Use of Blockchain in the Legal Sector
On 7 September 2020, London Tech Week 2020 was kicked off with the release of The Tech London Advocate's ('TLA') Blockchain Legal and Regulatory Group and Law Society Guidance. The report provides much needed guidance for legal practitioners regarding distributed ledger technology ('DLT') and clarification on the use of cryptoassets, role smart contracts and blockchain, amongst others. These areas starkly highlight the need for lawyers to evolve alongside technology advancements.
It seems the Law Commission is already responding, with the announcement on 21 September 2020 to commence reviews on smart contracts and digital assets. The law reform body aims to modernise our outdated legislation surrounding technology and move towards rapid digitisation of trade and transactions.
The President of the Law Society, Simon Davis, aptly points out that 'technology underpins innovation in legal services' and adopting new technologies could 'double productivity growth in the legal sector'. The coronavirus pandemic has motivated law firms to adapt and modernise their current technologies.
Anne Rose, the co-lead of the Blockchain group predicts 2020 as the 'breakthrough year' for DLT and hopes this guidance from legal and regulatory authorities can accelerate the adoption of blockchain applications in the legal sphere and reduce uncertainty.
Please see the full report on the Law Society's website, here. The key recommendations the report highlights are found in summary below.
What is DLT?
DLT refers to a broad umbrella of technologies that store, synchronise and keep digital records across a network. Distributed ledgers replicate and store data across computing centres (nodes), which aim to remove points of failure associated with a centralised ledger. This distribution of control and maintenance mitigates against the risk of attack. A well-known example of DLT is blockchain, which bundle digital records into data containers otherwise known as blocks. The blocks are appended in a chronological chain.
It's clear that blockchain is not the solution for everyone, with many critics describing blockchains as 'a solution looking for a problem'. However, in some specific cases, a private blockchain may be useful because the technology makes it hard to edit data once it has been recorded on the blockchain; and, by virtue of the use of digital signatures, helps to bring together disparate parties for better coordination and sharing of data.
In other cases however, having a trusted central authority as the golden source of data can be the best option - for example, the HM Land Registry holds all land and property ownership data. The report neatly puts it as, 'sometimes centralised is better than decentralised'.
Smart Contracts and Data Governance
In a nutshell, smart contract technology permits any written legal contract to be digitised into self-executing code. Each transaction and contract will have unique requirements and objectives. Smart Legal Contracts ('SLC's') are argued to allow for increased accuracy and the transparency of contractual terms, together with a traceable audit trail and less scope for misinterpretation or competing interpretations. However, over-automation can remove discretion and flexibility to provisions and thus expose parties to unintended risk. SLC's are also not yet suitable for highly complex, one-off transactions that are contingent on many external parties and factors.
The report highlighted that Legal counsel will need to play a vital role in the digitisation of contracts. Counsel will need to consider elements such as if digitisation can fully allow for implied terms and the application of principles that are derived from precedent. Breach of contract or frustration may arise due to inadequate digitisation scoping .
If contract law was not complex enough - Counsel will need to be aware of their exposure to liability when full consideration has not been given to the digitisation and transaction flow process.
A blockchain consortium is a collaborative system that is 'semi-private' with a controlled user group that works across a group of organisations to forward a common goal or purpose. Models include corporate joint ventures, contractual consortium agreements and participation agreements. Members of a consortium can benefit from resolving common issues relevant to the industry at hand, sharing development/deployment costs and obtaining access to innovative technology.
The report actively encourages lawyers to become involved early on in consortium discussions, as they can be complex to set up and operate successfully. The legal risks can range from contractual liability, intellectual property considerations, competition law issues and concerns around data protection.
Data Protection and Data Security Enhancing Measures
The report makes clear further guidance is needed from data protection authorities in relation to the risk-based approach in assessing whether or not information is personal data, as assumed by Recital 26 of the GDPR. In particular, how much data is stored, transferred and expressed on DLT and blockchain platforms.
It's important to note that at present, there is no legal certainty for developers who wish to handle keys in a GDPR compliant format. The report poses numerous questions for the Information Commissioner's Office ('ICO') to address, such as if the use of blockchain will automatically trigger an obligation to carry out a data protection impact assessment.
It's clear that uncertainty is rife here – changes in technology can increase tension between blockchain and the GDPR, yet at the same time, support GDPR.
Legal practitioners should be aware that we are moving away from the generation of sharing vast quantities of data with third parties in exchange for utility. There is an trend of trying to increase data privacy by sharing less, while enabling increasing utility from privately held data. Zero Knowledge Proof's ('ZKPs') and other Privacy Enhancing Technologies ('PETs') are discussed in detail as useful tools to keep encrypted data private. ZKP's are cryptographic outputs that can be shared by one party to prove to another that they are in possession of certain data, without revealing anything important about the data.
The application of DLT has the potential to revolutionise the recording, protection and management of Intellectual Property Rights ('IPRs'). For example, smart contracts, automation and tokenisation (sensitive data that is replaces with non-sensitive placeholders called tokens) could alter how royalties and licensing deals are done. However, lawyers must be aware of the negative implications of DLT here, such as:
- The permanency of DLT – copyright infringement;
- Current notice and takedown requirements for file sharing platforms;
- The potential for IPR registry applications for trademarks linked to DLT, to attract database rights themselves; and
- The potential for the smart contract application to attract IPRs.
Although the reliability, transparency and automation capabilities of DLT make it an ideal technology for digital file management, sharing and transfer, practitioners should consider the existing legal framework protecting digital copyright, given the potential for rights holders and infringers alike to enable access to original works via DLT.
The report concludes that the above mentioned tensions can be effectively managed by practitioners and that DLT can fit within the existing (European) Intellectual Property framework.
Blockchain and Tax
Although the report warns of the large scope for disruption regarding the relationship between DLT and tax, it also paints a positive picture of a digitalised and fair tax system.
Blockchain technology is able to provide real-time, reliable information to taxpayers and the tax authorities alike, through a streamlined system. A distributed ledger could be priceless to tax authorities, in that there should be no difference between the amount tax and the amount collected. The ledger allows the secure and transparent trading of anything of value, which can result in a efficient tax collection system where there is more trust between the payer and the authorities.
These core characteristics of DLT and blockchain technology also mean that transactions such as in-house tax function and taxation of cryptoassets and blockchain may be revolutionised. However, amongst many other issues - HMRC does not consider cryptoassets to be a form of money or currency, yet other jurisdictions treat cryptoassets differently.
Regulation of Cryptoassets
Unsurprisingly, UK legislative and regulatory framework governing financial markets has not been developed to consider cryptoassets. The report recommends assessments into the Market Abuse Regulations, amongst others, to scope out gaps that do not sufficiently protect parties against risks posed by cryptoassets. Similarly, assessing adjustments that can be adopted to facilitate the use of DLT and cryptoassets going forward was suggested in collaboration with the FCA.
The traditional legal landscape that we are used to is drastically changing. China has now dealt with 10,000 internet-related disputes in an 'internet court' based in Hangzhou, ranging from defamation cases to domain name disputes. Perhaps other countries will quickly follow suit?
In the UK, DLT is already used to assist litigation during disclosure and the use of digital signatures (especially during COVID-19). However, it appears lawyers may need to heavily rely on developers/programmers to read codes that are within SLC's. In addition, computers do not have the same support system with reading 'natural language' – thus creating a 'language impasse' and likely leading to more disputes. There is potential for law firms to follow suit of investment banks and employ a support system of developers to work alongside.
Although the UK Jurisdiction Taskforce is working hard to produce further guidance, it's clear there is a need for the development of on-chain dispute resolution mechanisms. The report considers that a platform must be created to facilitate the understanding of coded dispute-relevant data, whilst being aware which scenarios require human input, over a DLT solution.
What is a Decentralised Autonomous Organisation ('DAO')?
A DAO is an extension of the idea that human error, fraud or inaction is completely removed. Cryptocurrencies, smart contracts and DAOs have all emerged from an ideology that seeks to replace human involvement with the automaticity and immutability of distributed ledger technology. A DAO is an organisational structure which is automated by code in its governance and commercial activities.
Imagine a world where a DAO invests in proposals that are themselves smart contracts, as the investment process, performance and return is now totally governed and enforced by code. However, the report describes the autonomous aspect of any DAO is 'pretty slippery' and in fact an 'over-simplification of the reality'. For example, the DAO could not invest in areas that require negotiation of complex financial contracts or an inspection of physical goods. Similarly, the dealing with high-street banks, rather than cryptocurrencies is also out of the scope of a DAO.
The question therefore remains – can the DAO be a company? Or can the DAO act as an entity 'outside of a traditional corporate form'? The report illustrates that a company is a legal constructs and must meet the necessary legal requirements. Similarly, an unincorporated association requires the purpose to not be for profit and a limited liability partnership requires specific stepping stones to be followed (such as registering the partnership). It therefore appears that the DAO is somewhat a general partnership – with individual investors sharing a common view of profit.
The report insightfully notes that the common law should not, and cannot, create a new legal entity. However, as AI develops so will the interactions of DAO's – forcing these entities to be given some form of legal identity in the not so distant future. Legal practitioners and legislators should be aware of this potentially revolutionary concept, which will change the landscape as we know it.