This article, another in the continuing series on cloud computing, addresses blockchain technology as a special element of cloud computing. Cloud computing is any computing or storage away from your office or computers under your direct control.
In past articles we’ve raised legal issues associated with cloud computing, including:
- Jurisdiction for breach of contract suits, if the contract does not specify a choice of law and venue.
- Applicability of state laws for remedies for data breaches and data notification laws, which vary by state and by whether a cause of action may be instituted by an individual or whether the remedy is exclusive to the state.
These issues are more complicated and unresolved in addressing blockchain transactions. Because the answers are not yet resolved, you should be aware of the technology as you may be called on to make decisions on these subjects. For example, in researching the introduction of blockchain evidence at trial, we did not find cases where a court examined the introduction of blockchain transactions under federal or any state’s evidentiary rules.
What Is a Blockchain?
A blockchain is a distributed ledger. This means that the ledger can exist in more than one place at a time, and each version is considered an original ledger. The blockchain system works on the basis of independent computers performing the same calculations and then comparing the results. Each computer performing these verifying calculations is called a node.
Transactions are compiled into blocks of the same size (i.e., in terms of numbers of bytes). The block is then “hashed,” that is, converted into a string of text or a series of numbers by a mathematical formula. These hashes are not encryption because they do not allow for conversion from the hash to the original text. Hashes are generally shorter than the original text.
When most, but not all of the computers agree on the hash value of the block, then the block is complete and added to the chain. If there is a disagreement in the hash value of the block, then the block is added only when the critical number of nodes agree on the hash value. Once a block is added to the chain, the transactions that comprise the block cannot be changed.
Think of a transaction on a block like a deed filed in the county records. If there is an error, such as a misspelling of a name, the deed that was previously filed cannot be corrected. Instead, a new document is created identifying the error and the correction, and it is filed as part of the chain of title. This correction deed will have a new filing number. In the same way, transactions cannot be changed once they are accepted in a block. There can be a correcting transaction, and that new correction can be found in a new block of transactions.
The ledgers are synchronized and are based upon several computers (the number may vary from less than ten to more than 1,000,000) communicating with each other on a peer-to-peer network. These computers (nodes) are all running the same software and communicate without the assistance of an administrator. The computers are constantly comparing their answers with other computers on the network, and decide among themselves by agreement which blocks (and therefore the transactions that comprise the blocks) are valid.
Walmart and Sam’s Club initiated a requirement that its suppliers use IBM blockchain technology1 for tracking its produce back to the farm. This enables Walmart to speed up response in case of product recalls. 2
Your clients, particularly if any are suppliers, will be examining how they can integrate blockchain tracking into their current operations. They will need help in understanding the legal ramifications of these agreements.
How Are Blockchains Related to Corporations and Other Business Entities?
Delaware passed legislation allowing corporate records to be kept on electronic networks or databases,3 which was specifically worded to include blockchains. 4
This language attempts to enable corporate records to be created and held on blockchain. Corporations could avoid paper stock or debenture certificates, and instead rely on electronic certificates that are much easier to process. Annual reports and other communications with shareholders can also be communicated to shareholders without paper and postage.
Other states may wish to adopt this type of legislation. Texas and Arizona legislatures are considering this type of legislation but have noted that the ease of communications that corporations are trying to achieve may be prevented by the federal E-Sign statue5 and each state’s respective version of UETA (the Uniform Electronic Transaction Act developed by the National Conference of Commissioners for Uniform State Laws). 6
E-Sign and compliant state statutes must allow the consumer to withdraw consent at any time. Prior to consenting to an electronic transaction, the consumer must be provided with notice of the consumer’s right to withdraw consent to have the record provided in electronic form. If there are consequences to the action, then the consumer must be provided with these consequences prior to consent.
So, conceivably, a blockchain, which requires the use of electronic signatures and is governed by E-Sign and the applicable state’s UETA law, must enable an opt-out. 7 This opt-out then means that some of a corporation’s shareholders will be communicating using paper and some using blockchain. E-Sign and UETA could be described as blockchain killers because there is no paper alternative to the transactions as they occur for consumers; yet, each transaction must entail a mutual opt-in.
Already, legislation has been introduced that will create an exception to E-Sign’s applicability to blockchains and smart contracts. 8
Blockchains are already in use, and the computations that enable blockchains to be effective are “in the cloud.”
Major retailers see blockchains as a means to track food sources. Vendors see blockchains as a means to decrease accounts payable processing.
States see blockchain-enabling statues as a means to attract corporations that will seek lower-cost administrative fees, and electronic delivery of documents to shareholders could save businesses a great amount of money.
The efficiency and low cost of administration of transactions on blockchain may impact transfer agents and investment banks. Transfer agents may no longer be needed as the corporation would keep its own stock records and those records would be updated continually. The need and economics of keeping stocks in an account at a brokerage firm may change if transactions occur on a blockchain.
The uses are dramatic and across all of society. Laws and court rules have not yet caught up to the anticipated changes, much less the uses that will be developed.
1. Kim N. Pham, partner and blockchain leader at IBM, gave an example of a company instituting blockchain tracking of goods, delivery, and invoicing in transactions with its customers and reducing its collection time from more than 40 days to nine days. Blockchain in Shared Services Conference, June 28, 2018, Southlake, Texas.
2. Olga Kharif, “Walmart, Sam’s Club Start Mandating Suppliers Use IBM Blockchain,” Bloomberg.com, https://www.bloomberg.com/news/articles/2018-09-24/walmart-sam-s-club-start-mandating-suppliers-use-ibm-blockchain, September 24, 2018.
3. 8 Del. C. 1953, § 224, http://delcode.delaware.gov/title8/c001/sc07/index.shtml.
4. Delaware Senate Bill 69, 149th General Assembly, Section 1, “Amendments . . . and related provisions are intended to provide specific statutory authority for Delaware corporations to use networks of electronic databases (examples of which are described currently as ‘distributed ledgers’ or a ‘blockchain’) for the creation and maintenance of corporate records, including the corporations stock ledger.” https://legis.delaware.gov/BillDetail?LegislationId=25730
5. Electronic Signatures in Global and National Commerce, also known as ESign or E-Sign, 15 U.S. Code Chapter 96, §§ 7001-7006.
6. UETA has been enacted by 47 states and the United States Virgin Islands. Electronic Transaction Act, Uniform Law Commission, the National Conference of Commissioners for Uniform State Laws, http://www.uniformlaws.org/Act.aspx?title=Electronic%20Transactions%20Act.
7. “The requirement that both parties agree to conduct a transaction electronically also prevents the imposition of an electronic medium on unwilling parties. . . .” Uniform Electronic Transactions Act (1999) Drafted by the National Conference of Commissions on Uniform State Laws, http://www.uniformlaws.org/Act.aspx?title=Electronic%20Transactions%20Act, Annual Conference Meeting, Denver, Colorado, p.19 (1999).
8. Blockchain Records and Transactions Act of 2018, H.R. 7002, 115th Cong., (2018).
The text of this article has been altered to clarify the nature of distributed ledgers.