When a U.S. federal judge began hearing a lawsuit early this year that alleged a popular American digital currency exchange bungled the rollout of the crypto-currency Bitcoin Cash, he started with a proviso, warning the parties that this was “a kind of brave new world” with which he was not remotely familiar.
With the number of lawsuits mentioning the words crypto-currency, Bitcoin or blockchain tripling in the first two quarters of 2018 in the U.S., according to legal analytics firm Lex Machina, a trend legal experts fully expect to gain steam and eventually make its way into Canada, the legal world is going to have to come to grips with the complex, novel and thought-provoking legal issues that blockchain raises.
While litigation surrounding blockchain, the cutting-edge foundational technology that underpins digital assets such as Bitcoin, has so far almost entirely centred around crypto-currencies, that’s expected to change as blockchain is far more than just about virtual currencies. Often described as the most disruptive technology since the internet, blockchain is now moving beyond the exploration phase toward the identification and development of practical applications. Though still early days, blockchain shows promise to disrupt business, social and technological models that potentially can have a pervasive impact on business and society. The technology that allows for a digital ledger to be replicated and distributed across a network of computers to create a decentralized, secure and cryptographically protected database has yielded applications that range from smart contracts and digitally recorded property assets to supply chain auditing and management of patient records.
The legal world, too, will be affected. CaseLines, a global digital evidence management provider, filed an application to patent the use of blockchain for handling documents. But as with any nascent technology, blockchain also has the potential of creating conflicts with existing laws and regulations, raising challenging and complex legal and compliance issues that deal with jurisdiction, evidence, privacy, enforcement and, of course, illegal activities.
“People are trying to figure out what the issues are and how they can address them proactively,” notes Imran Ahmad, a business lawyer who specializes in cybersecurity, technology and privacy at Blake Cassels & Graydon LLP.
For now, thorny issues dealing with crypto-currencies are hogging the attention of the courts and regulatory authorities. In the U.S., as of mid-November 2018, 57 class actions and other private lawsuits dealing with digital currencies were launched as were 53 cease-and-desist order cases, 26 criminal cases and 19 suits filed by two regulators, the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission, according to a crypto-currency litigation tracker published by the American law firm Morrison Cohen LLP. In Canada, there have been 17 cases dealing with crypto-currencies that were heard over the past 18 months by the courts, securities regulators or administrative tribunals.
Most of these cases have several running lines. Other than those begun by regulatory authorities cracking down on crypto companies allegedly selling unregistered securities or allegedly engaged in fraudulent activity, some cases are the result of corporate partnerships gone sour and yet others by dissatisfied buyers.
On top of that, the North American Securities Administrators Association revealed that more than 200 active investigations of initial coin offerings or “ICOs” — a form of fundraising popular among crypto-currency firms — and cryptocurrency-related investment products are currently underway by state and provincial securities regulators in the U.S. and Canada as part of Operation Cryptosweep. More than US$20 billion has been raised by crypto projects through ICOs since the start of 2017, according to research firm Autonomous NEXT.
“The reason we are starting to see a lot of disputes involving cryptocurrencies is because even with the recent decline in prices, they have more value than they did a couple of years ago, and so obviously it is now more worthwhile to have a dispute,” says Evan Thomas, a lawyer with Osler Hoskin & Harcourt LLP, who works with crypto startups on regulations and compliance. The lack of clear-cut regulatory guidance over the status of crypto-currencies and ICOs does not help matters either. A 2018 report by the Blockchain Research Institute said that innovators in the space lament the “lack of regulatory clarity and guidance.”
In the absence of clear regulatory guidance over crypto-currencies, two cases emanating from the Supreme Court of British Columbia underscore the challenges the courts face in trying to craft rulings that meet the new realities of the digital economy. The first case involves Copytrack PTE Ltd., a Singapore company that erroneously transferred its digital tokens valued at approximately $495,000 instead of $780 worth of tokens to an investor. The company advised the defendant of the mistake, but he did not return them, claiming that the virtual currency was no longer in his possession or control. The court granted an order allowing Copytrack to trace and recover the wrongfully transferred crypto-currencies, thereby implying it is property, even though it did not explicitly hold that crypto-currencies are property. (It is highly unlikely that Copytrack will recover its digital tokens as the defendant died before the summary application was heard.) The “proper characterization of cryptocurrency” is “a complex and as of yet undecided question” that could not be determined by summary judgment, held the court in Copytrack Pte Ltd. v. Wall. Yet, several months later, in another case involving a former executive accused by his former employer of misappropriating US$5.3 million worth of digital currency, the court assumed that virtual currencies are property.
“These cases illustrate that the courts are in the process of figuring out how to apply the existing law to these novel facts,” says Thomas. “We are going to see inconsistencies around the edges between decisions, and that’s not unusual. That is often how the law develops.”
That is also the likely scenario that will occur when blockchain-related cases, other than those involving crypto-currencies, begin making their way to the courts. But the legal issues the courts will need to address will be of a different ilk.
Take blockchain-based smart contracts, an application of blockchain technology that growing numbers of business are adopting. This involves a computer code that automatically executes all or parts of an agreement that is stored on a blockchain-based platform. Smart contracts can either be the sole manifestation of the agreement between the parties or a digitized version of a paper-written contract. Proponents tout blockchain-based smart contracts as being able to cut out intermediaries and slash costs while rendering transactions traceable, transparent and irreversible.
The moniker smart contracts, however, is a bit of misnomer. Contracts are only legally binding if they meet certain elements: There must be an offer and acceptance as well as adequate consideration from both parties who have an intention to create legal relations — and that’s where complications may arise.
“If we are trying to use the code as a contract, how are we going to be able to demonstrate that factors such as multiple parties, adequate consideration and the governing law are met so that they can actually be called a contract?” asks Ahmad. “And if it is a contract that mentions governing law, which law would have precedence?” Since blockchains are decentralized across a network of unrelated computers, servers and devices — called nodes — located anywhere in the world, that can lead to complex jurisdictional issues. In a party-to-party transaction, any law in the world can govern the transaction, says Ahmad.
But if consumers are part of the picture, then issues related to public policy governing law may come to the fore. Even though the inclusion of an exclusive governing law and jurisdiction clause in a block-enabled smart contract is not always enforceable, it is nonetheless advisable to insert such clauses, says Thomas. “One of the issues that comes up with smart contracts and distributed applications is that no one necessarily puts written terms and conditions around their use,” he says. “If there is a dispute, that puts the court in a position of having to imply what those terms are — and that’s a whole world of uncertainty.”
There’s more. Linked with the knotty problem of jurisdiction are the related issues of liability and enforcement, concerns that touch on all blockchain applications and not just crypto-currencies or blockchain-based smart contracts. If something goes awry, such as code errors, data errors and just plain glitches, it can prove to be a real headache for the courts to establish liability as nodes are decentralized, with copies of transactions stored on a blockchain that does not have a single physical location. What’s more, transactions recorded on blockchain are technically immutable because they cannot be deleted or changed. Pinpointing, therefore, where a breach or failure occurred can be complicated and lead to jurisdictional confusion.
This all prompts Quebec City lawyer Jean-François De Rico, who practises information technology, intellectual property and privacy at Langlois Lawyers LLP, to assert that legislators and regulators will have to eventually figure out how to provide adequate legal protection to litigants. “Who should we point to?” De Rico asks rhetorically. “In the case of the internet, we pointed towards internet access providers. In the case of blockchains, we still rely on the network infrastructure, but the nodes are so numerous that I don’t see how network operators could be [held accountable]. So, will it be developers? This is something that needs to be reflected on because, ultimately, being able to execute judgments is a real, big difficulty.”
The courts will also have to consider how evidence will be handled in blockchain-related cases. In 2016, the state of Vermont passed a bill allowing a “digital record electronically registered in a blockchain” to be admissible in a court of law under its rules of evidence. More recently, in September 2018, China’s Supreme People’s Court allowed evidence stored and verified on blockchain platforms to be used in legal disputes, making it the first time blockchain technology has been recognized as an admitted means of evidence in a civil law case. Canadian courts will “need a pathway to address and consider the probative value of blockchain records,” says De Rico.
It may turn out to be a war between expert witness testimony, says Ahmad. “Depending on the issue the court is going to be asked to judge on, if it is going to be very technical, it it’s code-based, then I think it’s going to be a battle of the experts and the judge is going to have to make some decision on that,” says Ahmad.
Privacy is yet another conundrum that will have to be dealt with. Blockchains are inherently designed to be immutable and transparent. Information is also shared among every participant and node. If information in a ledger transaction or block contains private information, it will be visible to every user of every node.
That appears to run in conflict with privacy laws such as the European Union’s General Data Protection Regulation, which has been enforced as of May 2018. The GDPR strengthened the rights of individuals to digital privacy and enshrined the notion of the “right to be forgotten.” France’s data protection authority became the first regulatory agency to weigh on the issue by offering some tentative solutions that would allow blockchain to exist under GDPR, and the European Parliament recently adopted a resolution to explore the potential regulation of distributed ledger technologies such as blockchain.
Elsewhere, there is radio silence. “Many of our systems of laws don’t necessarily mesh well with the idea of a system that can’t be turned off or can’t be altered,” says Thomas. “A blockchain database poses a potential challenge to the right to be forgotten in that there is no central authority who can take down or delete a piece of information.”
Kris Klein, a privacy expert with nNovation LLP, has a slightly different take. “The issue is too new and it’s not clear how the technology is going to be deployed to know for certain if it will be a curse or a blessing to privacy,” says Klein. “Many experts suggest that some of its inherent qualities, being immutable, for example, can lead to advances in privacy. Time will tell which direction it goes, but it is exciting that it has the potential to be a privacy-enhancing technology.”
In the meantime, a growing number of jurisdictions, 16 U.S. states at last count, have slowly begun to leave their legislative imprint on blockchain technology or crypto-currencies. Most significantly, Delaware, home to more than 50 per cent of all publicly traded corporations in the U.S., amended its General Corporation Law to allow Delaware corporations to use blockchain to create and maintain corporate records, including the corporation’s securities register.
The ramifications are enormous, says Donald Johnston, co-chairman of the technology, privacy and data security group at Aird & Berlis LLP. Delaware companies can now cryptographically link shares of stock to an owner in a manner that cannot effectively be challenged thanks to the “more or less bulletproof nature of modern cryptography,” says Johnston. “That has the capacity to change the whole model of shareholder democracy. That could change a lot of the governance at the annual general meeting and transfer power from brokers to individual shareholders in a way that could be quite a shock.” Public companies may be rattled because they may no longer be able to influence individual shareholders in the way they were able to with big brokers. And big brokers may end up being flustered because “they used to have the voting power to do what they want at the general meeting, and now they don’t,” says Johnston.
Blockchain technology certainly appears to have the potential of shaking things up. Apart from crypto-currencies, litigation over legal issues raised by blockchain technology is still way off, though blockchain-enabled smart contracts seems fertile ground for legal actions. Time will tell how the courts will address the plethora of complex issues. A move afoot by industry associations to develop standards will likely end up helping the courts. So, too, will clearer guidance by regulatory authorities who so far have struggled to provide lucid answers. “The first few cases are going to be seminal,” says Ahmad. “They are going to set the tone for everything that is going to happen.”
Perhaps, though, it is time for nations to put their heads together to fashion agreements that will establish legal frameworks to deal with questions raised by blockchain technology, says Toronto-based blockchain lawyer Chetan Phull. “This is an area ripe for international treatment,” said Phull of Smartblock Law PC. “Blockchain technology is necessarily multi-jurisdictional in most cases, and it is very difficult to litigate a blockchain case, let alone enforce a blockchain case, when you don’t know what set of rules applies. What we need and what I anticipate will happen is that there will be treaties and then individual countries will clarify and fill in the gaps.”
Editor's Note: This article was updated to clarify that Imran Ahmad now practises with Blake Cassels & Graydon LLP.