An introduction to the law of blockchain and distributed ledger technologies (Part 2 of 5)


Legal Personality

Determining whether a system has legal personality has implications for many of the questions considered in relation to this topic.

In 'Horizon Scanning — Blockchain: The Legal Implications of Distributed Systems', the Law Society questions what legal status attaches to DAOs. An answer to this is needed to be able to answer questions such as who or what is claimed against in the context of a legal dispute.

Tendon and Ganado (in 'Legal Personality for Blockchains, DAOs and Smart Contracts') highlight the idea proposed by the government of Malta permitting the grant of legal personality in the form of a newly designed type of legal entity incorporating a blockchain and/or smart contract arrangements.

This shows another approach — that is to create a new legal entity through legislation. A consultation paper published in Malta in February 2018 by The Parliamentary Secretary for Financial Services, Digital Economy and Innovation, ('The establishment of the Malta Digital Innovation Authority; the Framework for the Certification of Distributed Ledger Technology Platforms and Related Service Providers; and a Virtual Currency Act') briefly raised the possibility of a “technology arrangement” (broadly defined as including DLT software and architecture, and smart contracts and related applications) having legal personality.

Ultimately, the Maltese legislation has not provided that an innovative technology arrangement could have its own legal personality. However, Tendon and Ganado (M Ganado, 'Maltese Technology Foundations — Initial Thoughts on an Important Proposal' (August 2018); S Tendon, M Ganado, 'Legal Personality for Blockchains, DAOs and Smart Contracts', Revue Trimestrielle de Droit Financier Corporate Finance and Capital Markets Law Review No 1-2018) have argued that such an approach has clear advantages. It could deal with allocation of liability and provide:

  • protection to counterparties, consumers and developers/designers/coders;
  • protection against damage caused by anonymous or bankrupt designers;
  • opportunities to impose compliance requirements; and
  • opportunities to introduce an element of jurisdiction to the DLT system, as the innovative technology arrangement would be required to be registered with the regulator in Malta.

Of course, these advantages should be weighed against the financial cost of compliance and registration, which may affect innovation and willingness to register a DLT system in the first place. (P L Athanassiou, 'Tokens and the regulation of distributed ledger technologies: where Europe stood in the last quarter of 2018', 34(3) Journal of International Banking Law and Regulation).

Liability Issues: Categories of Risk, Classes of Participants, Types of Transaction

One of the key consequences of the analysis of the legal structure of a DLT system is for the allocation of liability where loss has occurred. The use of DLT systems provides the potential for transactions to take place automatically, without human intervention. However, the use of these systems is neither failsafe nor fool proof. For example, Zetzsche, Buckley and Arner (in 'The Distributed Liability of Distributed Ledgers: Legal Risks of Blockchain' (2018) University of Illinois Law Review) outline the different categories of liability risk associated with DLT systems, including risks of problematic coding and negligent performance. The Law Society (in 'Horizon Scanning — Blockchain: The Legal Implications of Distributed systems') notes the problem of liability management relating to systems where there is an inability to control and stop the functioning of public blockchains.

Businesses using DLT systems, and their lawyers, should be acutely aware that these risks raise questions as to where losses will lie. Although parties are likely to mitigate against losses through commercial documents where possible, it is worth reviewing the various ways in which liability for damage could be considered.

The question of allocation of liability could be analysed by reference to the participants in the system. Commentators have considered whether a particular class of participants, such as smart contract code developers, miners or nodes, should be liable for losses. Commissioner Brian Quintenz of the US CTFC, has talked about the “key players essential to powering smart contracts on the blockchain”. In the context of CTFC regulations, Commissioner Quintenz posited that smart contract code developers should be held liable in some circumstances, and that the appropriate question is whether they “could reasonably foresee, at the time they created the code, that it would likely be used by US persons in a manner violative of CTFC regulations”.

P De Filippi and A Wright (in 'Blockchain and the law' (2018), Ch 11) consider different modes of regulation that could be applicable, including in the context of liability questions.

Another way of looking at liability is by reference to the type of transaction taking place on the DLT system. For example, it has been suggested that if the existing law does not specify how losses should be allocated, it may be appropriate to let the losses lie for commercial contracts but not for consumer contracts. In 'Smart contracts: legal framework and proposed guidelines for lawmakers' (October 2018), the European Bank for Reconstruction and Development and law firm Clifford Chance note that regulators and legislators could impose a requirement that transactional documents used in a DLT system must allocate liability.

It is also possible to consider questions of liability and loss through the lens of any legal structure of a DLT system.

Existing Legal Concepts

Most commentators consider the relevance and applicability of existing legal concepts to those systems. The analysis often involves making a choice between:

  • existing contract theory (generally considering the enforceability of smart contracts by mapping the elements of a contract onto new systems); or
  • the operations of the new technology, generally considering the question which is often framed as “code as law” (borrowing from Lawrence Lessig in Code and other laws of cyberspace (1999)).

We take two examples of the different approaches.

In the first case, Herbert Smith Freehills (in 'Hashing Out the Implications of Smart Contracting under English law') provides a walk-through analysis of each element of a conventional contract in the context of a blockchain system. Although outside the scope of the HSF note there is, however, scope for applying the elements of a contract to DLT technology if viewed from the perspective of the technology rather than the contract. This would include, for example establishing consideration for a contract through the “cost” of membership of the network.

In this second case, Zetzsche, Buckley and Arner argue against the “code as law” suggestion for regulation. Their view is that the law covers all relations among people and property. It is exhaustive and so analysis of blockchain by definition must fit within the existing framework.

As published in Butterworths Journal of International Banking & Financial Law, May 2019.