An introduction to the law of blockchain and distributed ledger technologies (Part 1 of 5)

International

Blockchain and other distributed ledger technologies (DLT) are approaching the mainstream. Technology companies offer products for commercial projects. IBM's Blockchain Platform references “500+ client engagements to date”. Financial institutions use them. HSBC said in January 2019 that it settled $250bn worth of foreign exchange trades using blockchain during 2018. They are used in fundraising in the syndicated lending and capital markets. In November 2018 BBVA arranged a $150m syndicated loan using DLT arranged over a private blockchain network. In August 2018 the World Bank launched the world's first public bond created and managed using only blockchain in a $100m transaction designed to test how the technology could improve practices in the industry.

Although there is still some way to go before blockchain lives up to the claims of its most optimistic adherents, organisations in both the private and public sectors are actively taking steps to develop blockchain-based solutions.

The legal community is involved in these developments. Lawyers in businesses and at external law firms work in development and implementation. Academic lawyers and lawyers at policymakers provide analysis and expert guidance on the issues arising.

We believe that it would now be useful to consolidate and categorise the legal issues that have so far been identified in relation to blockchain and distributed ledger technologies.

"Blockchain Law"

Some jurisdictions have legislated specifically in relation to blockchain, DLT and crypto-assets.

In July 2017, the Delaware General Corporations Law was amended to recognise the creation and maintenance of corporate records on “distributed electronic networks or databases”.

In April 2018, Arizona State in the US passed a “blockchain law” (HB 2417) to allow Arizona corporations to hold and share data on a blockchain and to clarify certain enforceability issues in relation to the use of smart contracts.

In July 2018 Malta passed three Bills (the Malta Digital Innovation Authority Act, the Virtual Financial Assets Act and the Innovative Technology Arrangements and Services Act) establishing a regulatory framework for blockchain, cryptocurrency and DLT.

In February 2019 Luxembourg passed Bill 7363 into law to facilitate the use of blockchain technology in financial services.

In February 2019, the state of Wyoming passed a law (SF 125, effective 1 July 2019) which, among other things, classifies digital consumer assets as intangible personal property for certain purposes. Wyoming has also enacted a series of other blockchain-specific legislation.

Many other jurisdictions are considering or implementing similar rules. These rules are generally directed towards clarifying certain specific administrative or regulatory points. They also demonstrate (and are usually intended to do so) an openness to the use of the technology. They leave open, however, many of the more theoretical legal points associated with the technology, as noted below.

Legal Nature of Blockchain and DLT Systems: Identification, Implications, Participants and Third Parties

D A Zetzsche, R P Buckley and D W Arner (in 'The Distributed Liability of Distributed Ledgers: Legal Risks of Blockchain' (2018) University of Illinois Law Review) provide the most comprehensive analysis of the nature of these systems and distinguish DLT systems from “traditional business networks” (such as franchise systems, credit card networks and supply chains). The latter follow a “hub and spokes”, centralised model. In the absence of express contractual provisions, individual participants, such as franchisees, are only connected to each other through the “hub” (that is, the franchisor). Participants do not owe loyalty to the network as a whole.

Zetzsche, Buckley and Arner distinguish the decentralised model which exists in some DLT systems. They argue that the peer-to-peer nature of these systems, with all nodes linking directly to each other, is “the tipping point at which a loose assembly of self-interested entities turns into a group of entities legally tied together”. There is also a common purpose in DLT systems, which goes beyond economic interests. The participants in the system share the aim of the joint performance of the ledger.

Zetzsche, Buckley and Arner suggest that these features of a DLT system could lead to it being considered at law to be one of several legal entities, including a joint venture, a multi-party contract and a partnership. For example, the authors suggest that the group that sets up the code design and governs the ledger could be considered a joint venture and that this could extend to nodes or even simple users of the ledger depending on the extent of their participation. Alternatively, the DLT system could be considered as a multi-party contract, with the group that sets up the code design and nodes under a contractual obligation to maintain the system's security and operations.

Potential legal structures will differ depending on the relevant jurisdiction. Under English law there is no distinct legal concept of a “joint venture”. Instead, that term covers legal structures such as a general partnership, a limited partnership, a limited liability partnership, a private limited company, and an unincorporated contractual arrangement.

Depending on the nature of the legal structure, Zetzsche, Buckley and Arner say that liability may arise under contract law, tort, partnership law or under specific legislation or regulation. Such liability may be “internal network liability” (that is, between the participants to the DLT system) and “external network liability” (that is, liability to third parties).

J Bacon, J D Michels, C Millard and J Singh, (in 'Blockchain demystified: a technical and legal introduction to distributed and centralised ledgers' (2018) 25(1) Richmond Journal of Law & Technology) note that elements of Decentralised Autonomous Organisations (DAO) may replicate those of a company. For example, a DAO could have a smart contract which allows the spending of funds based on approval by two-thirds of nodes (or members). In contrast, a DAO would not need a management team to exercise control over the DAO and its capital as this would be done by nodes and according to the code. Significantly, however, in the UK a DAO may not qualify as a recognised legal person (because it is not registered as a legal company with Companies House) or offer shareholders limited liability. Therefore, unlike a private company, participants in a DAO may face significant legal risk.

Several factors may therefore influence the potential legal structure of a DLT system, including, but not limited to:

  • whether there is an agreement which specifies the legal structure;
  • whether the system is permissioned or permissionless;
  • the express or implied purpose of the system (if any);
  • whether there is a pre-existing relationship between the parties;
  • the consensus mechanism employed by the system.
As published in Butterworths Journal of International Banking & Financial Law, May 2019.