Is blockchain the revolutionary technology that will rewrite the rules for the finance industry, identifying authenticity and verifying payment flows that arise at a business-to-business level or between business and consumers and peer-to-peer? The consequences of the blockchain evolution would significantly open the field for technology platforms and reduce operational costs. This would also be a major challenge to the established institutions in the consumer finance and business finance sectors. In order to be successful, this technology will need to overcome a number of legal and regulatory issues.

What is blockchain?

Blockchain provides a new approach to holding and authenticating data. It is a database operating through distributed ledger technology in which data is recorded on computers, by way of a peer-to-peer mechanism, based on pre-agreed consensus algorithms in the applicable participating network. It is a form of database where data is stored in the chain in either fixed structures called ‘blocks’ or algorithm functions called ‘hashes’.

Each block includes unique features such as its unique block reference number, the time the block was created and a link back to the previous block. Each block is reviewed by a number of nodes and the block is only added to the database if the node reaches consensus that the block only contains valid transactions. Content includes digital assets and instructions which reflect the transactions and parties to those transactions. The ability to track back through previous blocks in the chain makes it possible to identify transactions back to the first ever transaction completed, enabling parties to verify and establish the authenticity of the assets in the latest block. This makes blockchain exceptionally accurate and secure.

The blockchain is based on specialist users of the system being able to apply advanced computing software to identify time stamped blocks, verify the accuracy of the block using sophisticated algorithms and add the verified block to the chain. As the number of participants increases, the replication of the data over a wider base makes it harder for any person to alter the data in the chain. Any attempted addition or modification to the information on a block needs to be approved by all users in the network and verification of any block can only happen through a ‘proof of work’ process.

As a result, the data is identified and authenticated in near real-time, providing a permanent and incorruptible database sufficiently robust to operate as a store of value (eg in the case of cryptocurrencies such as Bitcoin) or providing an indisputable record for example relating to securities transfer and partnership. If the above description holds true, blockchain provides a revolutionary technology that could save the finance industry billions of dollars (for example, in settlement and reporting costs) but may impact the need for certain types of trusted third parties.

Important features

One of the most important features about blockchain is that it is a decentralised system, created and maintained by users of the network rather than being dependant on any central or third party intermediary. The blockchain may be public and open (‘permissionless’ or ‘unpermissioned’) or structured within a private group (‘permissioned’).

Permissionless blockchains include Bitcoin and Etherium, in which anyone can set up a node that validates, observes and submits transactions. The identities of the participants are not known (other than the unique and random identities known as an ‘address’). Permissioned ledgers restrict participation in the network and only the specific participants are given access and are known within the network. The network is private, and only organisations that have been authorised can participate and view transactions. Permissioned technologies include the Hyperledger Fabric project and the JPMorgan Juno project.

The development of blockchain technology enables parties to establish and transfer assets or information securely without the need for a trusted third party such as a bank or registrar. Verification is provided within the electronic system rather than based on, for example, a bank to bank identification number. Blockchain is best known for its role in establishing electronic currency such as Bitcoin. As a means of creating and securely transferring value on a fast and cost-efficient basis, it is viewed as a disruptive technology that could replace major aspects of the banking system. Blockchain may be used to improve various functions such as currency exchange, trade execution, peer-to-peer transfers and even enhance the application of and compliance with anti-money laundering rules.

If blockchain technology lives up to its promise, it may have a revolutionary impact on businesses across every major industry, governments and even the legal profession.

The conversation about blockchain technology has shifted over the last few years. Stakeholders have increasingly recognized that this peer-to-peer distributed ledger technology underlying the cryptocurrency Bitcoin has utility beyond Bitcoin, and lawyers should be paying attention.

Think of blockchain technology and other variants of peer-to-peer distributed ledger technology (collectively referred to as “blockchain technology” in this article) like operating systems for transactions over the Internet. Broadly speaking, a blockchain is a database of digital transactions that are recorded in chronological and linear order. Before a block of transactions is added to a blockchain, participants in that blockchain’s network must verify the authenticity of the transactions. Once a block is added to ablockchain, the block cannot be modified or removed.

Proponents of blockchain technology believe its main promise is that it offers a more efficient, secure and transparent mechanism for storing, tracking, trading and verifying assets and information — a mechanism that does not require the involvement of central authorities or other trusted third parties. Ifblockchain technology lives up to its promise, it may have a revolutionary impact on businesses across every major industry, governments and even the legal profession.

Some have compared the emergence of blockchain technology to the emergence of the Internet and e-commerce technology in the early 1990s. Much like the early 1990s, when businesses were exploring new uses for the Internet and e-commerce technology, we are seeing significant experimentation withblockchain technology. Some of the blockchain technology-related business and technical trends that we anticipate seeing over the next 12 to 18 months include:

• development of more robust blockchain frameworks
• continued collaboration among industry leaders and formation of new standards organizations
• propelled growth of the Internet of Things (IoT)
• acceleration of investments in blockchain technology startups.

Since Oliva Woolston Morgan and I spoke about the tech trends for 2016 and beyond in our Tech Crammer event last month, blockchain technology has never been far from IT/tech industry headlines. But what is it, and what is all the fuss about?

I will be posting a series of blog posts on the subject of blockchain in the coming weeks, but I will start here by shedding some light on what the technology is itself, and offering a window into its potential to be one of the most significant technological developments in recent years.

Blockchain is the cryptographic technology that underpins the digital peer-to-peer currency Bitcoin. Bitcoin itself has had mixed press, with a volatile value, limited traction with retailers and headlines that include hacks and fraud. Bitcoin is proving resilient, however, and when you look past the currency itself and at the enabling blockchain technology, Bitcoin’s success or failure is arguably an irrelevant side story.

Blockchain is increasingly being touted as being as significant a development as that of the internet. A bold claim, but if the internet provides near instant digital communication, blockchain provides near instant digital transfer of assets/ownership, and security of data movement.

It is a challenge to summarise technology that is rather complex, but in a nutshell:

• A blockchain is like a database, but the way it is updated and the way users or applications access the information is fundamentally different;
• A blockchain can store any data (e.g. not just the balance and ownership of bitcoins, but any kind of ledger, register or record);
• A blockchain binds computers together in a distributed network arrangement;
• A distributed network means that the entire record of the blockchain is accessible by every computer in the network, making it easy to verify any existing data, and very difficult to hack or alter data as it is reinforced by the rest of the network;
• Each block of new data is added to the chain of existing blocks, telling the story of every transaction that has gone before it.

This structure gives blockchain dual security traits: (i) the cryptographic storage and transfer of data, and (ii) the evidential layering of successive blocks creating a publicly verifiable, distributed record of events.

Although Bitcoin has suffered a number of security breaches, including one high profile ethical hack about a year ago, these attacks have all been focused at the “wallet” or the user interface area. Theblockchain itself remains secure, and very resilient to fraud.

In the hope that you’re still reading following the technical section, the take away message is that if data or transactions are being delivered via a blockchain solution, we can, for now, assume that the data itself is secure and trustworthy. The user interface such as the strength of your password remains an issue, but that is no different to the way we currently access data and online services.

I will be expanding on the potential uses for blockchain in blog posts to come, but current projects under use and/or development include an E-Governance system in Ukraine, a land title register in Honduras, and a register of diamonds set to crack down heavily on the blood diamond trade. And ironically, a whole host of private blockchains are being built by the world’s largest financial institutions in various collaborative efforts in order to trial the use of the technology to offer faster, cheaper, safer financial transactions.

As well as updates on the blockchain developments as they arise, other topics I will explore in future posts include ‘smart contracting’ facilitated by the blockchain, and what legal challenges the blockchainwill face.

The chances are this is not the first time you have heard of blockchain. You can guarantee it won’t be the last.

Over US$1B is likely to be collectively spent on bringing blockchain technology to capital markets in 2016, according to a recent survey of 134 global market participants. Of the businesses with bitcoin projects, 32% have an annual budget in excess of US$5 million, and 47% top US$2 million. This significant level of investment has been motivated by the various advantages presented by bitcoin technology and its potential to revolutionise global capital markets. Indeed, a majority of businesses surveyed predictedblockchain would create ‘meaningful change’ in capital markets within five years. Furthermore, the survey participants were mostly unconvinced that legal regulation would significantly impedeblockchain adoption. As such, the nascent interest in blockchain use in capital markets seems likely to continue.

Public financial institutions are also getting involved. At a recent international summit of international bankers, the US Chairperson encouraged attendees to educate themselves on blockchain. In Canada, the central bank is working alongside private banks and R3 (a blockchain company). They are trialling a digital currency (Cad-Coin) and allowing limited participants to engage in interbank payments withblockchain technology. The Bank of England is also looking into possible applications of the technology, with the deputy governor raising the possible consequences of a digital pound in a recent speech.

There is also continued interest in possible blockchain applications in the private sector. Japan’s Mizuho Financial Group have partnered with IBM to research the possibility of using bitcoin for the instantaneous transfer of payments during settlements. This is part of a broader strategic effort on the part of Mizuho to explore the various potential applications for bitcoin and follows Mizuho’s announced collaboration with Cognizant to explore the potential of blockchain in facilitating secure and safe record-keeping earlier this year.

The Market Abuse Regulation (MAR) becomes directly effective in Irish law from 3 July 2016. MAR is to be supplemented by delegated regulations (Delegated Regulations), and implementing technical standards and guidelines (Implementing Regulations) to be adopted by the European Commission and the European Securities and Markets Authority. In time, there will also be specific Irish implementing regulations.

Source: William Fry

The Economic Secretary to the Treasury, Harriett Baldwin, has announced that the UK will:

1. Establish a FinTech panel to (a) set an overarching FinTech strategy for the UK; and (b) monitor and drive forward FinTech initiatives;
2. Create a professional services information hub, to make it easier for FinTech businesses to find the services they need; and
3. Work with UK Trade and Investment to establish ‘FinTech Bridges’ with priority global markets, to help UK FinTechs to expand internationally.

Harriett Baldwin said, “The government wants to ensure that the UK continues to be the best place in the world to be a FinTech company … The[se] measures … show that we are … committed to initiatives which will make our FinTech sector even stronger“. The government will be announcing more policies to support the FinTech sector in due course.

The European Parliament formally agreed to delay the rollout of the Markets in Financial Instruments Directive II for one year, until January 3, 2018, according to published reports. The European Commission had recommended such action in February 2016 (Click here for details in the article, “EC Formally Proposes Delaying MiFID II Rollout for One Year” in the February 14, 2016 edition of Bridging the Week.)

Source: Katten Muchin Rosenman LLP

At first glance, PRA regulatory measures are of little interest to the buy-side. However, the PRA’s first consultation paper (CP 9/16) on the implementation of Recast MiFID (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) is worth noting for its impact on sell-side firms with whom the buy-side interact.

Source: Eversheds

ESMA has updated its Q&A paper on the common operation of the Market Abuse Directive. The updated Q&A include a new question on investment recommendation, specifically whether certain statements fall within the definition of ‘recommendation’ in Article 1(3) of the Commission Directive 2003/125/EC on the fair presentation of investment recommendations and the disclosure of conflicts of interest (Investment Recommendations Directive) and therefore need to comply with the relevant obligations set out in that Directive. The Q&A were last updated in November 2015. ESMA has also published updated version of its Q&A on the implementation of EMIR, which were last updated in February. The only change to the previous version of the Q&A is a new question and answer on the population of the “clearing obligation” field in trade reports (TR Question 42).

Source: Cummings Law Ltd

The Market Abuse Regulation becomes law on 3 July 2016 and will replace the UK’s existing civil regime. The Regulation will rely on a range of secondary legislation including a number of regulatory and implementing technical standards.

In March, the Commission published the following:

• a delegated regulation setting out the regulatory technical standards for the conditions applicable to buy-back programmes and stabilisation measures (if neither the Council nor European Parliament raise any objections, it will enter into force on the day after its publication in the Official Journal of the EU and apply from 3 July 2016) – to see the text in full, click here,
• an implementing regulation setting out the implementing technical standards with regard to the precise format of insider lists and for updating insider lists ((the regulation entered into force on 12 March 2016 (the day after its publication in the Official Journal) and applies from 3 July 2016) – to see the text in full, clickhere, and
• an implementing regulation setting out the implementing technical standards with regard to the timing, format and template of the submission of notifications to competent authorities by operators of regulated markets and investment firms, and operators of multilateral or organised trading facilities (the regulation entered into force on 18 March 2016 (the day after its publication in the Official Journal) and applies from 3 July 2016) – to see the text in full, click here.

Source: Hogan Lovells