It has been a decade since the invention of blockchain, the technology with the potential to disrupt industries and sectors far and wide. Yet it remains an area of confusion for many, with its application in the cryptocurrency sphere gaining a large part of the media’s focus, thanks to controversial digital currencies like Bitcoin.
The technology has far greater ramifications and reach than cryptocurrencies alone, and its possibilities are only just beginning to be realised. Blockchain and Bitcoin were invented in 2008 by Satoshi Nakomoto, although it is now generally believed that Nakomoto was the pseudonym used by a group of developers including the Australian academic Craig Wright. The excitement the technology created stemmed from its ability to allow a decentralised networked model of self-executing transactions, meaning funds or encrypted information can be transferred between computers and across borders without the need for a central counterparty. Data held on a blockchain is independently auditable and verifiable and cannot be written over or removed. So once a Bitcoin, for example, has been mined, its entire history will be indelibly recorded and part of it no matter how many times it changes hands.
Last year saw a global boom in cryptocurrency markets, with Bitcoin just one of the hundreds of currencies estimated to have a combined global market capitalisation of over US$375 billion.
Overcoming regulatory challenges
The dramatic fluctuations in Bitcoin’s price, however, have led to calls for regulation. In March this year the governor of the Bank of England, Mark Carney, said, “The time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system.” But for the immediate future it appears that the instability and volatility will remain.
It is evident that industry and regulator buy-in will be required before cryptocurrencies can be used by the general public, as uncertainties surround such areas as the application of existing securities laws due to the unclear legal character of coins and tokens, difficulties in regulatory oversight due to the decentralised nature of the currencies and the risk of criminal activity associated with an unregulated currency.
But a tightening of the reins may already be happening. “In the financial services sector, Herbert Smith Freehills’ client UBS is working with a number of the world’s biggest banks, looking to establish a ‘Utility Settlement Coin’ (USC),” says Nick Pantlin, the London-based partner who heads Herbert Smith Freehills’ TMT, Data and Sourcing practice in the UK. Building on the blockchain and ledger technology, USCs are also a form of digital cash, enabling financial groups to pay each other or buy securities without having to wait for the completion of traditional money transfers, but (unlike Bitcoin) they are backed by cash at a central bank and so would be free from credit risk.
APAC Financial Services Lead the Way
One region that has embraced the technology in its financial services sector is APAC, with Japan, South Korea and Singapore emerging as leaders in the sphere, while China is also becoming increasingly involved. South Korea in particular, despite its relatively small population, is responsible for a third of all cryptocurrency trading, and recent government attempts to ban cryptocurrencies have been met with such strong opposition that the focus is now on regulation rather than outright prohibition.
Chinese regulators also face challenges, says Danila Logofet, a partner from Herbert Smith Freehills’ Pan-Asian energy team. “[The technology] provides a great platform for innovation and growth, [but] it fuels the uncontrollable economy and is perceived to support money laundering and financial fraud.”
Most industry insiders, however, believe that China’s current ban on ICOs (initial coin offerings) will not last and that blockchain technology will have an increasing impact on the APAC region.
Elsewhere, regulators generally prefer to take a ‘technology neutral’ approach, says Herbert Smith Freehills regulatory consultant, Cat Dankos. “Regulators are looking at the economic functions of innovations in determining where those innovations ‘fit’ within the existing regulatory frameworks,” she explains. Blockchain is currently considered to fit within what the Basel Committee on Banking Supervision (BCBS) describes as ‘market support services’. This ‘technology neutral’ stance may now be wavering. On 8 March the EU Commission released a FinTech Action Plan, which outlines its creation of an EU Blockchain Observatory and Forum, to report on the technology’s challenges and opportunities later in the year.
Realising Blockchain’s Potential: Energy and Smart Contracts
Outside of the financial services sector, blockchain’s potential commercial deployment appears even more rich and varied. “The technology has proven to be particularly useful to streamline and simplify document heavy processes, such as regulatory reporting, KYC and AML procedures, commodity trading and settlement, supply chain logistics and so on,” adds Nick Pantlin. Industries ripe for disruption via this technology include the energy sector, with a blockchain-based system removing the need for the various brokers and intermediaries currently essential to the energy trading system. A consortium of major energy companies, including Royal Dutch Shell and BP, has already announced the development of a blockchain-based digital platform for energy commodities trading.
For lawyers and others in the legal profession, impacts are already being felt due to “the creation of potentially transformative legal instruments that will reduce the need for centralised authorities to facilitate or mediate transactions,” says Pantlin.
Smart legal contracts all lend themselves to at least partial automation of transactions and processes that have traditionally required long hours of human application. Other potential areas for beneficial disruption include intellectual property, with publically accessible ledgers available for patent filings, copyrights and trademarks, and land ownership, with the possibility of every piece of property linked to a detailed history of its provenance and ownership records. Blockchain’s irreversible nature, however, makes it vital that a valid legal framework underpins all and every self-enforcing aspect of the various parties’ smart agreements.
“The essence of a smart legal contract is that it is not only executed (i.e. agreed) electronically, but it is also performed electronically,” says Pantlin. “The reality is that the technology is still in development and it’s going to be a while before the techno utopians can leave laws and lawyers behind to freely transact in a stateless cyberspace!”
Andrew Moir, a Herbert Smith Freehills London-based partner and head of the Global Cyber Security practice, echoes Pantlin’s words of caution about the technology.
“Blockchain is often posited as an ultra-secure means of transacting, due to its distributed nature, the sequential nature of the blocks and inherent cryptographic security,” he says. “However, it is not a panacea. It is only as secure as the technologies it is built around and the privacy of the keys used to sign transactions, as demonstrated by the multiple cyber incidents affecting Ethereum and the recent hack of Coincheck.”
The future for blockchain is full of possibility and potential, but the extent to which it will deliver on those possibilities remains to be seen.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020