Legal Issues for Lawyers Advising Clients Involved in Blockchain Technology Presented by: James Cox Clear Law Institute | 4601 N. Fairfax Dr., Ste 1200 | Arlington | VA | 22203 www.clearlawinstitute.com Questions? Please call us at 703-372-0550 or email us at [email protected] All-Access Membership Program ● Earn continuing education credit (CLE, CPE, SHRM, HRCI, etc.) in all states at no additional cost ● Access courses on a computer, tablet, or smartphone ● Access more than 75 live webinars each month ● Access more than 750 on-demand courses Register within 7 days after the webinar using promo code “7member” to receive a $200 discount off the $799 base price. Learn more and register here: http://clearlawinstitute.com/member Clear Law Institute, © 2018 LEGAL ISSUES FOR LAWYERS ADVISING CLIENTS INVOLVED IN BLOCKCHAIN TECHNOLOGY James A. Cox DISCLAIMER This presentation should not be considered or construed as legal advice on any individual matter or circumstance. The contents of this document are intended for general information purposes only and may not be quoted or referred to in any other presentation, publication or proceeding without the prior written consent of Jones Day, which may be given or withheld at Jones Day's discretion. The distribution of this presentation or its content is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of Jones Day. 2 www.ClearLawInstitute.com (703) 372-0550 1 Clear Law Institute, © 2018 TABLE OF CONTENTS 1 Cryptocurrencies 2 Introduction to blockchain technology 3 Smart code and smart contracts 4 Applications of blockchain technology 5 Legal and ethical issues 3 1 Cryptocurrencies 4 www.ClearLawInstitute.com (703) 372-0550 2 Clear Law Institute, © 2018 CRYPTOCURRENCY • Virtual currency intended to fill same role as government currencies • Peer-to-peer electronic cash system • Not backed by any government • Bitcoin first decentralized cryptocurrency • Created in 2009 by Satoshi Nakamoto 5 CRYPTOCURRENCY Bitcoin Price Chart Source: https://coinmarketcap.com/currencies/bitcoin/ 6 www.ClearLawInstitute.com (703) 372-0550 3 Clear Law Institute, © 2018 CRYPTOCURRENCY Source: https://www.shutterstock.com (ID 670354525) 7 CRYPTOCURRENCY • Market Capitalization: Approximately $215 billion as of November 8, 2018 • Daily Trading Volume: Approximately $10-20 billion • Largest by market cap: • Bitcoin ($112B), Ether ($21B), Ripple ($20B), Bitcoin Cash ($10B), EOS ($5B), Stellar ($5B), Litecoin ($3B), Cardano ($2B), Monero ($2B) • Still small in comparison to other metrics • Daily Trade Vol.: USD ($4.4T), EUR ($1.5T), CLP ($12B) • Mkt. Cap.: Apple ($1T), Alphabet ($839B), Microsoft ($877B) 8 www.ClearLawInstitute.com (703) 372-0550 4 Clear Law Institute, © 2018 CRYPTOCURRENCY • ICOs have become popular form of raising capital to start-up companies • Over $5 billion raised last year; surpassed that this year • Companies issue digital coins that carry some rights • Investors pays in the form of an established cryptocurrency such as Bitcoin or Ether • Large capital raises: Tezos, Filecoin, Bancor Protocol • Legal gray area 9 2 Introduction to blockchain technology 10 www.ClearLawInstitute.com (703) 372-0550 5 Clear Law Institute, © 2018 CENTRALIZED SYSTEMS Bank Ledger • A central intermediary (e.g., a bank) transfers actual value between two parties and is normally the final authority • All parties involved in a transaction may keep and use their own copies of ledger, but the local copy isn’t authoritative • There is a single point of failure: • if a centralized ledger is lost through IT failure, physical disaster, malware attack, etc., information is lost due to the single point of failure 11 CENTRALIZED SYSTEMS Bank Ledger • Typical examples of centralized databases are relational databases we are all familiar with • Centralized databases may themselves be distributed for redundancy and efficiency purposes without changing their centralized character • The point of difference is whether there is a centralized network participant with unique validation or authentication responsibilities different from ordinary participants 12 www.ClearLawInstitute.com (703) 372-0550 6 Clear Law Institute, © 2018 DISTRIBUTED (DECENTRALIZED) SYSTEMS • Each network participant has its own copy of the ledger • Every local copy of the ledger is authoritative • No central point of failure or attack • Key challenges: • All transactions must be sent to all participants for updating their local ledgers • All copies of ledgers must remain consistent 13 DISTRIBUTED (DECENTRALIZED) SYSTEMS 14 www.ClearLawInstitute.com (703) 372-0550 7 Clear Law Institute, © 2018 WHAT IS A BLOCKCHAIN? • A blockchain is a way of recording a continuous stream of data packets • Example: – The flow of transactions in a financial system – Each transaction reflects some underlying simple operation, such as “A transfers 1 BTC to B” • The transactions are collected into similar-sized blocks • As each is generated, the blocks are recorded serially in some storage medium (memory, disk) • Each block includes a link to the immediately prior block, creating a chain 15 WHAT IS A BLOCKCHAIN? • At their core, blockchains are very simple. • A data structure • Linking blocks of data into a chain has been well understood for decades • Satoshi Nakamoto used that well-understood data structure together with key additional refinements and additions to create blockchain technology 16 www.ClearLawInstitute.com (703) 372-0550 8 Clear Law Institute, © 2018 KEY INNOVATIONS IN BLOCKCHAIN TECHNOLOGY Consensus Digital Signatures Hash Values Code Execution Mechanism • Defines • Makes content of • Miners calculate • Transactions ownership of each block valid nonce and cause execution coins immutable hash values for of programming • Authenticates • Used as link to blocks code valid transactions prior blocks • All nodes accept chain reflecting most proof of work 17 DIGITAL SIGNATURES • Digital signatures are derived from public-key cryptography • Each person has a generated key pair: one public and one private • What’s encrypted with private key can only be decrypted with public key (and vice versa) • Encrypting with private key is a digital signature 18 www.ClearLawInstitute.com (703) 372-0550 9 Clear Law Institute, © 2018 DIGITAL SIGNATURES • Bitcoin uses digital signatures to authenticate valid transactions • Valid coins are defined as chains of digital signatures • To initiate a transaction, a sender digitally signs it using his private key • A transaction can be directed to a specific recipient by restricting further spending of the coin using someone’s public key • The recipient can spend coins he’s received by digitally signing a further transaction using his own private key 19 HASH VALUES INPUT (Text) SHA1 HASH “We the people of the United States” 1482a4775eefc767a7fa975971e6531c0b73e73c “We the people in the United States” 6586a9712086a1a7288afc00dac7cfdcc07a08ab “We” b3780dbafddf7e06add542122118f38cc06884b5 • Hashing functions • Create a number of fixed size (hash) from input text of any length • Different input texts very unlikely to lead to same or similar hash – Any small change in input causes big change in hash – Hash becomes like a fingerprint for the data hashed 20 www.ClearLawInstitute.com (703) 372-0550 10 Clear Law Institute, © 2018 HASH VALUES INPUT (Binary) SHA1 HASH 00000001 bf8b4530d8d246dd74ac53a13471bba17941dff7 00000011 9842926af7ca0a8cca12604f945414f07b01e13d 00000010 c4ea21bb365bbeeaf5f2c654883e56d11e43c44e • Hashing functions (cont’d) • Hash is easy to calculate but very difficult to reverse-engineer – Even one bit difference in inputs leads to very different hashes – Cannot predict hashing result without actually running hash calculation 21 HASH-VALUE-LINKED BLOCKS 22 www.ClearLawInstitute.com (703) 372-0550 11 Clear Law Institute, © 2018 CONSENSUS • A key problem for blockchain technology is to make sure everyone’s copy of the ledger is the same • The problem is particularly acute when the blockchain is public, as in Bitcoin • Anyone can connect to and participate in the Bitcoin network • In a public blockchain, consensus must be achieved in the face of possible • Errors (of communication, of calculation, or others) • Malicious actors 23 CONSENSUS • Private or permissioned blockchains can use simpler consensus methods • Voting • Specialized authoritative nodes • Whatever method is used, it must call for all nodes, including any initial dissenters, to accept the valid results of the method 24 www.ClearLawInstitute.com (703) 372-0550 12 Clear Law Institute, © 2018 CONSENSUS • Bitcoin’s solution, mining, relies on the random-like distribution of hash values across their full range • Miners compete by repeatedly performing the following steps until a proposed timestamped block is validated 1. Choose a nonce (number used once) and place it in a field in the block 2. Calculate the SHA256-based hash value of the block 3. If the calculated hash value is less than a pre-specified difficulty level the block is valid and can be added to the blockchain 4. Otherwise, go back to step 1, choosing a different nonce 25 CONSENSUS • Once a block is validated, it is added to the blockchain and distributed to other network participants • Successful miners receive a mining reward of new Bitcoins or transaction fees • If other miners are still trying to validate blocks when they receive a valid block with some of