1. What is Blockchain?
The simplest way to explain blockchain is that it is a decentralized technology for recording information including transactions, property rights, identities, money balances, etc.[1] Particularly, blockchain is a huge list of records containing information known as “blocks”, which are linked to each other by a code “hash” and secured using advanced means of cryptography. Blockchain represents a high-performance tool for maintaining integrity of information, specifically about any kind of transactions, providing a reliable degree of trust that information will be kept unaltered. Thanks to the distributed mechanism once the transaction is validated taking form of a “block” it automatically becomes available to all participants of the network and can not be altered or modified, otherwise all the participants to the network will notice that chain was hacked or altered.
- How does it work?
Blockchain is a particular type of so-called distributed ledger technology “DLT” which in fact is a mechanism of recording and sharing information across multiple ledgers.[2] Each of that ledgers have the exact same data records and are collectively maintained and controlled by a distributed network of computer servers. Blockchain uses specific mathematical algorithms to create and verify a continuously growing data recording in form of blocks. Once these blocks are added they can not be removed due to this fact all records take form of a chain of blocks.
A new addition to the chain (database) is initiated by one participant to the network, who creates a new “block” of data, containing all sorts of information. A new block is shared automatically to all participants in the network being in the same time encrypted and secured.[3] A specific feature of the blockchain is validation of the block by other participants to the network. They collectively determine the block’s validity in accordance with an algorithmic validation method, known as “consensus mechanism”.
Collective determination of block’s validity as well as high degree of security of such data recording in addition to full transparency of transaction records which can be easily checked across the network, makes blockchain an extremely advanced and useful tool for new generation of technology, including fintech, commerce etc.
- Key element – Consensus mechanism
There are many ways of structuring blockchain consensus mechanisms, but two of them which are best-known examples of consensus mechanisms are Proof of Work (PoW) mechanism and the Proof of Stake (PoS) mechanism.
3.1. Proof of Work – this mechanism is most commonly used in cryptocurrency industry. Participants to the network solve a sort of sophisticated mathematical calculations or algorithms in order to get permission to add a new block to the blockchain. Each new block is the result of these calculations and after every block calculation becomes more and more complicated, so Proof of Work mechanism requires more electricity for processing information which brings significant amount of expenses. This sort of sophisticated calculations is called “mining” due to such calculations are carried out, new coins are generated taking form of a digital reward. The cryptocurrency as Litecoin, Bitcoin Cash, Monero etc. are based on PoW mechanism
3.2. Proof of Stake – within this mechanism, a participant must prove ownership of a certain asset (in case of equity transactions) or an amount of coins (in case of cryptocurrency) in order to be allowed to participate in the validation process of transactions. For instance, when it comes to the cryptocurrencies, a validator of any transaction has to prove his “stake” (a certain amount) of all existing type of coins in order to be allowed participating in validating transactions. The chances to become a validator of future blocks are higher depending on the amount of stake (or coins) the participants own, if stake is larger, chances are higher to become validator, in a way the degree of reliability is more significant. The benefit is that the validator gets paid a transaction fee for his validation services by the transacting parties.[4]
- Types of Blockchain
There are three different types of blockchain:[5]
4.1. Public – is completely decentralized and uncontrolled, which means that nobody has control over the network, ensuring the data can’t be changed once validated on the blockchain.[6] Anyone can view the ledger and participate in the consensus process to determine which transaction blocks are added. Public blockchains are built to be accessible by anyone with access to the Internet.[7] Some well know examples of Public Blockchains would be Bitcoin and Ethereum.
4.2. Consortium – this network is not under private control or public, it is usually operated by a group of entities without having a decisive leader. The consensus process for new transaction blocks is controlled by a fixed set of members, such a platform provides many benefits as efficiency and transaction privacy. According to some experts this platform is optimal for organizational collaboration.[8]
4.3. Private – this network is controlled by one organization or person having very limited access permission. The private blockchain typically requires a trustful agent to reach the consensus even when using the same blockchain technology, for which it adopts consensus object different from the public blockchain.[9] The transaction speed of a privately run blockchain can be faster than other blockchain solutions because there are fewer nodes on the chain and trust levels are high.[10] This sort of blockchain is often used in database management.
- The Legal Side
5.1. Governing Law
By its decentralized and global scale nature blockchain rises a lot of jurisdictional questions, as the nodes on a blockchain can be located anywhere in the world. Due to this fact a every transaction could potentially fall under the jurisdiction of the location where the node in the network is located. This can generate a number of complex legal issues with a special focus on governing law, taking into account that every jurisdiction has own specific contract law principles and identification of appropriate legal regulations is quite important.
5.2. Liability
Most likely the issue of liability would be a top risk related to blockchain transactions especially when it comes to the security and confidentiality. Deriving from the nature of each type of blockchain certain risks could arise, as inability to control or stop functioning of public blockchain, or in event of breach, malfunctioning or misconduct of private blockchain. In that cases who is going to be liable for the risks occurred or who is responsible if laws are broken using blockchain?
5.3. The enforceability of smart contracts
Thanks to the blockchain technology a new sort of technical-legal tool has been created, so-called “smart contracts”. Smart contracts are blockchain based mechanisms which are automatically executed when specific circumstances or conditions coded into the smart contract are met. When conditions are fulfilled the execution of the smart contract happens automatically without being enforced by the third party. This creates a new level of development in contract law but at the same time brings new challenges due to its new and unregulated field. Smart contracts twists both legal and technology knowledge.
5.4. Data privacy
One of the most important advantages of the blockchain is the protection of data, once data is recorded in blocks it cannot be altered without other participants to the network knowing that one block was altered or hacked. So, blockchain technology has close ties with data privacy, particularly where the relevant data is personal data or metadata sufficient to reveal someone’s personal details as well as commercial secrets. In order to find solution to these risks there is a need to create a tool for privacy-protecting within blockchains. This might include other legal risks especially when it comes to carrying out the Know Your Customer proceedings etc. It remains to be seen how stakeholders involved into the industry will tackle the balance of privacy versus transparency.
5.5. Intellectual property
Protection of intellectual property rights is one of common question related legal issues referred to blockchain. Despite of various opinions blockchain offers new possibilities for intellectual property protection and registration and as evidence which can be used as probative material in court. Potential use cases include: evidence of creatorship and provenance authentication, registering and clearing intellectual property rights; controlling and tracking the distribution of unregistered or registered intellectual property rights.[11]
With regard to the above mentioned legal issues related to the blockchain technology we will refer in our next blogs.
References:
[1] https://medium.com/coinmonks/blockchain-for-beginners-what-is-blockchain-519db8c6677a
[2]http://www.europarl.europa.eu/cmsdata/150761/TAX3%20Study%20on%20cryptocurrencies%20and%20blockchain.pdf
[3] https://haavind.no/content/uploads/2018/03/Legal-sides-of-blockchain_Haavind.pdf
[4]http://www.europarl.europa.eu/cmsdata/150761/TAX3%20Study%20on%20cryptocurrencies%20and%20blockchain.pdf
[5] https://www.cbr.ru/Content/Document/File/32967/101-103_%D0%9D%D1%83%D1%80%D0%BC%D1%83%D1%85%D0%B0%D0%BC%D0%B5%D1%82%D0%BE%D0%B2.pdf
[6] https://hackernoon.com/public-vs-private-blockchain-4b4aa9326168
[7] Blockchain – The Legal Implications of Distributed Systems, The Law Society, http://www.lawsociety.org.uk
[8] https://www.blockchaindailynews.com/The-difference-between-a-Private-Public-Consortium-Blockchain_a24681.html
[9] https://medium.com/7sevencoin/types-of-blockchain-public-private-and-consortium-blockchain-e190604df820
[10] Blockchain – The Legal Implications of Distributed Systems, The Law Society, http://www.lawsociety.org.uk
[11] http://www.wipo.int/wipo_magazine/en/2018/01/article_0005.html
