Blockchain technology has earned its place as a headline topic in the technological sector, in part due to its potential to disrupt and transform a vast range of industries. As an efficient and reliable way to store and exchange data, the use of a blockchain can reform industries that rely on the accessibility of certain data, such as, in the intellectual property space, IP chain of title or ownership. And because a blockchain can be used to represent and transfer assets in a digital form, companies have already begun envisioning new models for the execution of IP licensing agreements and the payment of royalties for consumed creative content.
The Blockchain and Smart Contracts
Many of our day-to-day activities rely on a central authority, or middleman, to establish “trust” between parties, such as those participating in an exchange of money or information. At its core, by combining certain aspects of cryptography, decentralized consensus mechanisms, peer-to-peer networks, and distributed storage, blockchain technology reduces the role of and need for a central authority. A blockchain can be thought of as a continually growing database that is distributed amongst certain participants of the system, known as nodes. It is comprised of a chain of information-containing blocks, each of which also contains a timestamp, a reference to the immediately preceding block in the chain (and thereby, all the blocks before it), and a way for the nodes to validate the block before it is added to the chain.1 The blockchain is not stored on a single, centralized server; instead, copies of the blockchain are replicated and maintained by each of the nodes themselves.
A key component of a blockchain is the dichotomy in the level of difficulty required to make changes to its state ─ it’s simple to add data to a blockchain, but far more difficult to remove or change data once it has been added. When someone wants to add information to the blockchain (a common form of which is a transaction between two peers), this information gets broadcasted to the entire network of participating nodes,2 who then bundle it into a new block. However, for any node to add this new block of compiled information to the blockchain, a majority of the remaining nodes must validate the block by way of a consensus mechanism, the most common of which is called proof of work.3 In a proof of work system, the participating nodes are competing to solve a complex mathematical problem that will allow them to add a new block, thereby expending a massive amount of computational resources.4 The first node to figure out that complex problem broadcasts it to the remaining nodes, who confirm the block’s validity against their own respective copies of the blockhain before it gets added; and, when its validity is confirmed, the block is added to the chain and the victorious node is rewarded for its efforts.5 Once a block is added to the blockchain, it can no longer be revised or deleted ─ it assumes its position as part of an immutable database, accessible and verifiable by all participants.6
As a database maintained by peer-to-peer network of computers, a blockchain enables the creation of what are known as “smart contracts.” Smart contracts may be thought of as computer-coded contracts stored within a blockchain that are autonomously-executed in a decentralized way upon the happening of predetermined criteria.7 That is, each of the participating nodes can, without the need for human involvement, read the smart contract and its conditions, verify its validity, and enforce its performance.8 Degrees of objectivity and flexibility can also be implanted into smart contracts by way of an oracle ─ a trusted external source used to provide extrinsic information to the smart contract.9 As an example, where human decision making is required to determine certain terms of a smart contract, an oracle comprised of an arbitration panel or judge, or even the parties themselves, may be used.
Potential Uses of Blockchain Technology and Intellectual Property Impact
Oft-mentioned use cases of blockchain technology are typically financial in nature, such as the use of a blockchain to issue private securities or shares of a company, make cross-border transactions, or enter into derivatives like futures, swaps, and options. But the utility of blockchain technology extends far beyond the financial sector, such as by having the potential to make more efficient or simplify the management of intellectual property; in some respects, in ways that have traditionally been deemed impracticable.
The most well-known use of blockchain technology is to allow people to buy and sell cryptocurrencies, such as bitcoin. Other uses, including one that has gained immensely in name recognition and importance, is the Ethereum blockchain used to implement smart contracts. These token technologies, and Ethereum in particular, have been used as a significant base for the development of real-word technologies to raise capital and track share ownership by the issuance of Initial Coin Offerings. ICOs are used by companies to offer a share value tied to the company that can be redeemed based on the company’s performance and traded on a virtual platform, such as Kraken, Bittrex, and Liqui, to name a few. Well over $1.5 billion in investments has been raised through ICOs this year alone, which has drawn legal caution and guidance from the SEC, as further addressed below.
In the intellectual property realm, the technology’s most obvious implementation is its most basic function ─ a distributed database of time-stamped information ─ to record chain-of-title and ownership of IP assets.10 The sequence of ownership, from inception, to registration, to initial assignment and any subsequent assignments, can be continually updated in real-time within a blockchain, creating an immutable audit trail of the transfer of any IP asset without the need to rely on a trusted third party. And with the potential for blockchain interoperability also comes the potential for a global intellectual property registry system, making recordation of the transfer of intellectual property between citizens of different nations no more difficult performing a Google search (albeit, this practically may be on the extreme side of the spectrum).
IP-ownership recordation on a blockchain can be combined with other aspects of the technology to create a variety of additional use cases. Blockchain technology allows for the representation of assets in a digital form, which in turn simplifies and makes feasible the transfer of micropayments (that is, payments on the scale of pennies).11 This brings to light a whole new paradigm for the payment of owners of creative works. As an example, the owners of the respective copyrighted works making up an online article (such as the pictures or videos) can record their ownership of these works on a blockchain. A smart contract stored within that same blockchain can then be used to effectuate an internet user’s automatic transmission, directly to the respective copyright owners, of very small payments in return for the consumption of their creative works.12 The amount of such payment may be based on, for instance, the amount of time spent on the webpage hosting the article.
Finally, just as smart contracts can allow for the automatic transfer of title to assets upon the occurrence of certain events, they similarly can automatically execute and enforce the conditions (e.g., territorial or temporal limitations) of licenses to IP assets. For example, imagine companies A and B agree to a patent license, wherein company A will receive a set percentage “X” of every sale of a certain item “Y” made by company B within the United States for the next three years. The parties can code and store to a blockchain a self-executing smart contract that includes all of these terms: for every item Y that is delivered to a customer within the U.S., the agreed-upon percentage X is automatically transferred from the value stored in company B’s blockchain address to company A’s blockchain address, with the smart contract’s self-execution automatically stopping in three years per the terms of the code. This would eliminate the need for a deposit or escrow, thereby removing the need for trust in a third party.
Legal Issues Regarding Blockchain Technology
Undeniably, the popularity of blockchain technology as a currency and its use in raising capital has not gone unnoticed by regulatory agencies such as the SEC. Recently, the SEC issued guidance on alerts, focusing on the ICO market. In particular, the SEC addressed the concept of whether these token offerings are subject to securities regulations, and flagged risks associated with ICOs.13 Although not going so far as to declare all coins associated with ICOs as securities, the SEC did conclude that U.S. securities laws apply even if a decentralized autonomous organization offers such securities and regardless of whether a virtual currency is used for the purchase.14 With regard to the subject company of its Report, The DAO, the SEC concluded the tokens offered during the company’s ICO, DAO Tokens, were securities and therefore subject to mandates set out in Section 5 of the Securities Act, including the filing of a registration statement.15 The SEC limited its analysis to the particular DAO Token, but the comments are instructive of how the SEC will subject token offerings to such scrutiny.
After finding the DAO Tokens were securities, the SEC went on to conclude that a number of web-based platforms that facilitated the secondary trading of DAO Tokens “appear to have satisfied” the criteria necessitating SEC regulation pursuant to Sections 5 and 6 of the Exchange Act, and did not operate pursuant to an appropriate exemption.16 Not surprisingly, companies are already looking to capitalize on the Report’s guidance in this regard, such as with the upcoming launch of the first SEC-compliant alternative trading system for the exchange of tokens categorized in the U.S. as securities, announced in September.17 Finally, although the SEC did not provide in its Report any analysis on whether The DAO qualified as an investment company under Section 3(a) of the Investment Company Act of 1940, these ramifications and applications should be considered before structuring any coin offering.
Some of the states have taken a friendly approach towards the technology, with Delaware approving legislation to use blockchain technology for state archival records and corporate recordkeeping.18 As Delaware is traditionally the landing zone for many a company across the U.S., the move did not come as a complete surprise. Other states, such as Arizona and Illinois, have followed suit in welcoming the technology.19
On the other hand, some countries, such as China and South Korea, have altogether banned Initial Coin Offerings, causing the value of even the most well-known cryptocurrencies, like bitcoin and ether, to take a dive.20 China has been extreme in its measures, shutting off the ability of exchanges of cryptocurrencies which facilitate the trading of such securities in its Country. In Singapore, the Monetary Authority of Singapore issued guidance and cautionary advice that such offerings may be subject to regulation and need to follow existing laws in the Country.21 But the implications of such exchanges and offerings cannot be underestimated. Every month, dozens of new ICOs have been released and offered, and as such, these coin offerings should not be viewed as a temporary blip in the investment space.
There’s no question that blockchain technology has the chance to change how things are done in ways that have not yet been envisioned, which is why it’s no surprise that blockchain is often touted as the “next internet.” And while it will surely be exciting to watch the technology continue its evolution and increase in notoriety at a seemingly parabolic rate, perhaps the more interesting aspect of it all will be how industries react and adapt to the technology as it becomes ubiquitous.