Blockchain: A Short Primer for Lawyers

Bitcoin is a leading type of digital or virtual currency that is exchanged by means of a decentralized online network. See, U.S. Securities & Exchange Commission, “Self-Regulatory Organizations: NYSE Arca, Inc.; Notice of Filing of Proposed Rule Change Relating to the Listing and Trading Shares of the Bitcoin Investment Trust under NYSE Arca Equities Rule 8.201,” Release No. 34-79955; File No. SR-NYSEArca-2017-06, 82 Fed. Reg. 10,086, 10,087 (Feb. 3. 2017).

Virtual currency itself is not a new concept, but has been a medium of economic exchange within online video games and virtual worlds for years. See, e.g., Jennifer S. Bisk, “Case Summary of Bragg v. Linden Research, Inc., Eastern District of Pennsylvania: Denying a Motion to Dismiss for Lack of Personal Jurisdiction and a Motion to Compel Arbitration,” in American Bar Association, Section of Intellectual Property Law, Division VII – Information Technology, Final Report 89 (Aug. 5, 2008) (subsection presented by Comm. 758 – Special Comm. on Computer Gaming) [hereinafter, “ABA Computer Gaming”] (discussing legal challenges around Linden's 2003 confiscation of virtual property purchased within Second Life); Second Life, Marketplace, (providing virtual items for sale in exchange for Linden Dollars, $L).

Over time, virtual currencies used within the economies of the virtual games or worlds began to be exchanged for United States dollars and other real-world, or fiat, currencies. See, e.g., Greg Lastowka, “Virtual Worlds: The New Laws of Online Worlds,” 120-21 (2010); Jon M. Garon, “Second Life's Prohibition of Unlicensed Banking and Securities Transactions,” in ABA Computer Gaming, supra, at 70-71. A fiat currency is the legal tender that a central authority designates and issues as the medium of economic exchange for goods and services. People accept and employ fiat currency because regulatory systems support its durability and stability and because they trust the governing central authority. See, Sarah Rotman, World Bank, Consultative Group to Assist the Poor, “Bitcoin Versus Electronic Money,” 1, CGAP Brief No. 88164 (Jan. 2014).

The evolution of cryptocurrency leapt completely beyond the confines of virtual games and worlds with the 2009 advent of Bitcoin (Ticker: BTC; Symbol: Ƀ). Bitcoin became the world's first successful cryptocurrency and now a current market cap of US$16.3 billion with one Bitcoin now selling for more than US$1000 (as of Feb. 24, 2017).

Examples of other types of cryptocurrencies include Litecoin (LTC), Ripple (XRP), and the recently-launched ZeroVert (ZER), and include and have included many others. See, e.g., BitCoin Forum, “List of All Cryptocoins,” (updated Jan. 1, 2013).

Bitcoin and other cryptocurrencies now participate in exchanges with fiat currencies and are used widely as a medium of economic exchange from goods and services ranging from beer to funeral services to houses. See, CoinsBank, “The Leading Platform for Professional Cryptocurrency Traders”; see, e.g., CNET, “25 Things You Didn't Know You Could Buy with Bitcoins”; Lester Coleman, “Man Buys California Home with Bitcoin, Makes $1M Profit,” Cryptocoins News (Jan. 30, 2017). Cryptocurrencies play a particularly important role in developing economies that lack well-established and -distributed banking systems. See, e.g., Cade Metz, “Why Bitcoin Will Thrive First in the Developing World,” Wired (Feb. 2, 2016).

By early 2015, the number of Bitcoin-accepting merchants worldwide surpassed 100,000. Arthur Cuthbertson, “Bitcoin Now Accepted by 100,000 Merchants Worldwide,” International Business Times (Feb. 4, 2015). Bitcoin's merchant adoption rate has ascended logarithmically. For example, in Japan alone, the number of Bitcoin-accepting merchants is expected to quintuple to 20,000 this year in the beginning run-up to the 2020 Summer Olympic Games. Samburaj Das, “Japan Could See 20,000 Bitcoin Accepting Merchants in 2017,” CryptoCoins News (Jan. 31, 2017).

Where the Magic Happens

Recall that cryptocurrency exchanges occur through an online network. The decentralized network operates without a bank or other trusted centralized payment authority in processing cryptocurrency exchanges. This means that exchanges operate across national borders with ease and without the need for currency conversions and sizable associated fees. Consequently, cryptocurrency transactions may be more quickly and cost-efficiently completed than fiat currency transactions. For example, one cryptocurrency payment processor charges merchants a 1% settlement charge for handling Bitcoin transactions, comparing that with the up to 3% rates charged by credit card companies. See, “Why Accept Bitcoin?” Bitpay.

Cryptocurrency transactions occur without the participation of a bank or other trusted central authority, that is, in a so-called “trust-less” environment. For this reason and to varying and often significant degrees, cryptocurrency transactions also may create barriers to the effective control of banking regulators and law enforcement authorities. See, Angela Walch, “The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk,” 18 New York University Journal of Legislation and Public Policy 837 (2015); see, e.g., U.S. Securities and Exchange Commission (SEC), SEC Charges Bitcoin Mining Companies (Dec. 1, 2015); Andy Greenberg, “Follow the Bitcoins: How We Got Busted Buying Drugs on Silk Road's Black Market,” Forbes (Sept. 5, 2013).

As with fiat currencies and centralized banking systems, cryptocurrencies would have no value without a system for validating those transactions so that they may be processed and the funds transferred between buyers and sellers. Blockchain is the technological and mathematical means by which such systems are configured and participants operate within those systems and by which transactional trust is achieved.

A blockchain network is made up of numerous P2P, i.e., non-hierarchical, computing resources called “nodes.” The work of the nodes is to execute open source digital protocols that employ cryptographic security and certain other computational methods. The purpose of these protocols is to validate cryptocurrency transactions presented to the nodes. The node operators are called “miners” because, once they carry out the protocols and validate a transaction, assuming that another miner has not bested them in first achieving that validation, the miner earn or “mine” cryptocurrency for that work.

The usage of the word “blockchain” was expanded since it was introduced in the seminal Nakamoto whitepaper, infra. “Blockchain” may serve to collectively label the protocols used by nodes to analyze and seek to validate blocks of data about individual transactions in sequence, that is, in a chain. Some use “blockchain” to refer more generally and collectively to the network, systems, or platforms within, upon, and around which nodes are organized and miners execute the given security and computational protocols.

For a good and more detailed review of Bitcoin and blockchain, see Shahla Hazratiff, “Bitcoin: The Trade of Digital Signatures,” 41 Thurgood Marshall Law Review 55 (2016).

To the Big Beyond

Bitcoin and cryptocurrency transactions are the first, but only one set of applications for blockchain technology and systems. Because much has been written about blockchain within the Bitcoin context, it is helpful to study existing materials and, with that understanding well-ensconced, move on and extrapolate to other use cases. Toward that end, the SEC recently published a useful and accessible overview of the Bitcoin network and blockchain, Bitcoin transactions, and the Bitcoin industry and market in the Federal Register. See, U.S. Securities & Exchange Commission, supra note 1, at 10,087-90. Paul Brody of Ernst & Young also publishes a terrific slide presentation with an embedded YouTube video. See, “BitCoin Basics: Doing Ordinary Things in Amazing Ways” (Dec. 2015).

The tremendous demand from consumers and businesses for cryptocurrency-enabled transactions also drives the heavy development and business investments by many of the world's largest companies and financial institutions around blockchain and related technologies. See, e.g., Joseph Young, “Most Airbnb Users Want Bitcoin Payment Integration in 2017, Asked by CEO Chesky,” Cointelegraph (Dec. 27, 2016).

Those blockchain investments include the financial technology, or shortly-named “fintech,” industry: healthcare, automotive, and numerous other industries rapidly harnessing and leveraging machine-to-machine communication systems collectively known as the Internet of Things (IoT); and a host of other industries. See, e.g., Reuters, “Nine of the World's Biggest Banks Form Blockchain Partnership” (Sept. 15, 2015); Paul Brody, et al., IBM Corporation, IBM Institute for Business Value, “Device Democracy: Solid 2015,” 13-14, 17, 19-23, 28-33 (2015) (regarding an IoT research project involving IBM's ADEPT platform); Samburaj Das, “Microsoft, KPMG Co-Launch Blockchain 'Nodes' (Labs) in Frankfurt and Singapore,” CryptoCoins News (Feb. 15, 2017).

For a comprehensive survey of blockchain applications and possible futures from a technical (but not overly so) perspective, an article by Hong-Ning Dai, of Macau University of Science and Technology, and colleagues is stellar. See, “Blockchain Challenges and Opportunities: A Survey,” International Journal of Web and Grid Services (Jan. 2017); see also, e.g., Jeanne L. Schroeder, “Bitcoin and the Uniform Commercial Code,” 24 University of Miami Business Law Review 1 (2016); Tom W. Bell, “Copyright, Privacy, and the Blockchain,” 42 Ohio Northern University Law Review 439 (2016); Sue Troy, “What is a Smart Contract and What's It Good For?” SearchCIO (Apr. 27, 2016).

Science, Technology, Engineering, and Mathematics as Trust

Given the absence of a “trusted” central authority, cryptocurrency transactions might otherwise never have occurred. Enter science, technology, engineering and mathematics and those mighty STEM wielders to save the day and, certainly, to spur significant future innovations. Through their brilliant work, STEM professionals imbue cryptocurrency transactions and other blockchain applications with trust, that fundamental rocket fuel to the future. Although this article does not elaborate the private-public key encryption methods used in blockchain technology, the proof-of-work and other analytical methods for validating cryptocurrency transactions, and other of these trust-producing STEM superpowers, investments in additional learning will reward the reader richly. All hail, STEM!

The seminal blockchain whitepaper and an inspiringly elegant piece of work is “Bitcoin: A Peer-to-Peer Electronic Cash System” (2008), pseudonymously published by Satoshi Nakamoto, the person or persons who invented Bitcoin. To drill down on blockchain hardware and other technology and miner operations, see, “Bitcoin and the Age of Bespoke Silicon” (Sept. 2013) by Michael Bedford Taylor, then of the University of California at San Diego, published in the Proceedings of the 2013 International Conference on Compilers, Architectures and Synthesis for Embedded Systems.

For a legal perspective, see, Catherine Martin Christopher, “The Bridging Model: Exploring the Roles of Trust and Enforcement in Banking, Bitcoin, and the Blockchain,” 17 Nevada Law Journal 139 (2016).

Conclusion

This article reviewed cryptocurrency transactions as the first significant commercial application of blockchain technology and has provided the reader with a fundamental overview of blockchain and its current and expanding applications across numerous industries. It has set out a few and valuable guideposts for the reader's further exploration as to blockchain's futures and the stunning scientific, technological, engineering, and mathematical achievements and ongoing work that make blockchain the powerfully disruptive force that it is and will be.

*****
Emile Loza de Siles is chief technology counsel of Technology & Cybersecurity Law Group, PLLC, which she founded in 2003. A member of the Board of Editors of Cybersecurity Law & Strategy, Ms. Loza de Siles practice emphasizes technology and cybersecurity transactions, due diligence, compliance, litigation, and corporate counsel services. She can be reached at [email protected].

To subscribe to Cybersecurity Law & Strategy, click here. Introductory rates are available for new subscribers. Call 877-807-8076 for more information.

Bitcoin and other cryptocurrency transactions depend upon the transactional trust enabled by blockchain, a distributed system using open source digital protocols with cryptographic security, and the operation of a distributed shared ledger within which chains of blocks of data from individual transactions are analyzed, or “mined,” for validity. Uses of the term “blockchain” range to include and reach beyond its technical reference to these chains of data blocks. Collectively, blockchain is the technology that enables peer-to-peer (P2P) payment to occur between individuals or companies without the involvement of a bank or other trusted intermediary. The use of blockchain and blockchain-leveraging systems is fueling these P2P financial exchanges and is beginning to enable so-called “smart contracts” and a host of other transactions, innovations, and industries well beyond the financial sector.

This article familiarizes lawyers with cryptocurrency and, particularly, the enabling blockchain technology, methodologies and systems. It also introduces lawyers to blockchain's current and future uses and points to other resources to learn more about this profoundly disruptive and promising collection of technological advancements.

A Bit About Bitcoin (and Other Cryptocurrencies)

Bitcoin is a leading type of digital or virtual currency that is exchanged by means of a decentralized online network. See, U.S. Securities & Exchange Commission, “Self-Regulatory Organizations: NYSE Arca, Inc.; Notice of Filing of Proposed Rule Change Relating to the Listing and Trading Shares of the Bitcoin Investment Trust under NYSE Arca Equities Rule 8.201,” Release No. 34-79955; File No. SR-NYSEArca-2017-06, 82 Fed. Reg. 10,086, 10,087 (Feb. 3. 2017).

Virtual currency itself is not a new concept, but has been a medium of economic exchange within online video games and virtual worlds for years. See, e.g., Jennifer S. Bisk, “Case Summary of Bragg v. Linden Research, Inc., Eastern District of Pennsylvania: Denying a Motion to Dismiss for Lack of Personal Jurisdiction and a Motion to Compel Arbitration,” in American Bar Association, Section of Intellectual Property Law, Division VII – Information Technology, Final Report 89 (Aug. 5, 2008) (subsection presented by Comm. 758 – Special Comm. on Computer Gaming) [hereinafter, “ABA Computer Gaming”] (discussing legal challenges around Linden's 2003 confiscation of virtual property purchased within Second Life); Second Life, Marketplace, (providing virtual items for sale in exchange for Linden Dollars, $L).

Over time, virtual currencies used within the economies of the virtual games or worlds began to be exchanged for United States dollars and other real-world, or fiat, currencies. See, e.g., Greg Lastowka, “Virtual Worlds: The New Laws of Online Worlds,” 120-21 (2010); Jon M. Garon, “Second Life's Prohibition of Unlicensed Banking and Securities Transactions,” in ABA Computer Gaming, supra, at 70-71. A fiat currency is the legal tender that a central authority designates and issues as the medium of economic exchange for goods and services. People accept and employ fiat currency because regulatory systems support its durability and stability and because they trust the governing central authority. See, Sarah Rotman, World Bank, Consultative Group to Assist the Poor, “Bitcoin Versus Electronic Money,” 1, CGAP Brief No. 88164 (Jan. 2014).

The evolution of cryptocurrency leapt completely beyond the confines of virtual games and worlds with the 2009 advent of Bitcoin (Ticker: BTC; Symbol: Ƀ). Bitcoin became the world's first successful cryptocurrency and now a current market cap of US$16.3 billion with one Bitcoin now selling for more than US$1000 (as of Feb. 24, 2017).

Examples of other types of cryptocurrencies include Litecoin (LTC), Ripple (XRP), and the recently-launched ZeroVert (ZER), and include and have included many others. See, e.g., BitCoin Forum, “List of All Cryptocoins,” (updated Jan. 1, 2013).

Bitcoin and other cryptocurrencies now participate in exchanges with fiat currencies and are used widely as a medium of economic exchange from goods and services ranging from beer to funeral services to houses. See, CoinsBank, “The Leading Platform for Professional Cryptocurrency Traders”; see, e.g., CNET, “25 Things You Didn't Know You Could Buy with Bitcoins”; Lester Coleman, “Man Buys California Home with Bitcoin, Makes $1M Profit,” Cryptocoins News (Jan. 30, 2017). Cryptocurrencies play a particularly important role in developing economies that lack well-established and -distributed banking systems. See, e.g., Cade Metz, “Why Bitcoin Will Thrive First in the Developing World,” Wired (Feb. 2, 2016).

By early 2015, the number of Bitcoin-accepting merchants worldwide surpassed 100,000. Arthur Cuthbertson, “Bitcoin Now Accepted by 100,000 Merchants Worldwide,” International Business Times (Feb. 4, 2015). Bitcoin's merchant adoption rate has ascended logarithmically. For example, in Japan alone, the number of Bitcoin-accepting merchants is expected to quintuple to 20,000 this year in the beginning run-up to the 2020 Summer Olympic Games. Samburaj Das, “Japan Could See 20,000 Bitcoin Accepting Merchants in 2017,” CryptoCoins News (Jan. 31, 2017).

Where the Magic Happens

Recall that cryptocurrency exchanges occur through an online network. The decentralized network operates without a bank or other trusted centralized payment authority in processing cryptocurrency exchanges. This means that exchanges operate across national borders with ease and without the need for currency conversions and sizable associated fees. Consequently, cryptocurrency transactions may be more quickly and cost-efficiently completed than fiat currency transactions. For example, one cryptocurrency payment processor charges merchants a 1% settlement charge for handling Bitcoin transactions, comparing that with the up to 3% rates charged by credit card companies. See, “Why Accept Bitcoin?” Bitpay.

Cryptocurrency transactions occur without the participation of a bank or other trusted central authority, that is, in a so-called “trust-less” environment. For this reason and to varying and often significant degrees, cryptocurrency transactions also may create barriers to the effective control of banking regulators and law enforcement authorities. See, Angela Walch, “The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk,” 18 New York University Journal of Legislation and Public Policy 837 (2015); see, e.g., U.S. Securities and Exchange Commission (SEC), SEC Charges Bitcoin Mining Companies (Dec. 1, 2015); Andy Greenberg, “Follow the Bitcoins: How We Got Busted Buying Drugs on Silk Road's Black Market,” Forbes (Sept. 5, 2013).

As with fiat currencies and centralized banking systems, cryptocurrencies would have no value without a system for validating those transactions so that they may be processed and the funds transferred between buyers and sellers. Blockchain is the technological and mathematical means by which such systems are configured and participants operate within those systems and by which transactional trust is achieved.

A blockchain network is made up of numerous P2P, i.e., non-hierarchical, computing resources called “nodes.” The work of the nodes is to execute open source digital protocols that employ cryptographic security and certain other computational methods. The purpose of these protocols is to validate cryptocurrency transactions presented to the nodes. The node operators are called “miners” because, once they carry out the protocols and validate a transaction, assuming that another miner has not bested them in first achieving that validation, the miner earn or “mine” cryptocurrency for that work.

The usage of the word “blockchain” was expanded since it was introduced in the seminal Nakamoto whitepaper, infra. “Blockchain” may serve to collectively label the protocols used by nodes to analyze and seek to validate blocks of data about individual transactions in sequence, that is, in a chain. Some use “blockchain” to refer more generally and collectively to the network, systems, or platforms within, upon, and around which nodes are organized and miners execute the given security and computational protocols.

For a good and more detailed review of Bitcoin and blockchain, see Shahla Hazratiff, “Bitcoin: The Trade of Digital Signatures,” 41 Thurgood Marshall Law Review 55 (2016).

To the Big Beyond

Bitcoin and cryptocurrency transactions are the first, but only one set of applications for blockchain technology and systems. Because much has been written about blockchain within the Bitcoin context, it is helpful to study existing materials and, with that understanding well-ensconced, move on and extrapolate to other use cases. Toward that end, the SEC recently published a useful and accessible overview of the Bitcoin network and blockchain, Bitcoin transactions, and the Bitcoin industry and market in the Federal Register. See, U.S. Securities & Exchange Commission, supra note 1, at 10,087-90. Paul Brody of Ernst & Young also publishes a terrific slide presentation with an embedded YouTube video. See, “BitCoin Basics: Doing Ordinary Things in Amazing Ways” (Dec. 2015).

The tremendous demand from consumers and businesses for cryptocurrency-enabled transactions also drives the heavy development and business investments by many of the world's largest companies and financial institutions around blockchain and related technologies. See, e.g., Joseph Young, “Most Airbnb Users Want Bitcoin Payment Integration in 2017, Asked by CEO Chesky,” Cointelegraph (Dec. 27, 2016).

Those blockchain investments include the financial technology, or shortly-named “fintech,” industry: healthcare, automotive, and numerous other industries rapidly harnessing and leveraging machine-to-machine communication systems collectively known as the Internet of Things (IoT); and a host of other industries. See, e.g., Reuters, “Nine of the World's Biggest Banks Form Blockchain Partnership” (Sept. 15, 2015); Paul Brody, et al., IBM Corporation, IBM Institute for Business Value, “Device Democracy: Solid 2015,” 13-14, 17, 19-23, 28-33 (2015) (regarding an IoT research project involving IBM's ADEPT platform); Samburaj Das, “Microsoft, KPMG Co-Launch Blockchain 'Nodes' (Labs) in Frankfurt and Singapore,” CryptoCoins News (Feb. 15, 2017).

For a comprehensive survey of blockchain applications and possible futures from a technical (but not overly so) perspective, an article by Hong-Ning Dai, of Macau University of Science and Technology, and colleagues is stellar. See, “Blockchain Challenges and Opportunities: A Survey,” International Journal of Web and Grid Services (Jan. 2017); see also, e.g., Jeanne L. Schroeder, “Bitcoin and the Uniform Commercial Code,” 24 University of Miami Business Law Review 1 (2016); Tom W. Bell, “Copyright, Privacy, and the Blockchain,” 42 Ohio Northern University Law Review 439 (2016); Sue Troy, “What is a Smart Contract and What's It Good For?” SearchCIO (Apr. 27, 2016).

Science, Technology, Engineering, and Mathematics as Trust

Given the absence of a “trusted” central authority, cryptocurrency transactions might otherwise never have occurred. Enter science, technology, engineering and mathematics and those mighty STEM wielders to save the day and, certainly, to spur significant future innovations. Through their brilliant work, STEM professionals imbue cryptocurrency transactions and other blockchain applications with trust, that fundamental rocket fuel to the future. Although this article does not elaborate the private-public key encryption methods used in blockchain technology, the proof-of-work and other analytical methods for validating cryptocurrency transactions, and other of these trust-producing STEM superpowers, investments in additional learning will reward the reader richly. All hail, STEM!

The seminal blockchain whitepaper and an inspiringly elegant piece of work is “Bitcoin: A Peer-to-Peer Electronic Cash System” (2008), pseudonymously published by Satoshi Nakamoto, the person or persons who invented Bitcoin. To drill down on blockchain hardware and other technology and miner operations, see, “Bitcoin and the Age of Bespoke Silicon” (Sept. 2013) by Michael Bedford Taylor, then of the University of California at San Diego, published in the Proceedings of the 2013 International Conference on Compilers, Architectures and Synthesis for Embedded Systems.

For a legal perspective, see, Catherine Martin Christopher, “The Bridging Model: Exploring the Roles of Trust and Enforcement in Banking, Bitcoin, and the Blockchain,” 17 Nevada Law Journal 139 (2016).

Conclusion

This article reviewed cryptocurrency transactions as the first significant commercial application of blockchain technology and has provided the reader with a fundamental overview of blockchain and its current and expanding applications across numerous industries. It has set out a few and valuable guideposts for the reader's further exploration as to blockchain's futures and the stunning scientific, technological, engineering, and mathematical achievements and ongoing work that make blockchain the powerfully disruptive force that it is and will be.

*****
Emile Loza de Siles is chief technology counsel of Technology & Cybersecurity Law Group, PLLC, which she founded in 2003. A member of the Board of Editors of Cybersecurity Law & Strategy, Ms. Loza de Siles practice emphasizes technology and cybersecurity transactions, due diligence, compliance, litigation, and corporate counsel services. She can be reached at [email protected].

To subscribe to Cybersecurity Law & Strategy, click here. Introductory rates are available for new subscribers. Call 877-807-8076 for more information.