Blockchain, a "fourth industrial revolution" technology of great promise, is being embraced by GCC governments and regulators. Seen as a technological foundation stone for improving productivity and streamlining of processes, GCC governments are adopting blockchain-based initiatives and regional regulators are creating environments to foster blockchain innovation and growth. So what is blockchain? Why is it so important? And what exactly are governments and regulators doing about it? In this article, we answer these questions and also provide some important pointers on legal issues that may arise in the context of blockchain-based projects.
What is blockchain?
In its simplest form, a blockchain is:
- Digital: it is made up of software and data. The software which is coding including algorithms allows the data to be transmitted, processed, stored and represented in human readable form.
- A ledger: it is a record in the form of a database of data representing transactions that have occurred.
- Distributed: identical copies of the ledger database are downloaded from the world wide web and kept on numerous computers spread across a site, an organisation, a country, multiple countries or in some cases the world. It is for this reason that a blockchain may be referred to as "distributed" or "shared" ledgers.
The transaction ledger is maintained simultaneously across a network of unrelated computers or servers, referred to as "nodes", like a spreadsheet that is duplicated thousands of times across a network of computers. The ledger contains a continuous and complete record (the "chain") of all transactions performed which are grouped into blocks: a block is only added to the chain if the nodes, which are members in the blockchain network with high levels of computing power, reach consensus on the next 'valid' block to be added to the chain.
A transaction can only be valid if each block is agreed to by all participants/the nodes and it is linked to the preceding block to make a chain back to the start. Each transaction includes small programs to verify their part of the transaction; it is at this validation stage that a 'smart contract' is formed (smart contracts being blockchain-based contracts which are automatically executed upon certain specified criteria coded into the contract being met).
Key Benefits of Blockchain Technologies
- Facilitate concurrent record-keeping and validation in an automated fashion (achieving costs savings)
- Eliminate duplication with one consolidated set of records that is the single and shared version of the facts
- Deliver cost savings by supporting the streamlining of back-office processes
- Authenticate transactions electronically and, therefore, more conveniently than physical authentication
- Provide a permanent record of transacting history which is immutable
- Enable direct peer-to-peer transacting without the need for a trusted third party intermediary
- Reduce time scales to near real time
- Enable automation in combination with smart contracts and other coded software.
A block generally contains four pieces of information which enhances it security:
- the 'hash' of the previous block;
- a summary of the included transaction;
- a time stamp; and
- the proof of work which is the validation of a block by 'minor nodes' who compete to solve a highly complex algorithm to verify it.
A blockchain network may be public and open ("permissionless"), like the internet, or structured within a private group, like an intranet ("permissioned"). The blockchains that many financial institutions are interested in are known as "private" or "permissioned" blockchains because only certain pre-approved participants may join them. These blockchains use a variety of means to ensure the identity of the parties to a transaction and to achieve consensus as to the validity of the transactions. The entities creating the "private" blockchain agree on rules that govern how entries are recorded and under what circumstances they can be modified. Only specific authorised participants are given access and are known within the network.
Blockchain in the GCC
Over the past 2 - 3 years we have seen growing interest in blockchain technologies amongst regional governments, especially here in the UAE. The UAE aims to become the world's first blockchain-powered government and in April 2018 it launched the Emirates Blockchain Strategy 2021. This strategy seeks to capitalise on blockchain technology to transform 50 per cent of government transactions into the Blockchain platform by 2021.
More recently, at the Second United Arab Emirates (UAE) Government Annual Meetings held in November 2018, the launch of the AI and Blockchain Guide initiative was announced, with its aims to provide a standardised definition of Artificial Intelligence and Blockchain at the federal level. The activity and focus on AI and Blockchain in the UAE represents the global trend of embracing the technologies across the health, education, finance, energy and government services sectors.
The Dubai government also recently launched the Dubai Blockchain Strategy, a collaboration between the Smart Dubai office and the Dubai Future Foundation. The Dubai Blockchain Strategy's aim is to make "Dubai the first city fully powered by Blockchain by 2020". The Dubai government is currently working with 20 blockchain projects and has made partnerships with IBM and Consensys to consult on SmartDubai, a city-wide initiative aimed at transforming Dubai into the "world's smartest and happiest city".
Bahrain is also viewed as a leader in blockchain development and is targeting "country-level" blockchain adoption, especially in the financial services sector and is seen to be embracing fintech and innovation from a practical and regulatory perspective. An example of this is the recently published regulation on 'Crypto-Assets' which is a blockchain based development.
Following on from these development, two examples of how blockchain is being applied in the real word, are the world's first Court of the Blockchain in the Dubai International Financial Centre (DIFC) and Dubai's launch of the online payment portal, DubaiPay. In the context of the DIFC Courts, blockchain supports greater efficiency in proceedings by helping to negate the need for duplicate papers where there are cross-border enforcement issues and allowing each party to have access to the same version of documents. It also introduces automated dispute resolution "smart contracts". As for DubaiPay, it integrates the blockchain technology into the payment portal allowing real-time reconciliation and settlement transactions to be performed, leading to efficiencies and more reliable record keeping.
In concert with governments, GCC regulators are promoting initiatives to support technological advancements like the blockchain. To this effect:
- the Dubai Financial Services Authority (DFSA), the regulatory vehicle of DIFC, launched the "Innovation Testing License" for fintechs, allowing firms to test their concepts, largely based on blockchain technologies within DIFC's territory;
- the Financial Services Regulatory Authority (FSRA), the regulators for Abu Dhabi Global Markets (ADGM), launched the RegLab sandbox, one of the pioneering licensing frameworks for fintech in the region;
- hubs have also been launched in Bahrain (Bahrain FinTech Bay) and the KSA (FinTech Saudi);
- the DFSA collaborates with other regulators on technologies and innovation including with the United Kingdom's Financial Conduct Authority (FCA), Bank Negara Malaysia and the Monetary Authority of Singapore (MAS); and
- the ADGM partnered with the ASEAN Financial Innovation Network in November 2018 to launch the first pilot stage of a cross-border digital sandbox that can operate between both hubs.
With the support of regional governments and regulators, we expect to see a further uptake of blockchain-based technologies in the region and can't help but expect to see "unicorns" arising in this space in the not too distant future. Given the expected level of activity in this space, what are some of the legal issues that need to be considered when it comes to blockchain projects.
Key legal considerations
With the emergence of new technologies, not only is it important to understand how the technology works, we need to pay attention to the contractual provisions and legal issues that blockchain technology raises. This is to ensure at all times that agreements are fit for purpose and future-proofed to cater for new issues arising as a result of the new technologies and where precedent may not yet be available. Some key legal considerations include:
- Governing Law & Jurisdiction
Blockchain has the ability to cross jurisdictional boundaries as the nodes on a blockchain can be located anywhere in the world. The principles of contract law differ across jurisdictions and therefore identifying the governing law of contracts or transactions concluded via the blockchain is critical. In a decentralised environment, this may be challenging. One option to overcome this issue would be the inclusion of a governing law clause. Parties to the transaction may also wish to agree where any disputes between them would be resolved, in which case a clause specifying which courts or arbitral body would have jurisdiction over such matters should also be included.
How to address liability issues in any particular transaction will depend on a variety of factors. For example, where blockchain infrastructure is being used for trading purposes, liability provisions would need to consider possible the risk to customers of a systemic issue arising trades are either not settled or settled incorrectly. Risks relating to security and confidentiality would also be particularly important. One of the main issues affecting a permissionless blockchain is the inability to control and stop its functioning. The allocation and attribution of risk and liability therefore in relation to a malfunctioning blockchain service must be thought through carefully by all involved parties.
- Intellectual Property
Given the amount of investment and potential financial returns of blockchain technology, vendors of blockchain related products and services will need to determine their IP strategy. Vendors will want to capitalise on the commercial benefits to be generated from the blockchain, including commercialisation of the underlying data set. This will have to be negotiated on a case-by-case basis, particularly where the underlying data is personal data or data of the users. Negotiation around ownership and use of the IP more broadly in the blockchain solution will be of significant importance, just as it is in a software development agreement.
- Data Privacy & Confidentiality
A balance needs to be struck between a blockchain's ability to store data in an unaltered state, which is one of its USPs, versus the privacy/confidentiality needs of individuals and organisations, particularly where the relevant data is personal data or data that can reveal someone's identity, such as by use of crypto-addresses. Take for example banks - no bank likes to be in a position where it is providing its competitors with precise information on transactions and banking secrecy must be kept by law. To make blockchain solutions more attractive, vendors will need to work on technology-based solutions to design privacy-protecting blockchains. This might include limiting who can join the blockchain and encrypting data on the blockchain but it remains to be seen how the right balance between privacy and transparency will be met.
The need for exit assistance will be required for certain blockchain solutions, especially where the vendor of the solution holds customer data. If customers do not have their own copies of the data, they will require a transfer of all such data, where possible, and a complete record of all transactions stored on the blockchain on expiry or termination of the agreement.
- Compliance with Financial Services Regulation
As financial institutions are highly regulated in blockchain technology contracts as with other fintech/sourcing arrangements, financial institutions will need to evidence that it can exert the right level of control over the vendor and ensure operational continuity in relation to the services to which the contract relates. Contracts will need to be reviewed carefully to ensure compliance with the local regulatory requirements.
Blockchain has captured the imagination of the region and supporting regulatory environments have been put in place to support further adoption of this emerging technology. While there is no doubt that blockchain has been high on the hype curve, we do expect it to become more mainstream in time, just as happened with breakthroughs like cloud computing over the past 5 - 7 years. Now is the time to take note of these developments and consider how best to address the legal nuances associated with the rise of the blockchain.