LAW AND BLOCKCHAIN TECHNOLOGY PT. 1

Blockchain technology has spread to different areas of business very quickly. Since its inception, it has traveled through industries such as Crypto, Finance, Cybersecurity, and more. Now, it has become one of the most preferred server technologies among developers.

The advancements in blockchain technology is increasingly shaping the lives of individuals, groups, organizations, and societies. This rapid developments call for an effective regulation to protect the basic interests and needs of these actors (individuals, groups, organizations, and societies).

In this article, we will briefly highlight the meaning of blockchain, how it works, its uses and the legal frame work for the regulation of blockchain technology at the international and national level (Nigeria).

What is a blockchain?

According to IBM, blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network. An asset can be tangible (a house, car, cash, land) or intangible (intellectual property, patents, copyrights, branding). Virtually anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.

In simpler terms, blockchain is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system (immutable). The innovation with a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party.

How does blockchain work?

The difference between blockchain and a typical database is how the data is structured. A typical database usually structures its data into tables, whereas a blockchain, as the name implies, structures its data into chunks knowns as blocks that are strung together forming a chain.

In detail, blockchain collects information together in groups, known as blocks, that hold sets of information. The blocks have certain storage capacities and, when filled, are closed and linked to the previously filled block, forming a chain of data known as the blockchain as the name entails.

This data structure of blockchain inherently makes an irreversible timeline of data when implemented in a decentralized nature. When a block is filled, it is set in stone and becomes a part of the timeline. Each block in the chain is given an exact timestamp when it is added to the chain.

The illustration below shows the recording process of a financial transaction carried out on blockchain.

Blockchain is a type of Distributed Ledger Technology (DLT) in which transactions are recorded with an immutable cryptographic signature called a hash. Distributed Ledger Technology is a digital system that records asset transactions at numerous places simultaneously.

The key elements of blockchain technology are that, it is a distributed ledger technology (decentralised), its records are immutable, it is built on smart contracts, there's transparency, and it is automated.

Use Cases and Application of Blockchain Technology

The elements of blockchain can be applied to various industries, creating a multitude of use cases. Here are some of the most pertinent blockchain use cases for enterprises, institutions, and governments:

1. Capital Market

For capital markets, blockchain unlocks easier, cheaper, and faster access to capital. It reduces the barriers to issuance and enables peer-to-peer trading, faster and more transparent settlement and clearing, reduced costs, decreased counterparty risks, and streamlined auditing and compliance.

2. Decentralised Finance (DeFi)

Decentralised finance refers to the shift from traditional, centralised financial systems to peer-to-peer finance enabled by decentralized technologies built on Ethereum. This new economic system is setting new standards for financial access, opportunity, and trust.

3. Finance

Financial services struggle with archaic operational processes, slow payment settlements, limited transparency, and security vulnerabilities. Blockchain enhances the efficient digitization of financial instruments, which increases liquidity, lowers cost of capital, and reduces counterparty risk.

4. Supply Chain Management

Existing global supply chains are inefficient, poorly tracked, and oftentimes exploitative. Blockchain can facilitate accurate asset tracking, enhanced licensing of services, products, and software, and transparency into the provenance of consumer goods, from sourcing to the point of consumption.

5. Digital Identity

A blockchain-based digital identity system provides a unified, interoperable, and tamper-proof infrastructure with key benefits to enterprises, users, and IoT management systems. The solution protects against theft and provides individuals greater sovereignty over their data.

6. Digital Currency creation

Many people have heard of bitcoin, ethereum and other digital currencies, but not as many are familiar with blockchain. Blockchain is the technology that allows digital currencies to be created, traded and tracked.

LEGAL AND REGULATORY FRAMEWORK FOR BLOCKCHAIN TECHNOLOGY

In a recent survey on technology tipping points, the World Economic Forum estimated that 10 percent of global gross domestic product (GDP) will be stored on blockchain technology by 2027. And, the survey estimates that taxes will be collected for the first time by a government via blockchain by 2023. The concerns in the wide and rapid adaptation of blockchain technology has raised the need to build a legal framework for the regulation of the technology.

We will address the regulations the European Commission, United States and Nigeria have put in place to ensure that the needs and interests of actors are protected.

The European Commission

The importance of legal certainty and a clear regulatory regime in areas pertaining to blockchain-based applications is well recognised by the European Commission which is why it strongly supports rules for blockchain that will cover the whole of the EU to avoid legal and regulatory fragmentation. The Commission adopted a comprehensive package of legislative proposals for the regulation of crypto-assets in order to increase investments and ensure consumer and investor protection. 

This package updates certain financial market rules for crypto-assets, and creates a legal framework for regulatory sandboxes of financial supervisors in the EU for using blockchains in the trading and post-trading of securities.

The European Central Bank (ECB) and the European Commission services are jointly reviewing at a broad range of policy, legal and technical questions relating to the possible introduction of a digital Euro.

Proposal for a new EU law on crypto-assets

Crypto-assets qualifying as 'financial instruments' under the Markets in Financial Instruments Directive have previously been subject to EU securities markets legislation.

However, these rules predated the emergence of crypto-assets and DLT (Distributed Ledger Technology). This could hamper innovation. So, the Commission proposed a pilot regime for market infrastructures that wish to try to trade and settle transactions in financial instruments in crypto-asset form. The pilot regime allows for exemptions from existing rules and allows regulators and companies to test innovative solutions utilising blockchain.

For crypto-assets that do not qualify as 'financial instruments' such as utility tokens or payment tokens, the Commission proposed a specific new framework, this framework would replace all other EU and national rules currently governing the issuance, trading and storing of such crypto assets.

The Markets in Crypto-Assets Regulation (MiCA) will support innovation while protecting consumers and the integrity of crypto-currency exchanges. This includes rules such as no insider trading or front running. The proposed Regulation covers entities issuing crypto-assets, firms providing services around these crypto-assets, firms operating digital wallets, and cryptocurrency exchanges.

Pan-European blockchain regulatory sandbox

A sandbox is an isolated testing environment that enables users to run programs or open files without affecting the application, system or platform on which they run. They are also used to safely execute malicious code to avoid harming the host device, the network or other connected devices. This facility brings together regulators, companies, and tech experts to test innovative solutions and identify obstacles that arise in deploying them.

The European Blockchain Partnership is planning a pan-European regulatory sandbox in cooperation with the European Commission for use cases in the The European Blockchain Services Infrastructure (EBSI) and outside of EBSI, including for data portability, business-to-business data spaces, smart contracts, and digital identity. This will cover sectors including  health, environment, mobility, energy and more.

United States of America

State Actions

Vermont became the first state to address blockchain in legislation in 2015, when it directed the attorney general, Department of Financial Regulation, and secretary of state to report to the General Assembly on opportunities and risks of creating a presumption of validity for electronic facts and records that employ blockchain technology. Then, in 2016, the Vermont General Assembly created the evidentiary standards to determine the authenticity of records using blockchain technology within the state’s rules of evidence.

In 2017, five states (Arizona, Delaware, Illinois and Nevada) enacted and adopted blockchain legislation.

Arizona enacted two bills. The first, H.B. 2417, established guidelines for electronic signatures and records using blockchain technology. In the second bill, H.B. 2216, the Legislature made it unlawful to require a person to use or be subject to electronic firearm tracking technology, including blockchain and distributed ledger systems.

Delaware enacted S.B. 69, providing statutory authority for corporations formed in Delaware to use blockchain to create and maintain corporate records, including the corporation’s stock ledger.

Following the formation of the Illinois Blockchain Initiative, a consortium of Illinois state and county agencies including the departments of Commerce and Economic Opportunity, Insurance, Financial and Professional Regulation, Innovation and Technology, and the Cooks County Recorder of Deeds, the Illinois General Assembly adopted a joint resolution. The resolution created the Illinois Legislative Blockchain and Distributed Ledger Task Force to study how and if the state, county and municipal governments can benefit from a blockchain-based system for recordkeeping and service delivery.

Nevada enacted legislation recognising blockchain technology as a type of electronic record for the purposes of the Uniform Electronic Transactions Act and prohibited local governments from taxing or imposing restrictions on the use of blockchain.

Federal Actions

In the United States, federal agencies are evaluating distributed ledger technologies like blockchain to improve transparency, efficiency and trust in government information sharing. The U.S. Government Services Administration’s (GSA) Emerging Citizen Technology program recently launched the U.S. Federal Blockchain program for federal agencies and U.S. businesses interested in exploring using distributed ledger technology within government. The GSA hosted the first U.S. Federal Blockchain Forum in July 2017, bringing together more than 100 federal managers from dozens of unique agencies to discuss use cases, limitations and possible solutions.

Nigeria

Nigeria like many other countries, has no specific laws regulating blockchain technology, neither has it had any bill introduced to the National Assembly with regards to blockchain technology. However, there are certain laws that regulate most of the industries where blockchain is largely applied. An example of one of such industries is the finance industry. Some laws that may take implicit regulation for the application of blockchain technology in Nigeria may include the followings:

1. The Finance Act 2019
2. The Nigeria Data Protection Regulation 2019;
3. The Cybercrimes (Prohibition, Prevention, etc) Act 2015;
4. The National Identity Management Act 2017;
5. The Companies Income Tax Act;
6. The Capital Gains Tax Act;
7. The Value Added Tax Act;
8. The Companies and Allied Matters Act;
9. The Money Laundering (Prohibition) Act, 2011 (as amended);
10. The Economic and Financial Crime Commission (Establishment) Act 2004; and
11. The Banks and Other Financial Institutions Act 1991.

In conclusion, a large number of countries are yet to take steps in regulating a sophisticated and highly decentralised system like blockchain but we will get there in due time.

In part 2 of this topic, I will be analyzing the following mind boggling questions:

1. How does a regulator apply rules to a blockchain system that is not run by anyone in particular, but instead exists as an autonomous form on Ethereum.
2. What happens if two Decentralized Autonomous Organisations with market power vote to merge and how does a competition regulator stop that?

Thank you for reading, and please ask questions if you have any.

References

1. Investopedia: https://www.investopedia.com/terms/b/blockchain.asp
2. IBM library: https://www.ibm.com/topics/what-is-blockchain
3. Euro money learning: https://www.euromoney.com/learning/blockchain-explained/what-is-blockchain.
4. Consensys: Blockchain use cases and application by industry.
5. European Commission: Shaping Europe’s digital future.
6. National conference of state legislatures: Blockchain technology (An emerging public policy issue).
7. SFI: Distributed Ledger Technology.
8. World Economic Forum: Global Agenda Council on the Future of Software & Society.
9. Frontiers.com: Blockchain technology and the future of governance.

Tags: #blockchain #technology #crypto #techlaw #regulations