Blockchain – When legislation and regulation can be a competitive tool

New technology and new technological advances often entail new business opportunities and challenges. The ongoing digitisation with the Internet as a public communications network creates such opportunities: we learn about and search for information online, we read our daily newspaper online – in digital format and not in paper format – and we shop to a greater extent online, and not in physical stores.

The question and challenge for the legislator is always how to deal with new technology and many people – especially new technology developers – often have the impression that the legislator does not “keep up” with developments, but instead applies the brakes. In some cases, the legislative tool is used to enable, or at least facilitate, the use of new technologies. In our increasingly globalised world, this is sometimes done to create comparative advantages and to entice new companies that rely on new technology to establish operations in the country, thereby attracting new businesses and creating investment opportunities in the country.

One example that can be cited to illustrate legislators on the leading edge involves the initiatives adopted early on at the EU level to harmonise and lay the foundation for a common EU legal framework in e-commerce. There is no question that these initiatives and the harmonisation that has occurred have contributed to today’s largely coherent and unified European e-commerce market.

Blockchain is a new technology that may be in its infancy in commercial terms, but that has great potential for new businesses; some people believe that the technology will alter society even more than the internet did. Only the future will show whether this is the case, but clearly major investments are being made in various types of blockchain technology-based operations.

In this article, we will highlight how some countries have adapted or have been proactive in their regulatory approach to promote businesses that are new or could potentially change through the use of blockchain technology.  The report does not portend to provide a cohesive picture of what is happening globally, but rather presents an array of examples of initiatives currently underway.

What is a blockchain?
Before we address actual legislative issues, it may be appropriate to briefly describe blockchain technology. This description is not particularly detailed or comprehensive, but will offer an overview of the fundamental elements on which the technology is based.

A blockchain can be described as a tool that manages the transfer of value from one party to another. Blockchain can also be used to store various types of information, such as contracts and other documents.

Just as the internet revolutionised the transfer of information between parties, many argue that blockchain technology may have the same significance regarding the transfer of value between different parties. Blockchain technology is based on several different components. Below is a comprehensive yet simplified explanation of the main components:

• Database structure
• Distributed database
• Consensus mechanism
• Cryptography
   

Database structure
A blockchain structures information in a database. It can also be compared to a type of ledger where information is built up and stored in different blocks. Each block has a timestamp and a reference to the immediately preceding block in the chain. The blocks are stored in chronological order and information in previous blocks cannot be deleted, which means that all data changes are stored historically. The method of structuring data in a blockchain in combination with an advanced form of cryptography means that, in principle, it is impossible to change and modify historical data without it being clearly visible in the database that something is not correct because if data is manipulated, the link to the previous block in the chain is broken.

blockchain_blocks.png

Distributed database
Another important component in blockchain technology is that it is a distributed database.  Everyone who participates in the network has access to a copy of the most recent relevant blockchain. Instead of a centrally stored database, thousands of identical databases stored in computers and servers around the world are used. Consequently, information stored in a distributed database is much harder to manipulate and less vulnerable to, for example, cyberattacks, since information is not only stored in one central location, but on many computers all over the world, which means that a cyberattacks must be aimed at substantially more parties to be able to cause damage.

Consensus mechanism
When adding new information to the blockchain and creating an additional block, there is a special consensus mechanism where those who participate in the network also check and validate a new transaction according to certain predetermined rules. In order for a transaction to be approved and added to the blockchain, the majority of those participating in the network must verify that the transaction is correct. In a blockchain, the network has the monitoring function, rather than a central party. In the largest open blockchains, such as Bitcoin and Etherum, enormous computer power is needed to maintain the blockchain.  

Cryptography
Cryptography is one of the most important components of a blockchain and the encryption method usually used is called hashing.

Cryptography ensures that network participants only see the information to which they have access rights and the transactions are secure, authenticated and verifiable.

A word on public and private blockchains
Blockchains are usually divided into two main categories, public and private.

A public blockchain are completely decentralised and open to everyone. Everyone can read transactions, carry out transactions and participate in verification and validation of transactions. The most widely  known public blockchains are Bitcoin and Etherum.

In a private blockchain, transactions are validated instead by trusted parties, e.g. banks and public authorities.  In a private blockchain, access to the information in the blockchain can also be restricted to certain parties. The most widely well-known private blockchain is Hyperledger, which was developed by companies such as IBM and Accenture.

In what sectors will blockchain have the greatest impact?
Following a brief review of the technology, the next question involves what sectors can use blockchain technology.

The technology has great potential in many sectors, where it could have a major impact in the future. Such fields include banking and finance, logistics, energy, health care, aid and authorities, just to name a few. The common denominator is that these sectors/industries manage large amounts of information and/or transactions, they have high demands for security and, in some cases, centralised management is replaced by decentralised management.

One example of a practical application can be seen in Dubai, which announced that it will use blockchain for storage of all government documentation (about 100 million documents per year) by 2021. The estimated annual savings will be a little over EUR 1 billion.

Some examples of legislation
Different countries have taken a variety of initiatives for new legislation and we will present our views on some of these initiatives below. The report is not comprehensive and is provided on an overarching level.

Switzerland – Initial Coin Offerings (ICO)
Initial Coin Offerings, or ICOs, comprise a phenomenon that has increased sharply in scope in conjunction with the development of blockchain technology. This is a form of crowdfunding in which a company, in conjunction with raising capital, issues its own “coins” or “tokens” without any dilution of equity in most cases. The ICO market has expanded sharply in recent years and is expected to have raised a total of USD 6 billion in 2017 alone. The trend in 2018 continues to be extremely strong. As an example it can be mentioned that in early June, Block.one completed the largest ICO of all time, raising more than USD 4 billion, which is on a par with the largest IPOs to date in 2018. ICOs have been surrounded with major uncertainties regarding what legislation to apply and there have also been a large number of frauds associated with ICOs, for which reason Finansinspektionen (the Swedish Financial Supervisory Authority) is among the regulatory authorities that has issued general warnings.

Switzerland has become a global centre for ICOs. The Swiss authorities have actively supported blockchain technology and the ICO market by clarifying the rules that apply for entrepreneurs in conjunction with raising capital through an ICO.  To this end, FINMA (Switzerland’s equivalent of Finansinspektion) has issued “Guidelines for enquiries regarding the regulatory framework for initial coin offerings (ICOs)” (source) and may also provide advance notification for certain matters.

By providing clarity in its legislation and a proactive approach from its supervisory authority, FINMA, Switzerland has thereby gained a comparative advantage and many companies that have wanted to raise capital through ICOs have done so in Switzerland. According to a survey conducted by PwC, four of the world’s ten largest ICOs used Switzerland as a base.  

US – Corporate issues
In the US several states including Arizona, Tennessee, Delaware and Wyoming have implemented various laws related to blockchain technology. For example, the new laws include a recent amendment to Wyoming’s Business Corporation Act (source) that permits companies registered in Wyoming to use a blockchain or other electronic networks and databases to store corporate documents. In addition, it will be possible to provide notice to shareholders regarding a general meeting by electronic transmission to a data address provided by the shareholders to the company and to allow shareholders to exercise their voting rights using electronic signatures linked to the electronic addresses. Under the amendment, blockchain can be used to identify shareholders in the corporation’s current record of shareholders by a data address, provided that the company can revert to a written record within a reasonable period of time. Wyoming has also clarified that companies may issue tokens in an ICO that are excluded from securities legislation provided that the acquisitions of tokens cannot be considered to be an investment. 

Gibraltar – Licensing of blockchain companies
In Gibraltar new legislation came into force on January 1, 2018 (source) requiring any company in or from Gibraltar that uses blockchain technology for storage or transmission of value belonging to another party to be authorised by the Gibraltar Financial Service Commission (GFSC) as a “DLT provider” (Distributed Ledger Technology Provider). Through its approach Gibraltar is the first country to introduce in legislation a dedicated license for Fintech companies that use blockchain technology.  One aim of the new regulatory framework is to promote Gibraltar as a jurisdiction that fosters innovation and understands the need for clear, but agile, regulations adapted to the rapid technological developments in this field.

Malta – Established a dedicated authority and new regulations
One of the most recent countries to announce new blockchain regulations is Malta. From the government’s standpoint the purpose of the regulation has been clear and government representatives have stated that Malta aims to be a world-leading hub for innovative blockchain companies. This aspiration is clearly expressed in the report “Malta: a leader in DLT regulation” issued in November 2017.  Malta recently published three different  comprehensive blockchain technology-related bills that have been proposed. The first proposed bill provides for the establishment of the “Malta Digital Innovation Authority,” (source) which will be responsible for developing and implementing regulations to facilitate and reduce uncertainty related to the regulations that apply for new innovative technologies. The second proposed bill, “The Virtual Financial Assets Act and the legal frame-work for Virtual Financial Asset Exchanges,” (source) concerns the regulatory frame-work regarding implementation of fundraising in conjunction with ICOs and a regulatory framework for cryptocurrency exchanges. The third and final proposed bill, “The Innovative Technology Arrangements and Services Act,” (source) concerns certification of various innovative technological solutions, as well as a registration procedure for companies that provide these types of services.

As a result of Malta’s new proposed bills even though they have not yet been formally adopted, Binance, the world’s largest cryptocurrency exchange based on daily trading volume, announced in late May 2018 that it will move its headquarters to Malta.

Sweden – what is happening here?
A number of initiatives involving a variety of participants are underway in Sweden.

One project in its final development phase, which also has garnered considerable attention in the international press, involves Lantmäteriet, the Swedish mapping, cadastral and land registration authority, which together with parties such as lenders SBAB and Landshypotek, and the phone company Telia, are exploring opportunities to digitise and secure all documents in conjunction with property transactions using blockchain technology – from the time of the sale, via the real estate broker and bank, until the new owner is recorded in the land registry.  Blockchain technology will be used in this process to verify all transactions and documents such as purchase contracts, loan documents, mortgage deeds and title registration documents.  

Several of the major banks are also engaged in various initiatives involving the new blockchain technology.  For example, SEB and Nasdaq have initiated a “Nordic Fund Ledger” project that could revolutionise mutual fund trading.  The purpose of the project is to digitise procedures related to mutual fund trading and to provide various market participants with access to a common database in which all transactions and changes can occur in real time. As a result of the blockchain solution, no central institution will be needed and by extension, both risks and costs will be reduced.

Regarding legislation and initiatives from Finansinspektionen, the following can be mentioned:
In March 2018, Finansinspektionen established a dedicated Innovation Centre with the primary task of providing information and guidance for innovative companies. However, the Innovation Centre does not engage in advisory services, investigations, or providing advance notice regarding the necessary permits an enterprise may need for its specific business; as previously, such matters are addressed through the customary permit application process at Finansin-spektionen.  In terms of legislation, however, we have not found any particular initiatives relating to blockchain technology.

Conclusions
The development of blockchain technology is progressing at a rapid pace and the new technology will probably have a major impact on many areas and industries over the next few years. As is often the case when sweeping technological changes occur, legislators do not really keep up, which creates uncertainty. In many countries we see legislators making an effort to facilitate these technology developments with new legislation and in several cases, this is done with the purpose of attracting new entrepreneurs and businesses to a country.

Sweden is at the forefront of many areas that will be affected by blockchain technology, especially in the financial sector, and in particular, the field known as Fintech.
While some regulatory activity is underway, the question is whether it is sufficiently bold and progressing rapidly enough. If Sweden lags behind in its legislative and regulatory legislative efforts, there is a great risk that blockchain technology-based businesses will become established in other countries. It is therefore important to ensure through clear, proactive and technology-friendly legislation that we create conditions that encourage enterprises to build their businesses using blockchain technology.