When two cultures collide

Blockchain and the law: Regardless of the special technology‘s success, the general trend behind it is not stoppable
By Dr. Nina-Luisa Siedler and Tom H. Brägelmann, LL.M.

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Introduction

Everyone is talking about blockchain. Not a day passes without articles on new, revolutionary ideas. The technology that initiated this hype uses automated databases that store the “transactions” according to a particular set of rules and are intended to prevent any human intervention for unauthorized users. The databases are decentralized and stored in parallel on numerous servers. They allow updating only on the principle of consensus, which effectively makes any manipulation by hackers impossible. The basic idea is, in fact, very simple: a database for transactions that manages itself according to rules that have been set and is tamper proof. The idea originates from the inventor of the cryptocurrency bitcoin.

Many examples of applications for this technology can currently be found in the financial sector within the growing FinTech industry. One that deserves mention is the R3 consortium, which has gathered together more than 40 banks around the world to provide the global financial market with secure and fast solutions for payment transactions and securities trading. The Australian stock exchange is moving in the same direction with its appointment of an US company to use blockchain technology for clearing. Besides this, there are numerous consumer products, such as payment in local shops by means of smartphone wallet apps that are organized through the use of cryptocurrencies. With a view toward property transactions, Sweden has already seriously examined and run tests together with banks on the extent to which the land registry can be operated on the basis of a blockchain.

In the United States, the Financial Stability Oversight Council (FSOC) has recognized the blockchain technology as a valuable mechanism for improving market transparency in its recently published annual report for 2016. The breakdown of risk concentrations among those still currently involved in handling financial transactions (particularly banks and stock exchanges) is also regarded as attractive. The technology reportedly has the potential to minimize risks and improve the stability of the financial markets. At the same time, the FSOC points out that every new technology is associated with risks that the supervisory authority has to observe. Due to a previous lack of experience, circumstances might arise under which weaknesses would not be recognized until after the damage caused was already considerable. The necessity for closer cooperation among the international regulators was also identified, as potential market participants are likely to act across national boundaries.

Fragmentation

This is the common problem of the new technology, which basically functions on a technical level around the world: the fragmentation of the law. Worldwide, there are some 200 national states or jurisdictions. The UN alone has 193 members. Added to this are numerous multilateral trade agreements and other transnational bodies of legislation. Consequently, the situation quickly becomes unclear for purely Internet-based, global offers. Barely a single legal topic exists that is subject to globally uniform regulation. Areas such as data and consumer protection, in particular, as well as regulatory standards, primarily in the financial sector, are drafted in extremely different ways according to the region.

As a matter of principle, suppliers initially have to adhere to the law of their own home country. If they then offer their idea across borders, they also have to observe the law of the country they are supplying to the extent that the law contains binding regulations that cannot be waived through a contractual choice of law with the user. This makes a general worldwide offering of the idea practically impossible. The only course remaining for suppliers, therefore, is to initially limit themselves to individual, selected jurisdictions in which they have examined the law and tailored what they are offering accordingly and to then gradually expand when they experience success.

Competition of locations

Against this backdrop, a real location-oriented competition among jurisdictions has now flared up. So far, Germany has not become involved. The relevant German regulatory body, the Federal Financial Supervisory Authority (BaFin), does not tire of pointing out that there will be no “playground” with reduced regulatory requirements for these young enterprises. In contrast, the United Kingdom has already declared the rule of the sandbox principle and offers FinTechs a set of simplified regulatory rules. This represents a win-win situation for the state and FinTechs. While the FinTechs are able to take their first legal steps on the market, the supervisory authority gains specific insights into the technical processes of the transactions. Reducing regulations is balanced out by protective measures. These include, for example, an indemnity obligation on the part of the FinTechs to cover possible customer losses. In the meantime, the Dutch central bank has been examining the technology by allowing a test series of blockchain transactions to run in a closed system. In one scenario, the bitcoin environment of the year 2140 was simulated in order to predict how the blockchain will work after creation of the last bitcoin unit. Within the framework of the EU Parliament, the Economic and Monetary Affairs Committee has announced it is in favor of taking a wait-and-see approach so as to not nip development in the bud. Switzerland goes beyond this: members of the parliament recently pleaded for deregulation of the concept of client deposits under banking supervisory law. According to this, companies that accept deposits (like savings deposits at banks) in the form of cryptocurrencies will no longer to be treated as banks. It comes as little surprise that Switzerland is taking a pioneering role in this area. The country has traditionally been very proud of its independence and the tendency of the blockchain community to hold itself independent of prescribed local regulations fits in very well with this culture.

The US state of Delaware, however, appears to be the most progressive: Governor Jack Markell announced the Delaware Blockchain Initiative in early June 2016. According to this, Delaware’s laws will be adjusted so that any ambiguity in connection with blockchain applications can be eliminated. Furthermore, companies registered in Delaware are to be given the opportunity to issue their business shares on the basis of blockchain technology.

Both in Europe and the United States, developments are, in fact, being observed with a certain amount of goodwill. Rigorous intervention is nowhere to be seen, not even where businesses in the blockchain community are operating clearly outside of traditional interpretations of the law. In any case, there is a prevailing conviction throughout the enthusiastic tech community that the business models based on blockchain technology are not legally regulated. After all, it only involves software. Some simply make their ideas available on the World Wide Web for anyone to use without a recognizable initiator. Bitcoin is leading the way. Which laws should govern such a virtual database that functions according to its own rules?

Outlook

The blockchain community has thus embarked on a path of globalization that current local laws are having difficulty managing. Regardless of how successful this special technology will be, the general trend behind it can no longer be stopped. It is therefore important to examine this phenomenon and provide a legal basis for any undesired technology possibilities – if in doubt, across national borders.

Further progress will be observed with excitement. Or, better still, it will be actively and jointly shaped by a broad stratum of society.

nina-luisa.siedler@dlapiper.com

tom.braegelmann@dlapiper.com