The extraordinary momentum behind the growth of programmable blockchain technology and its potential to revolutionise economic activity is debated on a daily basis. Discussion of the legal consequences of this unprecedented shift in system architecture towards decentralized processes that are more efficient, secure and transparent has failed to keep pace.
This late start to a more substantial debate on the legal implications of blockchain may be due to the distributed ledger technology’s more appealing aspects, disintermediation and decentralisation. These elements may be taken to imply, wrongly in my view, that blockchain technology will operate outside of current legal and regulatory constraints. Against this setting, the interesting - albeit predictable - question of whether new legislation is required to envelop blockchain transactions in the cloak of legality. However, I do not hold the view that this is the pivotal question blockchain proponents should be asking, or lawyers addressing.
Law as a blockchain facilitator
That the law is sometimes seen as a force that inhibits rather than enables blockchain, is far from reflective of reality. There are voices, largely from the world of technology, whose enthusiasm over blockchain technology completely disregards the social function of our legal systems, the prevalence of the rule of law and the legal certainty that commercial transactions require. More alarmingly, they ignore the fact that, for blockchain transactions to be the effective instruments they purport to be in a microeconomic context, all parties involved must have identifiable, legally enforceable rights.
As Hayek asserts, “within the known rules of the game the individual is free to pursue his personal ends and desires, certain that the powers of government will not be used deliberately to frustrate his efforts”. If the effects of blockchain cannot come to manifest in the real world, its potential is significantly diminished. These effects thus need to exist within the certainty that Hayek invokes.
Technologists should not regard the law as restrictive but rather as a facilitator of new ideas. Blockchain has the potential to create new ecosystems and new nexuses of economic and other activity, all of which can be harnessed for the greater good and bring about immense socioeconomic benefits. The law is our primary social institution and adherence to the rule of law is an integral element of economic progress.
Blockchain developers should therefore seek certainty and not advocate the absence of regulation. They will no doubt encounter sovereigns not willing to adhere to a utilitarian role will use legislation to curtail and control the economic activity developed by blockchain applications. But there are others that will create frameworks that impartially facilitate the operation and uphold the effects of activity undertaken on the blockchain, and in so doing afford much-needed certainty over its effects. By embracing blockchain, such jurisdictions will benefit from the efficiencies of its applications in increasing transparency, facilitating trust, enhancing data protection and improving accessibility to the market.
Identifying blockchain applications
Assuming therefore that blockchain can thrive in those legal orders which do not restrict it to subjectively pre-selected activity, the salient question becomes whether existing frameworks are sufficiently flexible to accommodate blockchain’s potential whilst providing the necessary degree of legal certainty in its economic effects. In addressing this question, we must distinguish between two distinct potential domains where blockchain applications will emerge.
The first domain is the implementation of blockchain to radically transform existing economic activity, such as the removal of intermediaries from financial transactions, as part of the wider fintech drive. For example, such applications could be the result of the work done by R3.
The second domain is the implementation of blockchain t create novel architectures of interaction between parties, whether in the sphere of the public or private sector. In the context of new economic activities which may arise, the implementation of blockchain can be compared to the creation of the company structure which replaced contracting between individuals. New digital economies may evolve from this domain, not unlike how new economics emerged from the world wide web.
Legal considerations can only be applied to the first domain, as our legal orders are dynamic and are informed and shaped by what happens in society and the market. We cannot – and should not -legislate in anticipation of the unknown. Where, blockchain addresses transactional affairs today carried out in conventional centralised ways, particularly as regards its fintech application, it is inevitable that legislation will come into play.
The distinction should therefore be drawn between the deployment of blockchain as a new means to achieve the same ends, on the one hand, and of blockchain as an systemic breakthrough that will not only require a new legal framework, but will drive an entirely new cognitive realignment, on the other.
Legal risks arise when considering that blockchain applications (beyond cryptocurrencies) could appear at any time that may not be the result of coordinated R&D efforts of stakeholders, but rather unplanned random implementations spun out of facilitating platforms (such as blockchain-as-a-service).
As cryptocurrencies have illustrated, the absence of intermediaries in technology does not always translate to the absence of intermediaries in the real world. Developers should therefore not divorce their work from the economic and legal realities into which it will be deployed.
The notion that the blockchain ecosystems will be independent and detached from conventional legal orders, formed and executed in a cyber-order of their own, raises serious concerns. The creation of contractual relationships is possible only due to their recognition by law, which transforms them from being merely unenforceable understandings with no legal effect.
Ultimately the success of blockchain technology is dependent on the crystallization of the applicable framework in any jurisdiction, backed by a globally subscribed set of legal norms., If transacting parties expect the result of their transaction to have legal effect and be enforceable in their respective jurisdictions, the application of law to the underlying transaction, whatever its nature, is a forgone conclusion.
The fact that blockchain technology has the capacity to enhance trust in transactions does not, of itself, create legally binding effects in any legal order. The act of transacting, premised on any level of trust, must also result in a change in the status of rights over the asset in the transaction, whether the asset is digital or not. Only then can the value of the asset be realised in the real world.
An example of existing frameworks embarking on a treatment of blockchain applications is the recent assertion by the SEC that tokens issued by The DAO, a decentralised autonomous organisation, constitute securities that should be registered under relevant US law. Moreover, it cannot be excluded that a decentralised autonomous organisation would be deemed to be a joint venture in some legal orders. In the absence of ad hoc legislation, I doubt such developments afford succinct legal treatment of the genuine intentions of blockchain developers.
For blockchain to achieve its potential and attain the widespread application it promises, transactions in the blockchain must affect rights over assets (digital or not). These rights can only be of value if recognised as vesting rights in rem under legislated norms. It is only through the party holding the power to verify the in rem rights taking part in the process of verifying the end result of a transaction that such results can acquire economic value within the structure of our legal orders.
Related dispute resolution issues also lead to a highly complex discussion. Although the blockchain is presented as operationally impenetrable and irreversible, the hierarchy of actors in its design and implementation, particularly where this is not permissionless, means there can be breaches of undertakings and obligations, as well as tortious acts. Fraud has been established as having taken place in the context of cryptocurrencies and vulnerabilities in code, unless eradicated, will leave a window open to fraudulent activity that could require the reversal of transactions on the blockchain as a remedy (in the absence of consensus to the contrary).
In the EU, several member states appear to be working towards developing blockchain strategies, which may ultimately result in legislation. The European Parliament (having an indirect right to legislative initiative) has exhibited an open-ended approach rather than tabling any proposal for anticipatory regulation. This approach could range in terms of results from ad hoc recognition or derecognition of the transactional by-products of blockchain applications to their assimilation into existing frameworks.
It is not inconceivable that existing EU legislation, such as EMIR and MiFID/MiFIR, could catch transactions carried out through blockchain. Revisions to other existing EU frameworks, such as that for payment services and electronic money, may also become relevant, depending on the nature of blockchain applications.
Perceiving and realising blockchain’s potential will lead to the development of applications that will operate outside the confines of our existing frameworks, not because such applications will seek to evade them but rather because they will relate to uses that society has yet to conceive. Nevertheless, under a laissez-faire approach on the part of legislators, blockchain applications could give rise to complex legal issues which will inevitably need to be addressed under existing legal tools.
The development of new legal norms will eventually depend on the nature, and the assets at the core of, blockchain transactions. Developers can rest assured that the law, as the backbone of economic activity, will develop and be applied to all the innovations blockchain spins off. It is therefore imperative that blockchain technologists and legislators engage in a meaningful dialogue, rather than in mutually exclusionary rhetoric.