important distinction that any general counsel needs to make is that blockchain does not equal cryptocurrency — the two remain distinct concepts. Cryptocurrencies like Bitcoin and Ethereum are associated with blockchain because they are essentially value data that are transferred across a blockchain network in a swift and cost-efficient manner without consideration of bank holidays, forex settlement processing timing constraints, national borders, or foreign exchange controls.
However, while cryptocurrencies are certainly compelling, they are just one of the many use cases for blockchain technology that have been identified and brought to market so far. Cryptocurrencies and blockchain generally each have their own separate uses. While blockchain has wider validation and consensus attributes, cryptocurrencies find their strength in monetization and trading as an alternative to fiat currencies like the USD or Euro, if not a competition threat.
Note also that many of these networks also employ digital tokens, essentially a registered unit of measurement or exchange on a blockchain. Tokens are not cryptocurrency, though their value is often denominated in whatever cryptocurrency is native to the public network the token is hosted on.
Nevertheless, in the rapidly evolving space that is the blockchain industry, the lines can blur and definitions can change. As such, it is imperative that GCs understand the differences alluded to above in both substance and terminology. This is particularly true when it comes to the decision whether to utilize a public or permissioned blockchain for an enterprise-level blockchain product.
For companies looking to jump into the space, one of the threshold decisions for market participants is whether to invest in or acquire a public or a permissioned blockchain network, as opposed to hiring or building from scratch. In all likelihood, many will opt for a permissioned blockchain, since they are better suited to enterprise-level adoption and are operated by a known entity.
Moreover, permissioned blockchains do not face many of the issues that hound public decentralized blockchains, including the fact that anyone can access or edit the information recorded on a public blockchain. GCs must be aware that the more public and highly traded a blockchain solution is, the more likely it is to face regulatory scrutiny, which we explain further in the next part of the series.
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