Code and Other Laws of Cyberspace, Lawrence Lessig’s book says that “code is law”, which refers to the idea that computer code has progressively established itself as major way to regulate behaviour to the same extent as legal code.
The introduction of blockchain technology has seen code playing an even greater role in the regulation of people’s interactions. However, while computer code is capable of enforcing rules more efficiently compared to legal code, it has several limitations.
With major regulatory implications, blockchain applications have already raised numerous legal questions even as they continue offering new capabilities for engaging in activities in ways that don’t fit perfectly into the current legal frameworks.
Cryptocurrencies as Legal Tender
The most widely recognizable digital currency in the world, Bitcoin, uses encryption techniques for regulating the generation of units of currency as well as the verification of the transfer of funds, operating independently of a central bank. It means that this money doesn’t pass through a financial institution such as a bank and nor has any government agency screened it.
If you have a major transaction that you would normally have to report, it just isn’t. This leads to major challenges, mostly regarding the existing laws and government regulators.
The “monetary policy” of bitcoin has been written into its code: Every 10 minutes, new money is issued, and its supply is limited, a hard money rule is applied that’s similar to the gold standard (the money supply is fixed to a commodity rather than being controlled by government).
It bitcoin is regarded as a commodity, then the Commodity Futures Trading Commission in the United States has jurisdiction over the bitcoin exchanges there. Whether or not it is a currency under certain legislation can determine whether transactions can attract taxes.
However, a proposal that would block local authorities from introducing fees or taxes on blockchain use was backed unanimously by senators in Nevada.
Money Laundering and Other Illegal Monetary Transactions
The blockchain technology that Bitcoin uses has remained resilient to attack, and supports a robust payment system. However, this does not mean that the people that use it are always upstanding citizens.
Blockchain actions are automated and fall outside human legal action, which means bonus funds i.e. bribes can be dispersed anonymously and automatically into various accounts.
The regulatory bodies responsible for the prevention of financial crimes introduced new regulations aimed at bringing within the scope of their enforcement in 2013. Later in the same year, some 22 bitcoin investors and companies subpoenaed by the New York Department of Financial Services, which ended in federal agents shutting down of the Silk Road (a dark market mostly provided by bitcoin).
West Virginia lawmakers recently deemed it a felony to use cryptocurrencies such as bitcoin for money laundering, with an update to the anti-money laundering statutes of the state. The laws created a definition for cryptocurrency, which is recognized as a ‘monetary instrument’ in the state.
Still, striking the right balance in these new regulations is a continuous challenge.
The ability to perform pseudonymous transactions is one of the key innovations of bitcoins among other virtual currencies. The vast majority of virtual currency transactions don’t require the parties transacting to know each other, interact directly, or even meet face-to-face to exchange value.
New legislation requires that the party charged with violations have actual knowledge and/or intent. The lack of direct communication between parties is essential, and highlights the narrow impact of the current legal changes.
Financial services in most countries have to comply with rules pertaining to Anti-Money Laundering (AML) and Know Your Consumer (KYC). Blockchains and other new payment networks will over time not be exempt from such requirements, which is why some countries have either severely restricted or outright banned cryptocurrencies.
Regulation of Decentralized Applications
Blockchains are sometimes used to create tokens not designed to be cash at all. For example, programmable blockchains such as Ethereum allow users to create decentralized applications with their own tokens.
“Decentralized” and “Distributed” refer to the peer-to-peer aspect of the blockchain network since there isn’t a single central database of the blocks. Each node on the network can have a copy of the entire ledger.
Blockchains have been designed to be decentralized, with “layers,” whereby each of the layers is defined by an interoperable open protocol that individuals and companies can use to build services and products.
Cryptocurrencies such as bitcoin have made a new decentralized financial system possible. However, it could be much simpler if the layers of intermediation were removed. It could help insure against risk, and since it allows the moving of money in different ways, it could open up the possibility for financial products of different types.
Blockchain, just like any other type of ledger book, becomes the official record for tracking both the validity and history of transactions among other information according to lawyer Marc Lamber of Lamber Goodnow. The record is visible to all, although individual elements of the transactions are not publicly visible because they are encrypted. Here, the division of private and public on a blockchain are particularly interesting.
For instance, your identity information or document such as a passport might be securely encrypted, but the proof of validation may be publicly used on a blockchain for proving that it is you for the purposes of that transaction without the need to reveal any underlying private data.
However, blockchains could raise challenges in situations where financial institutions are obligated to comply with some privacy laws.
Some financial organizations are required to remove data permanently by law when required by a court. This may pose a challenge for existing blockchain technologies since by their nature, blockchains do not allow for the deletion of data, but rather only the updating in subsequent blocks, which may not be enough to ensure compliance with the law.
The ownership of information that a blockchain secures is also up for debate.
A bill in Arizona that’s currently pending approval states that a person that uses blockchain for securing information actually owns the information. Other lawmakers are attempting to block what can and cannot be tracked, which included another bill in Arizona that would largely prohibit using blockchain technology for tracking firearms.
Legal Consequences of Blockchain Records
Thanks, in part, to the stringent encryption techniques that they use, blockchains will have more legal bearing in court. A bill recently passed in Vermont would make records verified using blockchain technology admissible as evidence in court.
Laws such as this help create a legal backing of sorts for blockchain-based information.
A bill in Nevada has deemed blockchain signatures and smart contracts as acceptable records under state law.
As blockchain systems and ledgers become increasingly common, their potential use in cases as discovery and evidence are more likely. It means that lawyers will have to know of the existence of such records along with how to handle such evidence in addition to what specific information to request.