By Jen Wolfe, Founder, Wolfe Board Advisory Group
What is blockchain and why is it important?
You’ve probably heard of blockchain, bitcoin and cryptocurrency. But do you know the real impact it will have on future society? Is there more to it than just digital currency? Should your company be investing resources for research and development in it? If so, how much and on what?
In its simplest form, a blockchain is an advanced form of a database or ledger with verified identities and conditions for what’s on each ledger line. As each entry is formed, it creates a legally binding contract or set of rules governing the information coded in the ledger between the party maintaining the ledger and the individual or property owner on the ledger line. This is why Legal’s input will be so critical to the formation of the terms that create the smart contract component of the ledger. Each entry is an account for something of value (i.e., money, property rights, commodity, etc.). These blocks of ledgers are then strung together using software code (referred to as a hash) that ensures the block can’t be altered without both parties agreeing to alter it in a later block.
Blockchain is important to corporate counsel because it could significantly reduce costs and use of time and resources, simultaneously increasing profits, in the future, particularly in managing supply chains and transactions. Because of the significant increase in value to companies rolling out blockchain in the future, legal departments need to understand the basic elements of the technology and its implications.
Why is it different from other databases or supply chain software?
There are a few essential elements to what differentiates blockchain.
Decentralized. This means that the database is in a lot of places at one time and there is no central data repository to hack. It doesn’t mean it can’t be hacked, but it makes it more difficult to hack, thus potentially solving part of the cybersecurity problem or at least creating more layers of protection in cybersecurity risk management. This also means the company will have to have agreements with all parties to the blockchain in a collaborative and shared environment (similar to cloud technology but with more parties).
Authenticated and Can’t Be Changed. One of the benefits of blockchain is that once it is created, it can’t be changed without both parties agreeing to change it or create a new block of information. This addresses a lot of existing concerns about potential corruption or errors and, in theory, creates greater transparency and trust. It also speeds up the process and reduces transaction costs, which, in theory, ultimately benefits both parties.
Smart Contract Capability. The ability to embed a smart contract into the ledger line is what could reduce significant transaction costs and eliminate steps in many legal processes. It’s important to note that smart contracts (i.e. technology that has a series of if-then scenarios coded into it) can exist in other contexts than blockchain, but it has become a fundamental component of blockchain.
Blockchain is an underlying technology to create more secure transactions and store encrypted records of ownership. It has the potential to disrupt every industry and every profession that manages these societal functions right now: banks, governments, credit card companies, insurance companies, rights management companies (i.e., music, photos, video), lawyers, accountants, architects, musicians, producers, healthcare record management, doctors, hospitals and so on.
Despite all of these potential benefits to organizations rolling out a blockchain, there are still some challenges. First, there are technical challenges. Most blockchain tests are being conducted in closed networks with a limited number of parties. To truly recognize the benefits, the technology needs to be scaled outside of the network. Second, this will require making clear determinations about whether the blockchain runs on a public network, private or semi-private network, whether it uses the existing internet infrastructure, as well as whether it utilizes blockchains created by companies like Ethereum or IBM’s Hyperledger or Ernst & Young. Additionally, there are many governance issues about how the blockchain operates between different entities which will have to be resolved. Much like as the internet was formed, the Internet Corporation for Assigned Names and Numbers (“ICANN”) was created as a governance and policy making body, the same will likely be true with blockchain. It’s likely this will come in industry verticals versus a global body like ICANN, but this is an area where in-house counsel and lawyers should explore their role, and strategic leadership opportunities as blockchain technology, governance models and regulatory frameworks are developed.
What industries will be most impacted and which companies are already leaders?
There are a few big categories that will be impacted by the use of blockchain as the underlying software or database. This has big implications because it raises questions about when this shift will occur and how legacy systems will be affected if there is a transition to a blockchain-based system. A few of the industries to be impacted:
Letters of credit / trade finance
Cross currency payments
Almost every financial transaction could be made more efficient and seamless by using blockchain based technology. This is why the financial services sector is so focused on developing the technology.
- Land registry and ownership
- Vehicle registry and ownership
- Citizen identification
- Medical records - this is potentially one of the most profound uses of blockchain. If your health care records could be shared across healthcare providers and insurance companies, it could revolutionize the steps needed (i.e. become much more efficient) to manage healthcare.
- Pharmaceutical supply and trackingInsurance
- Claims processing
- Internet of Things integration for policy monitoring
- Supply chain tracking - supply chain could be radically improved and made more efficient if all of the parties can synchronize their efforts into a permissioned blockchain.
- Products, parts and logistics tracking
- Maintenance records
Food Supply and Safety
- From farm to table, the ability to track food in the event of a recall would be vastly improved. Wal-Mart and IBM have partnered up for a great test case on this. Check out this video: https://youtu.be/SV0KXBxSoio
- Digital rights in music, movies, photographs, trademarks and intellectual property. Microsoft and EY have partnered to expedite how gaming developers get paid using blockchain. Watch this video to see a real-life example of how blockchain can reduce time and improve profitability for all the parties: https://vimeo.com/279679573
Some of the companies on the forefront of development include IBM, Microsoft, Bank of America, JP Morgan, Walmart, and Fidelity. Analyzing their patents (as the author of this article does outside the scope of this short article) is one of the best ways to understand the competitive landscape and how such companies are planning to reshape their industries using blockchain.
What is the role of the legal department in blockchain?
Legal will play an increasingly important role in the development and roll out of blockchain. In-house counsel can either be a partner and help your Research and Development (R&D) team develop cutting edge technology that will give the company a real edge and potentially significantly reduce costs or be a roadblock if you don’t fully understand it and try to apply old-school strategies.
Legal’s role in blockchain is to understand the future business implications and help the business invest and test use cases to ensure it remains competitive, while also evaluating and apprising the team of risk. It is impossible to eliminate risk in any type of blockchain proof-of-concept test, so it is a matter of mitigating this risk, not eliminating it. Learn best practices and tools, ask questions (see examples below) and ask what your R&D team needs. Don’t tell them they can’t do the things they need to do, but rather, work with them to understand what is needed to evaluate or test their theories and consider strategies to minimize risk. If your company has recognized this opportunity and wants to be a leader, they need the legal department to partner up in working with the research and development teams, not “over-lawyer” it.
What should in-house counsel know?
Blockchain has the potential to disrupt supply chain and transactions in the future, potentially saving the company millions to hundreds of millions of dollars and improve safety and trust.
- Most businesses can’t afford to just sit on the sidelines and do nothing. Those companies will get left behind.
- All blockchain tests will inherently involve partnering and sharing data, systems and risks with other parties. This is why most initial blockchain tests involve a small sample of companies in the supply chain – so the theories can be tested with minimal risk. Once the proof of concept works, however, to deploy blockchain will require expanding the contractual relationships to more parties. This is why many companies are seeking to develop their own technology versus relying upon others so that they can have more control in the long-term.
- Most tests involve a close-knit group of suppliers or other companies in the supply chain. The key is to draft agreements that provide clear metrics for the test environment, identify ownership of data (even if it is shared), and provide flexibility for changes to occur as laws, regulations, and best practices evolve. Agreements should be short-term, recognizing that things are changing and provide flexibility to update agreements as more is learned.
- Recognize that this is a burgeoning area. It is impossible to know what we just don’t know yet. Until these test cases evolve, in-house counsel need to give the business optimum flexibility.
- Discuss the value of participating in open source projects in tandem with developing your own proprietary patented technology. Savvy companies are blending the two into a cohesive strategy.
- Blockchain has many hurdles to overcome:
- For most companies, they may not be able to afford the cost of developing their own blockchain so they will be forced to use a big provider like IBM, Microsoft, EY, Ethereum or others. Unless you can afford the development, this is the reality and you need to read and understand their terms. Advise the company that they are locking themselves in if they go too far down the development path with just one company. This is why many companies are participating in multiple open source projects so that they have access to more than one blockchain environment.
- Most blockchains in test environments are closed- or permission-based blockchains (meaning one or two companies control the blockchain). A true blockchain is decentralized among all of the parties. This may not exist for some time and the technology may have to change to address these issues.
- While blockchain reduces steps and processes, it will also need to rely upon increasing speed to function the way we expect.
What questions should you ask your development teams?
- How do we prove the concept works? This could mean simply that you prove the technology works or it could mean that you actually prove a cost savings from the deployment of the technology.
- What are the metrics we will use to evaluate its success or failure?
- What if we become too reliant on any one platform or provider? This is a big concern if you build a mission-critical new technology using IBM, Ernst & Young or any number of other providers. Does that lock you in to their pricing long-term? These are the issues to consider.
- What are our other options? There are always options. Could you build your own? Could you participate in open source projects?
- Are we contributing to or using open source code?
- How do we monitor patching (the Equifax data breach of 2017 was a result of an open source code vulnerability that was not patched. If you don’t have an open source code policy in place, you should get one).
- What is the risk if we don’t do this? Most likely, it’s a cyber-breach, but you should understand what can go wrong if you don’t have a clear open source patching policy in place.
- Who do we need to cooperate with us to make this happen? You will always need cooperation for a blockchain to work. It could be a supplier or a customer, but you need to understand what you need from them in order to draft contracts that provide everything you will need.
- How will we incentivize them to do so?
- What do we need them to do in order to achieve the results desired?
- What if we don’t achieve the desired results? If the program doesn’t work, what can you do with the learnings?
- Are we filing patents or protecting our knowledge and test cases? Why or why not? You should evaluate how you compare to your competitors to make smart decisions about investment in a patent portfolio. Like all other technology in our digital age, most companies are protecting what they develop, even if it’s just for defensive purposes.
- Have we looked at what others are doing?
- Who else is doing something similar?
- What are clear benchmarks where we might re-evaluate our relationship or contractual provisions? This will be very important during a test program to ensure that you have points in time where you can tweak the agreement as you learn. A benchmark might be a time period or it could be accomplishing a certain number of transactions.
- What if something goes wrong with the smart contract and we need to roll it back? This has been done in the cryptocurrency world, to great concern. It is possible, however, to pick a point in time and roll back a blockchain. You may want to reserve this right during a test program.
- Is the blockchain controlled or permissioned or is it open? You will want to be in a controlled and/or permissioned environment at first.
- At what points in time should we re-evaluate the contract to address any changing laws? This should be done at least annually, possibly every six months.
There many other areas involved such as privacy, securities laws, criminal laws, intellectual property and contract laws. For now, the essential role for in-house counsel is to begin to understand what blockchain is and the potential it could have in the future to set reasonable assumptions and work collaborative with their research and development teams.
If you have questions about blockchain strategy and how the legal department can help your company successfully roll out blockchain test cases, you may contact Jen Wolfe, [email protected].
About the Author
Jen Wolfe is an author, speaker, lawyer and entrepreneur. She has written four books, her most recent is Blockchain in the Boardroom. She is the National Association of Corporate Directors Faculty expert on emerging technologies like blockchain and artificial intelligence, as well as cybersecurity and the future of work. She has served on GNSO Council of ICANN and is the CEO of Dot Brand 360, a digital advisory firm for c-suite executives.