Photo Credit: whiteMocca/Shutterstock.com

Blockchain and its use in the transfer and ledger of transactions including cryptocurrency has been promoted as the next Internet or even more. Blockchain, a decentralized data ledger of promised secure transactions provides a significant benefit to supply chain accounting and buy/sell logistics for products and food. As recently reported in the Wall Street Journal (WSJ):

True, blockchain is still in its early stages of development and deployment. Its capabilities have been often oversold, as is the case with just about all promising technologies. … [I]f blockchain one day lives up to its promise, it could “transform how society operates, becoming one of the most significant innovations since the creation of the Internet. The opportunity to harness this innovation to help tackle environmental challenges is equally significant.”

Irving Wladawsky-Berger, “Blockchain's Potential for Environmental Applications,” Wall Street Journal, CIO Journal (Nov. 30, 2018).

A report on blockchain by the World Economic Forum this past September listed over 65 blockchain-use cases in areas such as climate change and biodiversity, loss of air quality, ocean warming, and fresh water-related issues.

The WSJ article further notes that blockchain “in combination with other advances [and] technologies could disrupt existing business models and lead over time to truly transformative solutions,” including a “game changer” relating to “see-through” supply chains, as follows:

Supply chain applications will likely be among the earliest commercial blockchains in production. The infrastructures and processes of supply chains are significantly less complex than those in financial services, healthcare, and other industries. Their objectives are relatively straightforward: increase the speed, security and accuracy of financial and commercial settlements; track the supply chain lifecycle of any component or product; and securely protect all the transactions and data moving through the supply chain. Blockchains ability to record all transactions flowing through a supply chain creates an immutable record of a product's origin, with the potential for full transparency and traceability from source to store. … Looking into the future, blockchain has the potential to connect all stakeholders in a global supply chain. … A platform that provides the data, traceability, transparency, control or compliance mechanism that the given user needs would be a truly transformational proposition for workers in the informal economy and consumers alike.

Id.

By establishing “smart contracts” that automate processes in a blockchain transaction, supply agreements and their terms and conditions can be located nearly instantly to determine the location of foodstuffs or goods, their temperatures, their freshness, stops along the supply highways and more data as pertinent to the transactions. The data stored in the blockchain promises to be immutable and thus cannot be changed or misused due to the extreme difficulty of changing the data in all the locations in which it appears on computers and through the use of “hashes” or code to authenticate the transactions utilizing public and private data keys.

While blockchain promises to alleviate and remove the “middle man” in banking and securities transactions, especially as to clearing stocks and matching orders and collecting and paying funds, and doing away with clearing processes in back offices, it remains to be seen whether banks and securities firms, and their regulatory oversight, will allow robotized account transactions without the checks and balances of standardized banking or securities transactions. It is presently inconceivable that fields such as investment banking and complex transactions and processes can easily adapt to blockchain.

On a granular level, in terms of its legal implications and applications, attempts will be made to use blockchain to negotiate and complete transactions and automate and secure documents and electronically stored information, or ESI. While there is “no stopping progress,” these far-reaching applications will undoubtedly hit speed bumps in terms of maintaining attorney-client privilege and “work product” from disclosure. In addition, the use of smart contracts to notify the parties to transactions about compliance and default will be affected by the terms of the agreements and subsequent or contemporaneous changes and modifications. Partial or incomplete compliance with a contract might set off alarm bells if the smart contracts had the knowledge and wherewithal to search for breaches and to incorporate possible negotiations to cure what otherwise would be a violation. To use blockchain to truly revolutionize the drafting and performance of contracts, there must be a database of all general and particularized terms of a draft agreement with conditions and the requirements of the parties. Pen and paper or direct inputting through word processing programs currently work well in fulfilling this function and are not likely to be replaced by blockchain, potentially sacrificing speed and elimination of high transaction costs. Simple or repetitive contracts might be possible for a ledger if blockchain transactions became routinized and easy to use.

Other aspects of legal practice are not ready to function on a blockchain, such as litigation, except perhaps in terms of sharing and providing information through the discovery process. Issues concerning confidentiality and privilege will hamper a blockchain litigation ledger.

In a recent case, Commodity Futures Trading Commission v. McDonnell, the Hon. Jack Weinstein, Senior U.S. District Judge for the Eastern District New York, cited to the Feb. 6, 2018 written Congressional testimony of the Chairman of the Commodity Futures Trading Commission (CFTC), J. Christopher Giancarlo, who commented on the potential benefits of blockchain. Blockchain or distributed ledger technology or DLT:

promises assistance to financial market regulators in meeting their mission to oversee healthy markets and mitigate financial risk. What a difference it would have made on the eve of the financial crisis in 2008 if regulators had access to the real-time trading ledgers of large Wall Street banks, rather than trying to assemble piecemeal data to recreate complex, individual trading portfolios. I have previously speculated [in Keynote Address before the Markit Group, 2016 Annual Customer Conference New York, May 10, 2016] that, if regulators in 2008 could have viewed a real-time distributed ledger (or a series of aggregated ledgers across asset classes) and, perhaps, been able to utilize modern cognitive computing capabilities, they may have been able to recognize anomalies in market-wide trading activity and diverging counterparty exposures indicating heightened risk of bank failure. Such transparency may not, by itself, have saved Lehman Brothers from bankruptcy, but it certainly would have allowed for far prompter, better informed, and more calibrated regulatory intervention instead of the disorganized response that unfortunately ensued.

CFTC v. McDonnell, 287 F. Supp. 3d at 247 (Appendix C, U.S. Senate Banking Committee, Hearing on Virtual Currency, Feb. 6, 2018 (written testimony of J. Christopher Giancarlo, Chairman, CFTC)).

Again, smart contracts could be utilized widely in addressing market anomalies becoming a market “hot switch” or transaction circuit-breaker. As further commented by the CFTC Chairman: “… DLT will likely develop hand-in-hand with new “smart” contracts that can value themselves in real-time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.” See CFTC v. McDonnell, 287 F. Supp. 3d at 257; Massimo Morini & Robert Sams, “Smart Derivatives Can Cure XVA Headaches,” Risk Magazine, Aug. 27, 2015; see also Jeffrey Maxim, “UBS Bank Is Experimenting with 'Smart-Bonds' Using the Bitcoin Blockchain,” Bitcoin Magazine, June 12, 2015; see also Pete Harris, “UBS Exploring Smart Bonds on Block Chain,” Block Chain Inside Out, June 15, 2015; see generally Galen Stops, “Blockchain: Getting Beyond the Buzz, Profit & Loss,” August-September 2015, at 20.

Still, while the vision for blockchain looms large and has captured the attention of business leaders across many industries, practical application, despite significant investments, has yet to materialize beyond the cryptocurrency sphere, which has lost some momentum after Bitcoin's meteoric rise and ultimate plunge in late 2017. Global consulting firm McKinsey & Company estimates that venture capital has funded blockchain-focused startups with over $1 billion in capital investments and additional $5 billion funded for crypto-related startups and coin offerings alone. Established financial institutions and tech behemoths, too, have invested billions of dollars to begin testing the technology. Both fascination and fear of falling behind has spurred a technological “arms race” among firms and investors to lead the pack in implementing blockchain solutions; however, there is not much to show for it. As a recent McKinsey article notes:

Despite the hype, blockchain is still an immature technology, with a market that is still nascent and a clear recipe for success that has not yet emerged. Unstructured experimentation of blockchain solutions without strategic evaluation of the value at stake or the feasibility of capturing it means that many companies will not see a return on their investments. With this in mind, how can companies determine if there is strategic value in blockchain that justifies major investments?

Brant Carson, at al., McKinsey & Company, “Blockchain beyond the hype: What is the strategic business value?” (June 2018).

Another hurdle companies and investors face is creating a single platform with common standards. For example, is it difficult to imagine the success of the locomotive industry if multiple railcar companies established their businesses with different sized rails. Similarly, the essence of the blockchain lies in its ability to be a consistent ledger and tool used even by competing firms, ultimately creating efficiencies across entire industries. Again, as pointed out by McKinsey, it has been acknowledged that this is a shortcoming and will take major institutions and regulations to lead the way on establishing these standards:

The lack of common standards and clear regulations is a major limitation on blockchain applications' ability to scale. However, where there is strong demand and commitment, work is already under way to resolve this issue. Standards can be established with relative ease if there is a single dominant player or a government agency that can mandate the legal standing. For example, governments could make blockchain land registries legal records.

Id.

It is important for leaders not to view the blockchain as a simple “cure-all” for inefficiencies that simply requires a public announcement and an investment. Instead, leaders must recognize that it is a nascent technology and concept that needs to be applied in the beginning to smaller-scale, specific issues before it can become the next Internet.

In conclusion, blockchain may someday be a game changer as predicted as long as there is early adoption, and security in transactions that don't jeopardize the parties' expectations and provides safety with respect to goods, services and funds. After the kinks are worked out, blockchain may become a seamless aspect of the world created by, and in many instances enhanced by, the Internet. Despite its shortcomings, however, blockchain is here to stay, and, predictably, will be part of the “Internet of Things.”

Bruce A. Langer is a litigation partner at McLaughlin & Stern. who has written about technology and other subjects of interest to the bar.