08 Feb 2018 Regulation of Blockchain: Issues and Legal Challenges
Malta is set to develop a broad, national strategy aimed at embracing blockchain innovation. With the announcement of Malta’s launch of the world’s first legal framework for the creation of a regulator to oversee blockchain, artificial intelligence and Internet of Things Devices (“IOT devices”), the new legal framework is designed to satisfy anti-money laundering and know your client regulations without hindering technological innovation. As the entry into force of the new legal framework is highly-anticipated, experts have highlighted the legal challenges for regulation of the blockchain and distributed ledger technology.
What is blockchain?
Although it lacks a universal definition, blockchain has been defined as a distribued ledger technology (“DLT”) or a digital platform that records and verifies the entire history of transactions between users across a network. A DLT is a decentralised database defined as “distributed, shared, encrypted database that serves as an irreversible and incorruptible repository of information.” It functions by enabling parties to send, receive and record value or information through a peer-to-peer network of computers. Transactions entered between users or counterparties broadcasted across a network are verified by nodes using cryptographic algorithms. Decentralised nodes located in different jurisdictions verify the information in each block. Once verified, they are added to the chain of blocks, thus making the blockchain.
One of the most attractive characteristics of the blockchain technology is its incorruptibility, being both that it is cryptographically secure and that its data is permanent. With the decentralisation and location of nodes around the world, the need for a centralised authority is perceived as eliminated. In addition to being the technology created to power/record transactions for Bitcoin, blockchain serves as the platform for smart contracts.
According to the ESMA Discussion Paper, smart contracts are “self-executing codes meant to replicate the terms of a given contract. They effectively translate contractual terms (e.g., payment terms and conditions and confidentiality agreements) into computational material.” The paper further explains that “smart contracts, which would sit on top of the ledgers, may help reduce the uncertainty attached to contract terms and increase the automation of the processing of corporate actions, even if their use may be limited to certain types of instruments or contracts for complexity reasons, at least in the short term.”
Another phenomenon stemming from the blockchain revolution is the development of decentralised autonomous organisations which run on smart contracts and whose financial transactions are recorded and maintained on a blockchain.
Experts anticipate that blockchain and DLT shall be implemented in a variety of industries, from government services to healthcare. The growth of DLT application in the financial services sector is also predicted, where investors shall access the shared database directly and settle transactions and thus replace the need for an intermediary. Furthermore, the DLT could potentially facilitate the compiling of information that can be easily accessed and verified.
With the growing popularity of bitcoin and the anticipation of its wide variety of uses, questions have been raised over its legal status as well as the regulatory implications of blockchain and DLT.
New technology: Legal and Regulatory Concerns
Experts have speculated on the possible threats to blockchain technology including the possibility of corruptibility by hackers, bugs in technology, market volatility due to interconnectedness, and performance challenges.
Concerns have also been raised over the lack of effective framework that achieves investor protection, financial stability and market integrity. The following are grey, unregulated areas of the law which may prove problematic when developing legislation with regards to blockchain technology:
The question of jurisdiction is one of the most prevalent concerns for regulators. As the system is decentralised and with the location of the nodes spread over multiple jurisdictions, questions of territoriality are raised. From a legal perspective, blockchain’s lack of centralised jurisdiction raises the issue in determining the appropriate governing law and whether the issue presented is of a transactional or contentious nature. In the case of the latter, determining where the location of an erroneous transaction occurred may prove problematic, therefore it may hinder the application of the appropriate law.
(ii) Data Privacy
As blockchain technology shall be used in a number of industries, certain industries may be reluctant to implement blockchain for privacy concerns. For example, banking industries may be reluctant to use blockchain transactions due to the transparency of the transactions and any privacy requirements imposed by law.
(iii) Intellectual Property
Another area of concern is the value of ownership of the patent, including ownership of IP and its ability to be patented. Furthermore, when the data relates to personal information, questions on ownership of the database of information arise as data protection will require consent from the concerned data subject.
(iv) Legal Status of Smart contracts and Decentralised Autonomous Organisations (DAOs)
Comparisons have been drawn between the computer programs, smart contracts and conventional contracts. Much praise has been given to smart contracts for the elimination of risk, most notably counterparty risk. However, smart contracts do not fall within the definition of traditional contracts. In spite of the acceptance of electronic contracts within various jurisdictions, however it remains to be seen whether smart contracts shall also apply.
These are some of the concerns raised by the industry with regards to the development of legislation for blockchain technology. We anticipate that as time goes by, more grey areas will emerge and we hope that the legislation to be introduced by the regulators will tackle such grey areas of law.
With the enactment of new blockchain regulation, several aspects and concerns arising out of the use of DLTs and blockchain technology should be addressed. This newsletter is the beginning of a series of newsletters to be issued by leocqassociate ltd on the development of the blockchain technology, especially following the enactment of the relevant legislation.
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