Applications Ethics and Regulation

EVOLUTION and INFRASTRUCTURE

Just as the evolution of the internet enabled new methods of communication and business models, the arrival of blockchain systems is an enabling technology which creates opportunity to facilitate transactions and empower new business models. How this paradigm will be applied is evolving.

The evolution of digital commerce continues to drive disintermediation and dematerialisation. In any digital environment where one party is willing to make a payment remotely for property or services delivered against a digital promise, the need for intermediaries, brokers, trusted third parties and long supply chains is significantly diluted. One only has to look at the impact that e-commerce has had on retail and the "high street" to validate this statement .  

The internet started a process which blockchain technology is likely to accelerate, but it goes well beyond e-commerce to development of new paradigms in network computing, data validation and security.

Dematerialisation, involves removing layers of infrastructure.  Digitising transactions and automation of distribution centres facilitate matching the digital product identity with specific financial transaction and the digital identities of the participants.  Legacy business operations such as pick and pack and the reliance on complex extended supply chain is inevitably dematerialised as the internet of things enables physical and digital systems to operate as one "system".

THREE TECHNOLOGIES

There are three elements to this new digital environment; asymmetric cryptography, distributed ledger and blockchain. Whilst all three technologies come together in relation to cryptocurrencies they are not all necessary to other applications such as supply chain management.

Asymmetric cryptography also known as public key cryptography, uses public and private keys to encrypt and decrypt data. The keys are simply large numbers that have been paired together but are not identical (asymmetric). One key in the pair can be shared with everyone; it is called the public key. The other key in the pair is kept secret; it is called the private key. Either of the keys can be used to encrypt a message; the opposite key from the one used to encrypt the message is used for decryption.

Distributed ledger technology (DLT) records the same transaction in multiple places at the same time.  There is no centre data storage or control over what is recorded or when.

A blockchain ledger (database) comprises individual transactions and blocks. The first block consists of a header and data relating to the transactions taking place within a set time period. The block’s timestamp is part of the data used to create an alphanumeric string or hash. When a blockchain is held on a distributed ledger each of the computers in the distributed network maintains a copy of the ledger all copies are updated and validated simultaneously, hacking or changing one copy of the ledger will have no effect on the "consensus" that the true "block" is that validated by all of the nodes.

After the first block has been created, each subsequent block in the ledger uses the previous block’s hash to calculate its own hash. Before a new block can be added to the chain, its authenticity must be verified by a validation or consensus process. At this point of the blockchain process, a majority of nodes in the network must agree the new block’s hash has been calculated correctly. 

THE FUNCTIONAL CHARACTERISTICS OF BLOCKCHAIN

Assuming that a transaction is concluded between two parties (remotely) by which a digital token is exchanged for property, the data which is created (the timestamp, parties' IP address, wallet ID, the amount of any token etc) are converted to hash and that data is added to the block. If a digital token is used in the transaction (such as Bitcoin) the system must reach a “consensus” to ensure that the same token is not spent twice; miners perform this function by validating the transactions and ensuring that only the first in time is joined to the current block. 

As the blocks are chained and “distributed” there is no credible way of altering the transactional data. As the distributed ledger is not in the hands of a central administrator there is negligible risk of the data being altered.

Blockchain introduces a new conceptual understanding namely that “trust” can be established with someone you do not know. Trusting transaction validated by a public network of computers requires a philosophical change acceptance of a new method of doing business, there is much less scope for what was "intended" in a trust-less instantaneous agreement and payment system.

USE AND APPLICATIONS OF THE TECHNOLOGY

Applications based on these technologies have the capability to fundamentally affect remote trusted transactions, legal documents and . Trusting transaction validated by a public network of computers creates opportunities for business models that have yet to be conceived.  It seems likely that as confidence and understanding grows blockchain enabled systems will gradually play an increasingly significant part of the formation of contracts and accounting; if for no other reason than the technology is likely to be considered by courts as a more reliable record of transactions than human recollection or analogue documentation.

ADOPTION OF TECHNOLOGY

As with many disruptive technologies, the timing and adoption process can be unpredictable. Whilst futurologist speak with unnerving certainty, history tells us that the adoption of new systems and technology is difficult to predict. Out of the plethora of projections, it is inevitable that someone will identify the black swan, but history tells us that event horizons arise from a combination of events which are usually unconnected to such a degree that the outcome can be considered to be random. The product of change in an ecosystem usually lies outside the control of the innovator. The application of the blockchain related technologies is in a state of evolution to such an extent that attempting to predict the outcome based on knowledge of prior centralised and analogue systems is a fool's errand.As Clayton Christiansen ("The Innovators Dilemma) pointed out, conventional valuation prediction and risk analysis does not work when the innovation has no history. 

THE RESURGENCE OF PRIVATE MONEY

The adoption of crypto-currency as a means of exchange must be considered as a highly probable outcome. Central banking and management of the money supply by government is relatively new concept in the history of money. Modern centralised banking systems are the product or consequence of technology.

The commercial incentive to sell large scale data management and data transfer systems created a virtuous circle driving interbank competition to provide greater digital functionality in the fight for customers. Contrast that with the necessity driven innovation in in payment systems in Africa where people started using phone minutes as legal tender where conventional banking was. simply not commercially viable.  

Extrapolating that experience, it is likely if not inevitable that cryptocurrency will evolve into an acceptable medium of exchange that reduces reliance on centralised ledgers and institutions.  It is yet to be seen who the winners will be in the battle for the hearts and minds of business users.

Speed of transaction and the need to reduce the hidden costs of transactions will drive adoption, but one cannot discount the importance that participants will place on the reduction in control by banks and governments to set interest rates and the terms upon which transactions can take place.

If one learns anything from history it is likely that the token which is finally adopted as the means of exchange will arise from a wealthy trading business. The rise of the Medici dynasty from trade in the 16th Century created banking as we know it today. Private banking arose because traders trusted the rich merchant houses to honour the paper they issued. This resonated through the stock exchanges of the Victorian Era, "my word is my bond". Trust lay at the heart of these systems and institutions. Converse to trust is risk, the arbitrage between risk and certainty is the price of money.

Knowing that an industry will be disrupted is not the same as predicting the effect of that disruption, how fast it will happen, or who the winners or losers will be.

Managers in the most affected industries are usually the last to accept the inevitable, they are trained to manage what exists not to disrupt their own systems which create certainty in favour of a more uncertain but perhaps more lucrative state. We often value what we have, however imperfect more than what we might get in the future. Individual managers are unlikely to be able change the environment they operate in, and are unlikely to be capable of realign their skills to do so. Existing business structures limit the ability of a business to adapt.

Those who predicted the end of days for music when digital music took hold lived to see the volume of published music rise exponentially, stars created on YouTube and greater access globally to creative media than could have been conceived.  At the same time as iTunes reached 14 million downloads a month, the stock price of the high street music retailer HMV was still rising. It was some time until the conventional retail distribution matrix responded to the inevitable change of state.

BLOCKCHAIN AS AN ENABLING TECHNOLOGY

The combination of technologies has created the opportunity for parties to exchange digital tokens remotely with certainty that the token they receive has not been used in any other conflicting transaction.

Just as when one passes cash from one banking ledger to another, or one party hands over physical currency, a token that is passed through a blockchain/distributed ledger system is validated using asymmetric encryption and consensus algorithms (mining) to ensure that any one token cannot be spent twice and therefore has the characteristic of a currency transaction. 

It is for the parties to decide what a digital token represents and what it can be exchanged for. A unit of fiat currency has a value because people accept it as a medium of exchange. That credibility is backed by a central or sovereign bank as the “lender of last resort”. With the explosion of new crypto currencies, it is perhaps inevitable that a handful will survive as the chosen medium of exchange.

Once the ledger code has been “launched”, and is proliferated across multiple platforms and computers, it cannot be centrally controlled. Changes to the way tokens operate is undertaken by “forking” the token’s underlying code and creating a new variant.

As an enabling technology blockchain enabled tokens can be applied in any circumstances where two (or more) parties wish to engage in a digital transaction remotely without needing to trust the other party to do what they have promised to do. Transactions are executed automatically using computer code or what is termed, smart contracts.

TOKENISATION AND PROVENANCE

In principle, the title to any physical asset (or digital right) can be represented by a digital token. For example, the serial number on a high value luxury item such as a watch can be converted to a hash using public/private key encryption. By adding the owner and a transaction date, the hash becomes a province.

Only the holder of the private key can create that hash and only the public key holder can verify it. In principle therefore, the title to any asset which can be represented by a hash can be tokenised, and title passed in a digital transaction. If the owner’s personal data or identity is given the same treatment, it is possible to create a “hash” from the property data combined with that created an immutable evidence of current ownership. 

Starting with the manufacturer the “hash” could be a combination of the manufacturer’s identity and the serial number of the asset. A new owner would be “added” to the block giving a complete chain of provenance that can be validated online by any prospective owner who is provided with the public key (only the key pair will validate).  The only one owner can validate a single unique hash there can never be two.

If one extrapolates this thinking it can be understood that a provenance can be provided for any asset from digital media to land. That provenance will only ever identify the current owner, there cannot be two owners of the same asset. Presentation of any digitised asset by a third party whose “hash” is not presented on the chain will not validate.

PUBLIC AND PRIVATE BLOCKCHAIN

Whilst the use of a distributed ledger is an attractive way of ensuring that tokens that are exchanged remotely have not been duplicated, and that the transactions on a blockchain are valid, it is not necessary for this to be the case. 

The blockchain database can be held on a single instance database “privately” and provide certificates which evidence that transactions took place and were recorded on a specific date.

LENDING ON MOVEABLE ASSETS

Assuming that one has sufficient data to create a unique digital hash that identifies both an individual, and a physical asset, it is possible to create a registry that can be used to identify assets which are pledged for a debt.

The challenge to such systems is whether such registries operate as legal “notice” to third parties who may purchase assets without notice of the lender’s rights. On the premise that the owner cannot pass better title than he has, such applications would appear to be attractive. Some jurisdictions such as the USA already recognise pledges of moveable assets.

EVOLVING LAW

Since the advent of the internet there have been comparatively few new internet specific laws . In the early days of the internet there were accusations of it being unregulated, that the Wild West etc. would abound. Now, we take it for granted that we deal remotely with companies and buy and sell high value assets across web portals, despite the proliferation of fraud, individuals and banks have found ways of doing business. The method may have changed but the principles of contract, criminal law and tort have not.

The principle of the law relating to trade has not changed since it was codified in Roman Law. (Justinian's Institutes) in the 6th Century. Whether, common law or civil law, the principles of contract are remarkably similar. The laws relating to misrepresentation, unfair contracts and the like apply as much in the digital world as they do in the analogue world. There is however the need for the courts to reinterpret the law to apply it to the new paradigms. It may be useful to note that the principles of contract are simple, one looks to what was agreed, everything else is an exception.

CRYPTOCURRENCY AS A MEDIUM OF EXCHANGE

Concerns that has been raised is whether government control of the money supply will be materially affected as means of economic management. It seems however that banks will

The first countries to lead with regulation have been those who are most concerned at preventing assets from leaving the country. Tight central control is challenging if commercial operators are willing to accept tokens for payment which do not need to pass through conventional foreign exchange control mechanisms.

Christine Lagarde head of the IMF (14th Nov 2018) has said "Central banks had to work quickly to establish digital cash for burgeoning networks of private financial transactions or risk their mushrooming into trading networks that were inherently unstable"

Much of the legislators concerns over the emergence of crypto currency relates to the potential anonymity of transactions rather than the economic effect. The ability of governments to track transactions was a consequence of the emergence of centralised data driven banking, that in turn led to efficient taxation systems. Such perceived anonymity may however prove to be just as illusory as the same concern which was voiced on the rise of the Internet. In fact what happened was that the internet, connected to GPS and smartphones gave much greater visibly than could ever have been conceived.

DOCUMENT AND PROJECT TOKENISATION.

The philosophy behind distributed ledger technology was initially anarchistic in character. Driven to a great extent by the desire to provide systems that dilute central control over individuals. Ironically the anarchists may have handed government the greatest tool for control the world has ever seen. Blockchain is capable of immutable recording of any event which can be digitised from the opening of a door to the printing of a piece of paper (and what's on that paper).

Blockchain creates opportunity to validate digital documents and events for any business and to record events and transactions which could abrogate the need for the production of millions of documents in court proceedings and the unrewarding experiences of thousands of hours spent on manually trawling through these to establish legal rights and working out who did what and when?   These systems are likely to take many years to develop and adopt. The perversity would be that to go "off grid" one would need to go back to physical paper and analogue systems.

SECURITY TOKENS

It is entirely possible to build business ownership models using tokenised equity which are subject to smart contracts built on algorithms that echo conventional company law (this would need to accord with tax and securities laws). There is no reason why pre-emption rights issues and the like could not be achieved digitally. 

Similarly, there is no reason why rewards structure cannot be linked securely to almost any event that can be recorded. In this way the internet of things could well be the catalyst for new reward systems that generate tradeable tokens.

PROJECT MANAGEMENT 

The potential to disrupt conventional contract documentation for complex projects is possibly the most compelling case for application of blockchain and smart contracting.

Any event which is capable of being converted into a digitised process can replacing thousands of hours of narrative agreements into code. The digitised project plan linked with even recording and smart contract technology in a  blockchain environment can be tied to a CAD design, diary and to sensors, smart validation of work done and payment algorithms which release funds automatically. 

As each task is completed a token generating event arises and token can be created. When the criteria for release are loaded, the transaction is time stamped and cannot be reversed or duplicated. As an event is recorded and validated, funds are automatically released.

Digital models would need to be created, but once created the recording system is programmed, and the core program need never be rewritten. The “contract” records its own progress: creating and reading invoices, project plans and demanding authorisation by the appropriate stakeholder. The timeline stores multimedia timestamped records of each work product authorises payments.

A legal team is required to create such a “smart contract” and to develop it, but the time spent in negotiation would be directed to operating the project rather than arguing over the narrative. 

This narrative is an explanation as to what is possible. Whether it is economically viable or probable, I will leave to others. Elements of this speculation are likely to be achieved and some are already happening, with contracts being made remotely and events recorded in a way which cannot be altered or reordered. Businesses that sell media rights and other easily digitised assets are some of the first to develop systems which permit each transaction and resale to generate and distribute value to the original creator as well as the immediate vendor. Something which is possible if the “hash” records the full title of the digital asset.

These contracts are already in existence in the financial markets where the terms of the trades are standardised and the importance of recording the exact timing and sequence of transactions is critical. The development of XML schemas for the narrative of legal agreements means that automated contract review is within reach. If documents are drafted within the constraints of standardised XML schemas and all of the events, transactions and agreements of a business are digitised and digitally signed, then the records of transactions and interactions with suppliers, customers and employees could be analysed using the AI methodologies and payments made automatically.

GAME THEORISTS

Game theorists have for decades been mapping human economic behaviour but struggled to correlate cause and effect.  In the blockchain era, game theory comes of age. The rules of competition and behavioural response can be preordained. 

With the internet of things and the analytics engaged by “no-sql” and unstructured data analysis opens the potential to move from static to dynamic commercial agreements, where specific behaviour can trigger a price change, create a reward or limit a risk. The cause and effect of any change can be analysed in real time using big data analytics.

The design of these “dynamic” contracts has been evolving for some time as the travel industry commoditises aircraft seats, hotel rooms and car hire to respond instantaneously to demand changes. The same has been going on for some time in digital advertising where digital assets are auctioned in hundredths of milliseconds. 

Algorithms derived from game theory and behavioural economics can be coded to recognise and respond to events. As the movement of people and goods and value becomes increasingly digitised, data analytics can analyse and predict behavioural change in real time.  

THE RELEVANCE OF ARTIFICIAL INTELLIGENCE (AI)

Much of this work has been characterised as AI, but in truth it's not AI at all. Few current systems are Turin Compliant or capable of making decision beyond pre-ordained and a combination of anticipated behaviours. AI comes into its own when the machine can make a decision intuitively to an event which has not been anticipated. AI has become a sales pitch rather than a destination.

The evolution of smart cities and the allocation of resources from a parking space to road use no longer requires crude predictions of how consumers will respond to regulation many months after the event. Parking costs in a smart city can be altered in real time to respond to demand, payments can be tokenised and personalised and programmed to respond to the status of the driver. 

REGULATION

Regulation of the use of these technologies will be reactive depending on perceived abuses as they are identified.

European payments legislation, money laundering, corporate transparency rules and cross border regulation are likely to be modified to protect the innocent, disadvantaged and unwary.

DATA & MACHINE ETHICS

GDPR (General Data Protection Regulations) was out of date even before it reached the statute book. Regulators have recognised that putting in place strict regulations before technology has evolved and its impact evaluated will probably staunch valuable innovation. There has been a much slower recognition that new legislation will probably need to focus on the ethics and application of technology rather than any specific abuse.

Collecting personal data for offering advertising, tells one nothing about how that advertising and information will be interrogated or applied; how prices are individualised and how one group could be silently preferred over another. Most conventional law regulates behaviour of the citizen and the businesses within a territory. Laws regulate the interaction between citizens (including business) (private law)and between citizens and government (public law).

If behavioural responses are dictated by layers of code that can react and implement actions dynamically, to influence behaviour, price and even the way we vote, then conventional regulations would have to proliferate and an alarming rate to keep up. Recognising the difference between ethical communication in an election and unethical behavioural manipulation using complex messages machine generate to respond to news and media might be considered legal but unethical.

The recent debates over the use or misuse of facebook data in elections and beyond stand as precedent. In a blockchain enabled world where algorithms (published or unpublished) determine or manipulate behaviour, the law of unintended consequences could dominate.

Some of the self proclaimed "anarchists" who developed early blockchain and distributed ledger transactions have been dismayed by the technology being adopted as a control mechanism by the very people they wished to disempower. Be careful what you wish for!

It is seems likely that a new body of law will need to evolve around the ethics of data use and misuse and particularly around computer driven decision making and machine driven bias. If the potential of blockchain and distributed ledger is extrapolated to what is possible society, is going to have to decide where the moral compass of a digital infrastructure should point, how citizens are entitled to interact with it and how and to what degree they are to be protected from adverse consequences.

Just as this technology provides great opportunity; it is also right to say that just because you can do something, does not mean you should do it…