Blockchain Technology

The Regulatory Challenges facing Blockchain Technology

Dr. Priscilla Mifsud Parker | 20 Oct 2017

Blockchain

Blockchain Technology

Regulatory Challenges facing Blockchain Technology

Blockchain technology is deemed to play a key role in the financial services industry and has the potential of disrupting the entire sector. The key feature that will lead the Blockchain technology to be an essential part of the industry down the line is the possibility to record and store identities, financial transactions and all kind of legal dealings. Furthermore, the distributed nature of Blockchain technology is expected to bring new applications, which to date have been unachievable.

Nevertheless, Blockchain technology and its applications are still subject to further research and development particularly in the banking sector. At the same time, regulators are responsible for coordinating and guaranteeing industry stability, which plays a crucial role for the overall global economy. However, to date, the opinion of regulators worldwide to Blockchain technology has been fairly disjointed. Consequently, banks and other financial institutions may need to continue for some time to face uncertainty and inconsistency in terms of the regulatory application of blockchain technology.

As with every new technological proposal, opportunities that distributed ledger technology (“DLT”) will provide are accompanied by important regulatory challenges which will influence their widespread adoption. The current regulatory landscape is complex and it depends on the broad adoption of the following initiatives which are based on DLTs: cryptocurrencies, blockchains, shared ledgers, smart contracts, ICOs etc. Although the regulatory discipline of each of these components is different, the lack of specific regulation within the industry is a common thread.

Legal framework regarding the legal nature of blockchains and shared distributed ledgers

This includes territoriality (issues of jurisdiction and applicable law) and liability should something go wrong. As a definition, shared distributed ledgers do not have any specific location. In terms of jurisdiction and applicable law, territoriality constitutes a problem as each network node may be subject to different legal requirements. Moreover, there is no “central administration” responsible for each distributed ledger, therefore the nationality of which might act as an “anchor” in terms of regulation. In addition to that, liability may also pose some regulatory issues as there might be no party ultimately responsible for the functioning of distributed ledgers and the information contained therein.

Legal framework for recognition of blockchains as immutable and trustable

A legal framework is required for using Blockchain technology as unique and trusted sources of identity. However, in order to successfully implement such framework standardised regulation is necessary on data protection.

While there is wide consensus among the cryptographic and IT community regarding the immutability of blocks in a well-defined blockchain, either because it is technically impossible to modify blocks in “work test” systems or other kind of controls linked to consensus mechanism, there is as yet no legal recognition of this aspect of blockchains, hence it could not be enforced as a legal argument in court.

Regulation regarding interpretation of the “right to be forgotten”

The “tamper-proof” characteristic of blockchains colludes with said right, granted under European regulation to protect personal data. Such right allows any European citizen the right to have information stored in external databases, either on paper or in electronic format, deleted should they so wish.

Based on the above, a feasible solution to overcome this issue and to reconcile such rights with the inner nature of blockchains may be to replace the right to have such information “deleted” with a right to “prohibit the use” of personal information by third parties. This might be achieved by a combination of automatic data encrypting when certain conditions are met (which could mean use of smart contracts) or alternative solutions to prevent said information being accessed when an individual decides to exercise their right.

Legal framework concerning the legal validity of documents stored in blockchains as evidence of possession or existence

A second level of recognition is required before blockchains can be used in certain business. This would regard not only the recognition that the information contained cannot be modified, but also recognition that inclusion in a blockchain of a deed declaring ownership or the existence of an asset represents reliable proof of ownership, which shall constitute a valid and enforceable title in the Court of law.

Legal framework regarding the legal validity of financial instruments issued in blockchains

When blockchains are used as a platform to define “native” financial instruments, such as bonds or derivatives, recognition is required of the legal validity of these financial instruments by regulators and supervisors. One key financial instrument that could be issued through Blockchain technology is money that would lead to important monetary and macro-economic implications.

Legal framework for smart contracts

The regulatory issues mentioned in point 1 (i.e. territoriality and liability) are likewise valid to smart contracts, but further considerations might be sought:

  • As far as jurisdictional issues are concerned, there is not only the matter of whether the distributed ledger has a specific location but also the issue of having several location for signatories of the contract, therefore being subject to different laws under their respective jurisdictions.
  • With respect to liabilities, numerous parties are involved in smart contracts which are not limited to the actual parties of the contract, but also its creator (usually an encoder) and the custodian of the contract ( even though this presence might not be necessary).
  • Based on the above, potential issues might arise in case the contract is flawed due to coding or design mistakes. Thus, it is paramount to define which party would be liable when the smart contract fails to work as expected.

​Regulation on the use of blockchains as a valid regulatory registry for the internet of things

During the various debates in the industry it has been highlighted how Blockchain technology would be a turning point in the so called “Internet of things”.

The term Internet of Things (IoT) refers to the network of physical devices, vehicles and other items embedded with electronics, software, sensors which enable these objects to collect and exchange data. The IoT allows objects to be controlled remotely across existing network infrastructure, creating opportunities for more direct integration of the physical world into computer-based systems, and resulted in improved efficiency, accuracy and economic benefit in addition to reduced human intervention.

Consequently, all connected devices have an identity leading to the need to set up and establish a shared registry storing the “identity” and details of each connected thing bringing up the need for a stable regulatory framework.

Conclusion

Notwithstanding the challenges regulators will have to face, it is however undoubtable the increasing importance this phenomenon is acquiring. Hence, regulators shall become more aware on the potential widespread use of Blockchain technology in order to set up a well defined framework giving the possibility to the financial players to best make use of these powerful tools which in way or another will have a stable presence in the financial future down the line.


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