How does the law keep up with the cryptocurrency revolution?
Cryptocurrencies are set to disrupt and revolutionise the way transactions are done, and there is nothing stopping its rise.
All cryptocurrencies operate on the blockchain, which is a distributed ledger. A distributed ledger is a database held and updated independently by each participant (or node) in a large network. Anyone can download this public ledger to see how much everyone else has in their accounts. However, each account holder’s name is obscured by a 32-bit encryption so consequently, one can only see how much the address holds, but not know who that person is. For a transaction to be approved on the ledger, each node on the network will come to their own conclusions and vote on their respective conclusions to update the ledger accordingly.
To put the distributed ledger into perspective, let us first visit what a “centralised ledger” is. A centralised ledger is a list of transactions and accounts held by a single entity, such as a bank. In banks case, the bank has full control over which transactions are posted on the ledger. This means they can freely transfer your money without your consent, freeze your assets at will, and if the central authority gets hacked or attacked, transactions can no longer be processed. The centralised model operates on a model of trust, with a third-party maintaining the ledger. With the onset of computers and digital networks, the efficiency of recording and transacting increases, but makes maintaining integrity more problematic; so, who watches the watchers (CSIRO)? Imagine a “trustless” banking system where the transactional decisions are made democratically.
This is blockchain; a decentralised ledger.
So why are decentralised ledgers so powerful? First, security. Should a hacker get into the main server of a centralised ledger, they are able to steal all the information that held by the ledger, whether it be in writing or code. In decentralised ledgers, you may be able to hack into one person’s account but you cannot touch other people’s ledgers.
Second, distributed ledgers are much more efficient at verifying transactions, compared to a bank transaction. On average, a bank transfer may take you two business days. Sending thirty ether tokens (approximately $US10,000) to an address, can be received in under thirty minutes on average. Smart contracts are legal document translated into code, with a computer verifying it. It is an automated process. Looking beyond the banking vertical, the blockchain technology is particularly relevant to the legal industry. More frequent than we would want, words in legal documents are intentionally ambiguous. The concept of a smart contract is very useful for legal documents that are repeatedly used, automating an otherwise manual process and allowing the contract to be executed far more efficiently.
The interest in cryptocurrencies and its use cases has positively exploded this year. Since the beginning of the year, Etherium, the 2nd largest cryptocurrencies by market capitalisation, saw a meteoric rise of over 5,000% at its peak going from $USD8 on January 1st to $USD407 in June. It now sits at approximately $USD300.
The technology has made it possible to perform international transactions with incredibly high speeds and low transactional costs; however, it imposes a series of regulation related challenges since the system is not governed by a central agency, but rather, operated by its millions of users. How can one regulate a self-managed system that emits units of value independently while acting as both a means of payment and a means of custody (Silva)?
Historically, legal framework for regulation of new technology has always been a laggard compared to the development of technology. The work of UNCITRAL has been the only source of international law to date when attempting to resolve legal issues arising from the use of blockchain technology. These include the Model Law on Electronic Commerce (1996), and the Model Law on Secured Transactions (2016). At present, the legal status of bitcoins varies substantially from country to country, and is still undefined in many.
To unpack the Electronic Commerce Model Law further, the admissibility of information stored in the form of a data message on the blockchain shall not be denied legal effect or validity (See Articles 5 and 9). Article 12 of Model Law extend the principle of legal intent, providing that the performance of a contract by an automated system may not be denied effect because no person intervened in the individual actions carried out by the automated system. This gives clarity around the concept and enforceability of smart contracts.
The second question examined by the Secured Transactions Model Law, is whether cryptocurrencies are deemed to have the same benefits as “money,” which is defined as a currency authorised as a legal tender by the State (Article 2(t)). A cryptocurrency has the potential to be recognised as a currency, but for the fact it is not a tangible asset, a key characteristic of money under the Model Law (Article 2 (II)). This means that the cryptocurrency may be encumbered by a blanket security right covering all the granter’s movable assets so any subsequent transferee of the crypto-asset will take the bitcoins subject to the bank’s security interest (Article 9(2)). Transferees of money however, take free of a pre-existing security interest (Article 48). A similar outcome is found in Article 9 of the U.S. Uniform Commercial Code. Frederic Megret describes in The Cambridge Companion to International Law, that international law’s weak decentralised features make it less of a legal system. Applying this to the crypto-debate, international law merely serves as a “model”, since it is ultimately up to the enacting State to devise special rules for cryptocurrency units.
In Australia, cryptocurrencies recently received status as a currency on 1 July 2017, allowing digital currencies to be treated just like money for GST purposes, which eliminates double taxation (Federal Budget). The SEC in the USA takes a tougher stance towards cryptocurrencies, publishing a report in July 2017 that raising money through the sale of digital assets needs to comply with Section 5 of the Securities Act, and to register their offerings accordingly. The European Banking Authority takes a similar stance in explaining that Bitcoin should be categorized as a commodity. However, there is still no clear indication on whether a token is a security, with each token needing to be analysed on a case-by-case basis under the Howey Test.
Academics have put forth that self-regulation may be the most practical way to regulate cryptocurrencies in absence of the State manifesting any regulations, which has been the main way cryptocurrency has been approached internationally to date. To garner credibility, the participants themselves issues rules to regulate the activity and create uniform standards. Those who do not abide by these norms are not well regarded in the community. Martti Koskenniemi (writing in the same publication), notes that, “International law does not contain a readymade blueprint for a better world,” instead suggesting that it contains a “[bundle] of positions, principles and precedent that may be employed to express contrasting interests or values in a relatively organised way”.
This is the exact position cryptocurrencie are in; with countries and states attempting to use the limited source international law to shape their regulatory approach to this novel, yet game-changing technology.
The above piece is extracted from a research paper I wrote for the UNSW Law School.
