Blockchain and the Law: an Exclusive Insight


MoFo helps us understand what lawyers need to know about the blockchain revolution

Blockchain tech is set to revolutionize so many aspects of business globally. Understanding it will be invaluable as you enter OCI season, so we turned to two experts – Dario de Martino at Morrison & Foerster and Josh Klayman formerly of Morrison & Foerster – to help us grasp blockchain’s big issues and its impact on your role as a lawyer.

Chambers Associate: How will Blockchain revolutionize the way we do business?

Joshua Ashley Klayman: Although blockchain technology is often referred to as being “disruptive,” I share Marco Iansiti and Karim R. Lakhani’s view that “[b]lockchain is a foundational technology: It has the potential to create new foundations for our economic and social systems.”

Adam Smith and other economists have emphasized that trust among parties is essential for economic growth. Without trust, for instance, specialization is impractical. Traditionally, one method of ensuring trust in transactions has been to include a “third party intermediary,” which is often paid for its services.  Sometimes, decreased time efficiency and increased cost may be trade-offs for enhanced trust.

With key features like decentralization, transparency, security and arguable immutability, blockchain establishes trust through technology, potentially revolutionizing – from the ground up – how we do business across industries.

Self-executing "smart contracts" – computer code using if/then logic to cause an event to occur automatically upon the happening of a specified triggering event – when paired with information stored on a blockchain, may help reduce certain manual errors and inefficiencies.

Digital token sales are revolutionizing the global capital markets.  Creating tokenized economies may unlock value and liquidity from previously illiquid assets. “Network effects” of token distribution may benefit businesses by building goodwill and brand recognition.  Many credit blockchain for promoting the growth of peer-to-peer transactions generally, the trust economy and the sharing economy.

Chambers: What industries or types of companies are taking advantage of Blockchain?

Josh: The list is long – and growing! In addition to technology-focused emerging companies, many well-established enterprises are exploring, implementing or investing in blockchain technology.

Numerous global financial institutions have formed internal blockchain “incubators,” joined consortia or are developing blockchain projects (including smart contracts). In addition to “proofs-of-concept,” new financial products, including bitcoin futures, have been launched, and regulated and unregulated cryptocurrency exchanges have proliferated. Recently, we have been representing a traditional investment bank that believes itself to be the first to market a security token sale.

‘Blockchain is being used for humanitarian efforts and to achieve social impact and sustainability goals.’

Many national and local governments are harnessing blockchain to improve records accuracy; promote voting transparency; record real estate title; and establish and verify personal identity.  Blockchain is being used for humanitarian efforts and to achieve social impact and sustainability goals. Notably, the UN used the Ethereum blockchain to deliver vouchers to Syrian refugees in Jordan.

Supply chain-focused industries (such as food and healthcare) are using blockchain technology to track in-transit temperatures of heat- and cold-sensitive items, to preserve efficacy of vaccines and pharmaceutical products, as well as to track food, potentially enhancing food safety and management of food recalls. The possibilities are virtually endless!

Chambers: What industries could take advantage of the technology in the future?

Josh: At its core, blockchain technology is a distributed ledger – a form of database, so, while not a cure-all, blockchain arguably may be implemented by any industry that needs to verify and track information.

A few industries that I believe increasingly will employ blockchain include: (i) communications and media, to verify news sources and combat "fake news"; (ii) the legal industry and law firms, including for dispute resolution and deal management; (iii) healthcare data management, including patient and clinical trials data and healthcare provider authorizations; (iv) energy; (v) real estate; (vi) music, art and other entertainment; and (vii) trade finance, a multi-trillion dollar industry that still relies heavily on manual confirmations.

Chambers: How will cryptocurrencies and Blockchain technology change the way people, businesses and governments operate?

Josh: We are in the early days of blockchain development and adoption, so the “how” is hard to predict.  In my view, interactions among individuals, businesses and governments will change significantly; in some ways, they already have. 

To me, the “why” is just as interesting.  Why are people so excited about a database?

I believe that a broader social movement is at play – a push toward decentralization, transparency and peer-to-peer interaction, as well as questioning existing business and social paradigms and hierarchies. In other words, it’s not just about the database.

Blockchain is a democratizer. It provides direct market access and information to would-be buyers and sellers. Some predict that nearly everything we own may become tokenized and tradeable, peer-to-peer.

There is a parallel push by individuals to reclaim and control the access, use and monetization of their personal identities and data, particularly after recent large-scale data breaches and greater understanding of how certain for-profit businesses collect, use and sell individuals’ personal data.

‘…many previously disenfranchised people may be able to participate meaningfully in the world’s financial system, in some cases for the first time.’

Ever-increasing globalization is bringing attention to the many unbanked and undocumented individuals worldwide, as well as those living in jurisdictions where the local currency is unstable or devalued. With blockchain-based proof of identity and the rise of digital tokens, many previously disenfranchised people may be able to participate meaningfully in the world’s financial system, in some cases for the first time. 

I believe that we are at a real inflection point, a time of reexamining how we relate to one another in business and at a human level. This cultural and technological shift presents an on-ramp, an opportunity for those traditionally underrepresented in commerce and technology to become involved – because this is new for all of us.

Chambers: What are the emerging regulatory issues with cryptocurrencies and Blockchain?

Josh: While some call the crypto space a lawless “Wild West,” digital tokens implicate myriad laws, making many transactions resemble law school issue-spotting exams.  In the US, tokens may be, among other things, securities, property, currency or commodities, depending on the regulator.  We enjoy helping our clients to navigate the changing regulatory landscape.

The global reach, and seemingly continuous evolution, of blockchain-based transactions means that regulators worldwide must grapple in “real time” with regulatory concerns – often reaching very different conclusions. For instance, some, but not all, jurisdictions have determined that many tokens are securities (or equivalent). Wyoming deems certain tokens a new asset class.

Existing regulations often fit imperfectly. Even if one embraces the view that tokens are securities if sold to US persons, and structures a token sale accordingly (whether pursuant to Regulation D, Regulation A+ or otherwise), the path forward is not simple, including for tokens with a consumptive use.

Other emerging issues include: federal pre-emption of state laws; conflicts of law/choice of law matters; privacy and data security (including GDPR) requirements; sanctions, “know your customer” and anti-money laundering concerns; investment company/investment advisor issues; federal and state securities (including broker dealer) laws; and tax and CFTC/commodities laws.

Chambers: Where are law firms currently utilizing opportunities to be involved in Blockchain, cryptocurrencies and Smart Contracts? What law firm practices are involved?  

Dario de Martino: To use Morrison & Foerster as an example, the firm is a tech powerhouse with a natural inclination to be at the forefront of emerging technologies like blockchain and cryptocurrencies. Virtually every practice group of the firm is working on a blockchain matter and is helping our clients understand, deploy and integrate this transformative technology to their best business advantage. We routinely represent the most influential market participants, including companies developing blockchain-based technologies, venture, hedge and private equity funds and their portfolio companies, cryptocurrency exchanges, financial institutions and global investment banks. Our interdisciplinary team connects our remarkably talented clients with legal pioneers from our capital markets, regulatory, private equity, FinTech, IP, privacy and litigation practice groups, and provides strategic guidance to help our clients thrive in this rapidly evolving ecosystem. Notably, our team includes former regulators, including lawyers who worked for the relevant regulatory agencies, including the SEC, FINRA, the CFTC, FinCEN, the FTC and the DoJ. 

'… since blockchain tokens are not a homogeneous asset class […] and affect markets that cross national borders, there is a significant amount of uncertainty and a critical need for legal experts to offer unequivocal advice.'

In addition to structuring token offerings (aka ICOs) and private equity investments or joint-ventures for companies developing blockchain-enabled technologies, we also assist a wide range of clients in creating and implementing strategies to support a host of commercial objectives. Interestingly, many of our “old economy” industrial company clients are finding plenty of uses for blockchain and enlisting our help in that regard. From supply chains to medical records, from digital rights to micropayments, from improving internet security to helping low income people access basic financial services, from reshaping the way electrical power is delivered to underdeveloped countries to the way people use social media, purchase tickets for live events or determine the accuracy of news, our blockchain group delivers experienced and practical counsel to execute on dynamic, cutting-edge, and high-velocity projects.

Chambers: What are the problems, unknowns, and risks that lawyers, businesses, and governments face in relation to Blockchain tech?

Dario: As blockchain technology heads towards mass adoption worldwide, regulators have sprung into action to clarify the application of existing laws to blockchain-related issues while responding to fraud, market manipulation and other misconduct. In the same vein, as ICOs are disrupting the way start-ups raise capital, regulators are monitoring all market participants, and pondering whether further specific regulation is warranted. However, since blockchain tokens are not a homogeneous asset class—they may feature characteristics of securities, commodities, currency units, or a combination thereof—and affect markets that cross national borders, there is a significant amount of uncertainty and a critical need for legal experts to offer unequivocal advice. 

'Financial institutions are at a crossroads: either they embrace blockchain or they risk being replaced by it.'

As the blockchain industry matures, and our regulatory and policy infrastructures adapt, I am proud to say that the MoFo blockchain group is uniquely positioned to assist market participants as they navigate all applicable laws and continue to drive innovation.

Chambers: How are traditional financial institutions approaching or incorporating blockchain technology?

Dario: Financial institutions are at a crossroads: either they embrace blockchain or they risk being replaced by it. Some of the most avant-garde financial institutions have already completed cross-border payments in real-time using blockchain and, in doing so, they were able to reduce or eliminate fees, delays, and processing mistakes.  Other interesting live applications include the issuance of certificates of deposit, digital identity management, KYC verification and the prediction and detection of fraud.

Chambers: Some have speculated that Bitcoin is similar to the .com bubble of the 90s. What would happen if the Bitcoin bubble bursts?

Dario: In some ways, I believe the .com bubble is certainly comparable to today’s bitcoin hype. As an example, since 2014 ICOs have raised more than $12 billion. Some of the companies raising capital via ICOs have been able to pull in millions of dollars in a few months and, in most cases, long before the product they were raising money for was even built. Regrettably, inexperienced investors may be enticed by the potential of massive returns or the volatility of cryptocurrencies. And while a handful of ICOs, especially a few in early 2017, are said to have multiplied their investors’ capital by ten, the vast majority of ICO-funded companies have not done well so far. So, just like in the 90s, a significant number of companies that expect to be at the forefront of blockchain technology may not be able to pull through, and most of the bullish valuations of cryptocurrencies will fall dramatically and often faster than their rise. The companies which survive will be the ones that have a solid business use-case for blockchain technology and were able to balance innovation with regulatory compliance. We’re not trying to sound alarm bells. We’re really excited about the wave of innovation being unleashed. However, as with any revolutionary technology, a prudent approach is warranted.

Chambers: What would you recommend to a lawyer or prospective lawyer considering building a practice in this area?

Dario: I think it is imperative to speak the language of your clients. As an example, I have been learning to code, use Python, and build a (simple) blockchain in about 50 lines of code. It’s been an intellectually enriching experience that made me realize how lawyers are somewhat comparable to coders: just as we strive to craft unambiguous provisions so that our clients, their counterparties or, in the event of litigation, a judge would not need to interpret them, coders create language that a computer can execute with no uncertainties. 

However, markets are still developing in ways we can’t predict today, so lawyers in this space will likely encounter unexpected regulatory barriers and hurdles to overcome. While we have witnessed a significant number of ICOs, we have very few examples of functioning blockchain-enabled platforms. Out of the 1,600 cryptocurrencies in circulation, only Bitcoin, Ether and few other cryptocurrencies are freely tradeable. Importantly, we don’t have any exchanges that are licensed to trade tokens in the US.  Having said that, I can’t remember a more exciting time in my career and I believe that MoFo’s blockchain group has been playing and will continue to play a pivotal role in the continued development of this nascent but transformative industry, while judiciously advising clients and protecting their investors as well as the users of this new foundational technology.

'[It has] made me realize how lawyers are somewhat comparable to coders: just as we strive to craft unambiguous provisions so that our clients, their counterparties or, in the event of litigation, a judge would not need to interpret them, coders create language that a computer can execute with no uncertainties.'

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