Many people are familiar with terms like blockchain, Bitcoin, and cryptocurrency, but few understand the underlying technology that drives them all: distributed ledgers.
Distributed ledgers have caused arguably the greatest shift in technology since the dawn of the Internet. However, this same technology has yet to coalesce into a standardized form of adoption and to make matters more challenging still, it lacks legal and regulatory clarity.
In this article, we examine the basics of distributed ledgers and the importance of having such expertise moving forward.
What Are Distributed Ledgers?
Ledgers are a well-understood concept in business: a buyer makes a purchase, and the buyer’s bank statement records the amount paid, as well the name of the seller. At the same time, the seller’s bank statement records the amount received and the name of the buyer. Some business leaders may find it hard to imagine any other way of operating.
In a distributed ledger system, the ledger does not reside with a bank or any other financial intermediary, and there is no “master copy.” Instead, every person who is a part of the system has a copy of the ledger. Each time a transaction is made, all copies of the ledger are updated, cementing the transaction in the system. Such transactions are visible and verifiable, making falsification or changes after the fact a near impossibility. Because of this, the participants can engage in direct transactions with one another in real-time, without any intermediaries to charge fees or cause delays.
Some have called distributed ledgers disruptive, especially to intermediaries. Distributed ledgers have the potential to eliminate the need for financial middlemen altogether, which would fundamentally alter the relationship between transacting parties and “democratize” the financial system.
However, this paradigm shift also brings new concerns for businesses. For example, the ability to see every transaction within the system, even if one is not involved in that particular transaction, highlights the increased need to protect the identities of system participants. Imagine knowing that every other customer of your company’s bank being able look at your corporate accounts, including your cash on hand and spending habits. Businesses considering moving to distributed ledger technologies must also consider considers like users’ anonymity; encryption; safeguarding the system from hacking, theft, and fraud; and fulfilling Know Your Customer (KYC) requirements. Distributed ledgers need not be public. In fact, many corporations now operate internal distributed ledger systems exclusively for use by employees on private internal networks.
Despite these concerns, many companies feel that it is in their best interest to incorporate distributed ledgers into their future strategies. On one hand, distributed ledgers provide a hedge of sorts against external disruption. On the other hand, those adopting the distributed ledger technology earlier have sometimes been able to reduce their operating costs significantly, freeing up enough capital to lower market prices and finance more research and development.
Blockchain and Beyond
Blockchain is the best-known application of distributed ledger technology. Even though it was originally developed to launch Bitcoin, blockchain is also responsible for the current growth in the decentralized virtual currency market.
Not all cryptocurrencies are blockchain-based, however. For instance, the Chinese government’s central bank digital currency (CBDC) does not involve blockchain.I Instead, the Chinese government plans to launch a digital form of the government’s fiat currency. Likewise, the Chinese government will be the central authority with full authority to track and control the ledger. It was rumored to rolled out for testing in August 2020. By late-October 2020, testing of the currency was confirmed and digital counterfeits spawned.
Even though cryptocurrency is arguably the most well-known application of distributed ledger technology, many other applications exist. For example, IBM operates a blockchain-based partnership that helps companies manage their supply chains. Current partners include Nokia, JetBlue, Lenovo, and AB InBev. Additionally, Estonia launched and adopted a blockchain-based ID card system for its citizens. It seems that the decentralized finance industry is actively seeking to disrupt major banking processes including payments, lending, and investing at the expense of entrenched intermediaries.
Distributed ledger applications may vary by industry, but noticeable patterns are beginning to emerging in the space overall. Start-ups, often backed by private equity funding, are looking to roll out business lines and innovate that established players cannot target without undercutting their own business models. On the other hand, established companies continue to have better access to cash, more employees, brand recognition, and other resources unavailable to startups such as the legal and regulatory expertise to weather any future challenges.
The Shifting Legal and Regulatory Environment and Its Significance
It is difficult for legislation and regulation to keep up with emerging technology. In fact, many rules and guidelines are issued in reaction to the various developments in the field, such as a “no-action” letter in the finance space. For this reason, regulators are also dealing with a greater number of anticipatory challenges concerning virtual currencies than ever before.
From an international standpoint, both China and Russia have banned Bitcoin’s use in banking and financial transactions, while Egypt, Bolivia, and many other countries have banned use of the currency altogether. In the United States, regulators take varying positions depending on the industry and state. On the other hand, virtually all countries have expanded the scope of their fraud, anti-money laundering, and terrorist financing laws to include distributed ledger systems. Because of this, the legal environment surrounding distributed ledger systems may be quite unfamiliar to those seeking to launch start-ups in the distributed ledger space.
The Value of Expertise
Distributed ledgers raise serious questions about future business operations, laws, and risks. Businesses of all sizes are making variations to the ledger structure that could either be rewarded with mass adoption or obviated by regulatory action. Such ambiguity may also result in longer, more serious litigation, as well as unexpected changes to public’s perception of certain brands.
Even though cryptocurrency securities fraud cases receive most of the media attention, cases are being litigated in industries as diverse as consumer privacy law, tax and accounting, and intellectual property. Unfortunately, only a few business models are currently designed to seamlessly absorb and respond to changes of this magnitude. Freeman Law, on the other hand, remains ready to provide its clients with the proper counsel, insight, knowledge, and experience that they need to help navigate this ever-changing environment.