Blockchain, Bitcoin and the Bar

Peter Susman QC provides a beginner’s guide to Blockchain and Bitcoin, and suggests the Bar has nothing to fear from such innovations

It may well have been the case that the devising of blockchain, around 2008, was an idea whose time had come. Amid the general feeling that electronic transfers of virtual currency could not be safely entrusted to banks, who were being blamed for prompting the 2008 stock market crash, there was also a perception, right or wrong, that banks were independently or collusively charging at excessive rates for electronic transfers of money. These days, thinkers, techies and startup entrepreneurs seem to relish the prospect of sidestepping bankers, derivatives traders, insurers, and especially lawyers. Should the Bar fear for its future?

I suggest not! Surprise was expressed that lawyers were still smiling at the end of three days of brainstorming and a final day of speakers at the inaugural Conference on the ‘Internet of Agreements’ in London in October 2017, organised by Vinay Gupta of Hexayurt.Capital and Imogen Heap of the Featured Artists Coalition, with participants from many parts of the world. Some of the thoughts expressed there are adopted or challenged below.

What’s Blockchain and cryptocurrency?

About 10 years ago, Satoshi Nakamoto (now thought to be an Australian of European extraction using a Japanese sounding name) put into effect the linking of a large number of computers, each holding the same copy of an electronic ledger that recorded a series of finite blocks of transactions, which within a short time would be closed to further entries. To make transactions, users would need a generally available ‘public key’, as well as a personal ‘private key’ (in effect, a personal password). This system thus constituted a permanent shared record of those transactions, verified by each of the computers on which a copy of the block was held, and therefore secure from unauthorised further change or other interference. Once a block is closed, a new block is created, and then another and so on, in a chain, and hence the name ‘blockchain’ describing this ‘distributed ledger’.

A blockchain can be used for an independent and universal medium of exchange, or cryptocurrency, existing only as ledger entries in the blockchain. It is so much more than an entry in a single electronic ledger, or than a mere means of transferring money electronically. The first and best-known cryptocurrency is Bitcoin, but Ethereum and several hundred more have been created (not all of which have been successful).

Cryptocurrency also fulfils other functions of money by being used as a benchmark of value (a unit of account) or wealth (share of economic value). New cryptocurrencies tend to start with an offering to investors, usually called an Initial Coin Offering or ICO, after which they or others may participate in the formidably risky game of speculation on the rise and fall of the cryptocurrency in relation to an established national currency such as the US dollar. The exchange rates between cryptocurrencies and national currencies are extraordinarily volatile.

New blocks to join the single chain of an existing blockchain are created one by one, in a process for which the incentive is that the software bestows cryptocurrency upon the first competitor to solve a mathematical puzzle using ever more elaborate and expensive computing power. This is imaginatively given the name of ‘mining’, as if the cryptocurrency was buried precious metal, and has so far proved effective for the continuation of blockchains.

What’s next? Smart contracts

Further development is intended to involve coordination with the so-called ‘smart contract’, which may be described as software which is intended to model the provisions and effect of a valid and enforceable standard form of written contract in order to facilitate blockchain transactions. Yet further contemplated uses of a blockchain include replacing a food commodity chain of supply from farmer to retailer, where a mutually agreed added value or transfer price of the commodity at each link of the chain of supply is agreed and recorded in a blockchain distributed ledger, so as to reduce or even eliminate some added costs such as the cost of credit, or of trading in futures, or in derivatives: see sweetbridge.com. In relation to other applications the blockchain need have no necessary connection with cryptocurrency, but could for example include electronic databases for the storage of public records.

Security issues with the blockchain system

One persisting problem remains how to keep identity secure, when any error, due to mistake or fraud, may result in the irretrievable loss of cryptocurrency. Nobody has yet devised a wholly secure private key. A short and memorable combination of numbers and letters is insecure. A combination long enough to be practically secure will be too hard to memorise, and once written down, is insecure. The pattern of one’s iris can be snapped on a mobile phone. Use of a thumb print could encourage criminals to cut off thumbs. Even if this problem is solved, any human intervention will open the prospect of error or fraud.

Sidestepping control by emanations of the State?

A widely held view of those imagining fresh applications for blockchain is that it will be feasible to sidestep control by emanations of the State, whether legislators, regulators or judges. They seem to believe that because the distributed ledger has no central hub to control it, but exists only by way of a large number of computers linked to each other, control is not feasible. I consider this to be fallacious.

The UK government has so far contented itself with issuing general risk warnings to potential investors. However, the Canadian (federal) Securities Administration declared in August 2017 that it was prepared to exercise its regulatory powers to control any ICO that appeared to it to constitute an invitation to take up a speculative investment. News reports in September 2017 of the People’s Bank of China imposing a total ban on ICOs and cryptocurrencies have probably been exaggerated, and the true position may be that the Chinese government is doing no more than trying to regulate abuses by criminal gangs involved in scam ICOs and fraudulent cryptocurrency exchanges. Either way, there is no fundamental reason why the State should not succeed in regulating Blockchain and cryptocurrency.

One speaker at the Conference even suggested that because the blockchain makes cryptocurrency somebody’s property without the intervention of the State, the State through its courts can provide no remedy for stolen cryptocurrency; and that this may even prove beneficial, since there will be incentive for users of blockchain to use instead of judges, who do not understand technical innovation, arbitrators who do.

However, every judicial system empowers itself to deal with innovations made by citizens without the intervention of the State, prominent examples in English law being the judicial creation of rights and obligations in relation to trusts of land and other property, or over private trading contracts. Experience suggests that English judges would be able to deal with any developing technological advances by traditional methods, including the common law method of argument by analogy. In English law, money as a token of value has long been regarded as property, as convincingly argued by Dr David Fox in his monogram Property Rights in Money (2008).

I see no reason why English judges could not decide that cryptocurrency is property, equally capable of being stolen. When printers of bank notes were tricked into permitting fraudsters to circulate unauthorised bank notes in Portugal, a majority of the House of Lords held the printers liable in damages for the exchange value of the spurious bank notes, rather than just for their nominal value as printed paper: Banco de Portugal v Waterlow and Sons Ltd [1932] AC 452. In Fairstar Heavy Transport NV v Adkins [2013] EWCA Civ 886, the Court of Appeal held that a principal was entitled to recover its business emails from a former agent who had control of the only copies, there being no reason in such a context to distinguish between printed and electronic documents. Combining the effect of these two cases, there would seem to be no principled objection to treating a claim for the loss of cryptocurrency as deserving a remedy related to the exchange value of the cryptocurrency. Indeed, HMRC treats cryptocurrency as foreign currency for the purposes of income, corporation and capital gains tax, and the ECJ has accepted that no VAT is payable on an exchange of cryptocurrency for a national currency: Skatteverket v David Hedqvist (Case C264/14).

Multi-jurisdictional problems

Similarly, blockchains and cryptocurrencies operate without border controls between jurisdictions, but I see no particular problem with that. International trade is hardly novel. States make treaties with each other to deal with the jurisdiction that may be exercised by national courts, the choice of the law of which jurisdiction to apply, and the enforcement in one jurisdiction of judgments in another. If there are no applicable treaty provisions, courts may determine and apply their own rules. If a defendant moves to a State where enforcement is impossible or difficult, or the defendant simply disappears, that is a risk that is inherent, and is by no means restricted to cases involving new technology, such as the recent US federal first instance case of Leidl v Project Investors Inc (District Court for the Southern District of Florida), where in or about July 2017 the judge gave judgment in default for a large sum against a defendant who had disappeared, with no apparent prospect of the plaintiff being able to enforce the award.

In short, there already exist established systems for judges in different jurisdictions to deal with disputes involving international trade (including enforcement of arbitral awards), not free of all problems, but mostly effective, and readily applicable to disputes that may arise concerning cryptocurrency. A court cannot seize a blockchain as it could a ship or a cargo or money in a bank, but it can seek to compel compliance with its orders by punishment including imprisonment. Therefore, it is not necessarily impracticable for a court to grant relief, although it is understandable that those involved in a dispute might prefer to submit to arbitration (and Conference participants urged that it would also be of great general advantage if the grounds for the result of each arbitration was published, and preferably without identifying the precise dispute or the identity of the parties, but so as to develop a body of precedent).

Opportunity or risk for the Bar?

All but the simplest systems have an inherent and inexorable tendency to become more and more complex, with the result that simple and repetitive manual tasks are devalued and become obsolete, leaving newer and more complex tasks to be performed. To take an example at the Bar, affordable photocopiers made it unnecessary (as it was until about 1970) to employ a copy typist to type for use at trial copies of existing documents as an original court bundle with several carbon copies. Photocopiers have since added immensely to the complexity and overall cost of preparing court bundles. Increasing complexity will always create work for lawyers. Software may take on the basic aspects of tasks such as residential conveyancing, or the preparation of lists of documents for disclosure, leaving the more difficult and interesting tasks for human attention.

Parties will almost certainly still need professional help before entering into a smart contract if the stakes are high enough. It seems unlikely that software will be developed in the near future that will advise a party whether to accept allocation to it of a particular risk that may be dependent on considerations that the party itself has not fully considered. Efforts are currently being made to design software to draft a smart will, but it again seems unlikely that software will soon be able to competently advise the testator on planning to avoid inheritance tax, when this may be dependent on elusive facts or emotional family issues.

It is not practicable to code software that will deal with everything that could possibly go wrong. Life is already too complex. Certainly, software can defeat a human playing chess, and now even playing Go. But it seems unlikely that software will be developed that could competently compile, devise and organise arguments to achieve success at a hearing of a complex dispute that had reasonably not been anticipated by the terms of a smart contract; or to determine an inherently complex dispute, such as whether mother or father should have custody of a child; and even remembering that tossing a coin is one method of alternative dispute resolution!

Human error: crypto case law

What tends to go wrong is not fault in the software, but in one or more of the humans involved. The only English civil case involving cryptocurrency of which I am personally aware is still at a very early stage indeed. The most notorious case is that of the Japanese company MtGox KK, trading as a bitcoin exchange, which collapsed in February 2014 after bitcoin valued at hundreds of millions of pounds virtually vanished. The criminal trial of the alleged thief and former CEO, a French national named Mark Karpeles, started in Japan in August 2017, and various other lawsuits including insolvency proceedings and class actions are pending in various jurisdictions. Ironically, the great increase in the value against the US dollar of the remaining bitcoin held by Mt Gox KK may mean that there is sufficient to pay all civil claims at the value they had in 2015.

Another fraud case was resolved in December 2015, when a US (federal) criminal court in San Francisco imposed a 71-month prison sentence on a man called Bridges, who while a member of the US Secret Service’s electronic crimes task force investigating Silk Road, an online criminal market place that was part of the ‘dark internet’, had participated in stealing bitcoin that at the time was worth some US$350,000.

In BitPay, Inc v Massachusetts Bay Ins Co, commenced in September 2015 in the (federal) District Court in Atlanta, Georgia, USA, BitPay sued its insurer for failing to pay under a policy against computer fraud, covering ‘loss of… money… or other property resulting directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises or banking premises’. The definition of ‘money’ was later extended by agreement between insurer and insured to cover bitcoin. BitPay alleged that a fraudster sent an email which caused it to connect to a fraudulent website, where it was deceitfully persuaded to disclose the private key to its bitcoin account, and lost bitcoin to the value of US$1.85m. The insurer filed a defence denying liability on grounds that included a denial that the lost bitcoin was removed from inside the plaintiff’s premises or banking premises. The other grounds of defence might have been arguable, but one recalls the dictum of HH Judge Mackie QC sitting in the English High Court in W v Veolia Environmental Services [2011] EWHC 2020 (QB) at para [40] that: ‘Cheerful, prompt and knowing overpayment of claims by insurers is unheard of, at least in this court.’ The case was settled in June 2016 on terms that have not been published. 

Contributor Peter Susman QC of Henderson Chambers, with thanks to Butterworth’s Journal of International Banking and Financial Law for kind permission to base this feature upon his earlier article ‘Virtual money in the virtual bank: legal remedies for loss’ [2016] 3 JIBFL 150; and to Clive Freedman of 3 Verulam Buildings for technical and other insights; but any views expressed are the sole responsibility of the contributor.

 

Author details: 
Peter Susman QC

Peter Susman QC, Henderson Chambers