Blockchain and in-house legal teams: entering the realm of the unknown

First published by IBA In-House Perspective on 30 September 2019

Blockchain has long been touted as the technology that will revolutionise the global economy, so it was only a matter of time before the legal sector started taking note. Law firms such as White & Case and Clyde & Co are among those getting in on the act, with the former using the technology to streamline the due diligence process while the latter has created a blockchain-powered contract for its insurance clients.

Given that blockchain is essentially a time-stamped record of data that no one directly owns and no one can tamper with, its attraction to an industry that values transparency and integrity is clear. Yet for in-house legal teams, blockchain and its uses remain in the realms of the unknown. Lesley Wan, General Counsel for First Bank of Nigeria’s United Kingdom arm FBN Bank (UK), predicts this will have to change. ‘General counsel are still learning about this’, she says, ‘but they are interested and know they need to get on top of it’.

Part of the reason why so many in-house lawyers have started thinking about how blockchain technology could impact their working lives is the hype around it. Persistent predictions suggest that cryptocurrencies, like Bitcoin, Ethereum or the as-yet unlaunched Facebook Libra, will render existing currencies – and banks – obsolete. Meanwhile, blockchain can simply make transacting business better, according to the near-constant chatter about the technology.

However, as Callum Sinclair, Head of the Technology Sector and Divisional Head of Commercial and a partner at Burness Paull, points out, for now, this is mainly just talk. ‘There’s about a million people talking about this, but it’s a bit of smoke and mirrors: when you go beneath the surface they are just talking about it’, he says. ‘The number of businesses doing it at scale is very small at the moment’.

Joost Linnemann, Vice Chair of the IBA Technology Law Committee and a partner at Dutch firm Kennedy Van der Laan, agrees, although he believes the bluster may have peaked, allowing serious discussions about the technology’s implications to take place. ‘We’re in a post-hype situation in the sense that there was a lot of buzz around it and people were evangelising about it changing the world’, Linnemann says. ‘A lot of reference was made to Bitcoin and public blockchains that would disrupt infrastructure systems like payments. We’re now in a situation where that buzz has largely died down.’

Part of the reason why people have been unable to cut through the rhetoric is that, even at its most basic level, blockchain is a complex concept to explain. Most people have heard terms like ‘distributed ledger’ and ‘decentralised database’, but few would be able to explain what they mean. Throwing in words such as ‘immutable’ and ‘unhackable’ has done in-house lawyers, some of whom have been convinced that blockchain could totally disrupt their industry, no favours.

‘There are two types of explanation’, Linnemann says. ‘One is so technical and complicated that if you’re not a computer scientist you won’t understand it. The other is so abstract that it fails to serve the purpose of telling you what’s important in a legal context. What’s missing is an explanation of the technology that’s not too complicated but complicated enough for a lawyer to be able to use it.’

At the same time, as Addleshaw Goddard partner Steven Francis points out, for in-house legal functions, many of which will be made up of just one lawyer, ‘the business as usual stuff dominates’. ‘Understanding of blockchain is quite good in private sector law firms and is very good in some commercial organisations that are at the IT [information technology] sharp end and are looking to provide blockchain services’, he says. ‘But in-house lawyers tend to be the most pragmatic of people and they are under-resourced; there’s not a lot of budget for this’. 

Despite this, examples are beginning to emerge of ways blockchain technology could make an impact in the wider corporate world. IBM and Walmart have teamed up in China on a project designed to monitor food safety; United States financial services giant AIG has created a smart contract that is expected to cut costs and promote transparency in the insurance world; Danish conglomerate Maersk is trialling a project that allows organisations in the container logistics industry to have a shared view of shipping transaction data; and Dutch technology business Essentia One is developing a system that will allow customs agents and borders staff to record and store passenger data from a range of different sources.

Though these are all much smaller in scope and scale than anything envisioned in the cryptocurrency world, for Sinclair, they are perfect examples of how blockchain is likely to end up being used.

‘Bitcoin and other cryptocurrencies are the best known [uses of blockchain] and they’re all being launched on an open-source basis, but the smaller private ones could be substitutes for databases, in banks for example’, he says.

Sinclair explains how blockchain excels at things like asset tracing in supply chains. He points to Spiritus, a company based in Edinburgh that specialises in asset tracing in healthcare, and which has run a couple of pilots with NHS Scotland and Napier University. ‘If you have a pacemaker and it goes wrong there are very serious potential consequences. It’s imperative to detect what the weak link is in the chain, especially where there are multiple suppliers involved in making a complex piece of equipment. If the tracking numbers are all in the blockchain then you can detect very quickly where the problem lies.’

Another example cited by Sinclair is Axa’s insurance product fizzy, a smart contract that automatically processes compensation payments if certain criteria are met. ‘Based on a smart contract it will interrogate an independent source of flight information and will use computer code to say “if that plane arrives after that time then that account will be credited with this amount of money”’, Sinclair says.

However, for these systems to work efficiently, businesses have to surrender their data to them, something that is likely to create a range of issues for those tasked with safeguarding such information.

‘[In-house lawyers] need to think about cybersecurity because using new technology or integrating it into your own systems involves certain risks’, says Nazar Chernyavsky, Cybersecurity Officer on the IBA Technology Law Committee and a partner at Ukrainian firm Sayenko Kharenko. ‘Not many companies are aware of all the cyber risks; a lot of education still needs to be done. When you open up your data or integrate your system with an external system you need to make sure it won’t damage your own one. If blockchain is used in some critical infrastructure like nuclear energy or telecommunications you need to be sure that it can’t be interfered with and that nobody can destroy it.’

It is generally taken as a given that blockchain is highly secure: one of its key features is supposedly that once the computer code has been written it cannot be overwritten and once a piece of data has been recorded it cannot be altered or removed. In itself, that can have serious corporate governance implications given that the potential for human error will always exist. At the same time, and almost paradoxically, there are issues in that the assumption of immutability is not necessarily true.

‘If you feed the blockchain the wrong information and it perpetuates it’s very difficult to reverse out of that’, Sinclair says. ‘Ethereum was $150m into people losing money [after a code bug was triggered in 2017] before people realised there was an issue, but you can’t reverse that out without breaking the integrity of the blockchain. If you’re a core developer and you can change the code where does that leave the whole premise? At the same time, if you preserve the integrity of the chain people lose out.’

Even if a mistake is obvious and all users of the blockchain agree it should be reversed, risks remain. ‘If there’s an obvious mistake then all users can vote on a remedy’, Chernyavsky says. ‘If it’s an obvious mistake that’s a good thing and you can always trace all the changes, but governments are afraid that someone might accumulate a majority vote to do that. It is untested ground how that might develop and governments [are not using blockchain themselves because they] don’t want to take that risk’.

Yet it does not necessarily follow that governments will start writing laws to help mitigate the risk. In Chernyavsky’s view, ‘blockchain is a technology so it doesn’t require any legal regulation’.

Linnemann agrees. ‘People argue that this is new and will need a legal system, but that’s not the case’, he says. ‘What complicates things is that there’s an ideological underpinning. The reason Bitcoin was invented was to get rid of banks. It’s not surprising that if you want to get rid of traditional banks you will also want to get rid of traditional and limiting legal systems. Laws are not required to use the technology in any useful sense.’

Even if individual countries did end up bringing in specific laws, it is unclear how effective they would be in practice given that the long-term vision is for blockchain to become as pervasive and as global as the internet.

‘There’s a core issue around the validity of smart contracts because they have no geographic tie to anywhere in particular’, Sinclair explains. ‘Any blockchain of any scale will have nodes in lots of countries so even if it is regulated in one country, where would you bring an action? Would the validity of the smart contract be recognised by the court? That’s all still very much up in the air.’

For the companies creating or using such contracts, this clearly creates a legal minefield, which is why Francis at Addleshaw Goddard believes that the very least that is required is some kind of international guidance on best practice that all businesses could refer to. He believes there is little use in a single country bringing in legislation on its own but that some kind of supranational common standard is essential. ‘We are so far away from being able to draft a statute that says “when a contract is on a ledger these are the elements that make up that contract”, but it would be worth having guidance’, he says. ‘There will eventually be standard ways that parties do things and legislation might be written on the back of practice, but for now we need some really good, detailed guidance, for example on how to produce evidence in court. That would help companies to at least get to grips with it.’

Whether or not such guidance does emerge, Linnemann believes that other rules are likely to be adapted to take account of the technology’s influence on already-regulated sectors.

‘There are specific areas like financial services, which are regulated anyway, where this technology will lead to some additional regulation’, he says. ‘Initial coin offerings have been found to be a new way of raising money, which need regulation like all the other ways of raising capital like IPOs. Like we saw with the internet, quite a lot of the rules we have already could be used to deal with any legal issues.’

For now, this is likely to remain moot to some degree, with Chernyavsky noting that ‘at the moment there’s quite a limited use of blockchain’. ‘There are some small projects in different countries, but when it comes to the actual application of blockchain there’s not much there’, he adds.

Nevertheless, Linnemann predicts that ‘we’ll see a significant uptick in the more corporate situations [as opposed to public applications like cryptocurrencies] and a lot less hype’. If this transpires, all in-house lawyers will have to familiarise themselves both with the technology itself and the possibilities – and issues – it presents.

‘It won’t be in an instant, but in a few years’ time, given that the technology is there, the uptake will be rather swift’, Linnemann says. ‘Unlike the internet, where in theory a lot was possible but [there wasn’t] the bandwidth or connectivity to make it happen, the underlying infrastructure is there. The technology as such is robust, we just need to figure out the right business models and the right governance models and people need to get used to a situation where they share an administrative process rather than having one of their own.’

To be able to weigh the legal risks such a scenario will present, Linnemann believes in-house lawyers should ensure they are ‘able to understand a bit of the technology involved’. ‘You don’t need to be able to understand your car to be able to drive it, but on the other hand you have to have some understanding about what’s typical about blockchain technology to be able to advise on the legal aspects’, he says. ‘Even that basic understanding is quite often lacking in lawyers’.

With the jury still out on just how widespread blockchain is likely become, though, Francis says that, ultimately, it will be up to in-house lawyers themselves to decide whether it is worth investing the time and money required to go beyond the basics. ‘Some people think that blockchain is a solution that hasn’t yet found a problem’, he says. ‘In-house lawyers need to do a bit of an analysis to work out how it might impact them. It was known in the early days of the internet that it was going to be transformational, but it’s different with this, so it’s worth asking yourself what the right level of investment is.