Investors and business leaders have recently been swept up in bitcoin-mania and the fluctuating cryptocurrency marketplace, but few have taken the time to understand the underlying technology that makes it all possible: blockchain. In order to realize the full potential of blockchain, companies must consider how future regulation might affect their ability to incorporate this technology into their business operations.
Finance traditionally has been quick to adopt cutting-edge technologies that increase security and efficiency. Other industries, including health care, supply chains and energy, are now also embracing blockchain as a way to replace paper-based processes. Blockchain can also be used by federal and state governments to ensure transparent elections, manage property titles and verify online identities, reducing the risk of identity theft. But every practical application of blockchain invites new regulation, and early adopters must consider how best to develop such technology that conforms to existing and anticipated regulation.
Blockchain technology is innovative because it creates a trustworthy ledger of transactions. For example, every bitcoin transaction—which uses blockchain technology—is recorded and verified by specialized participants who are part of a decentralized bitcoin network. A set number of transactions are grouped together (a “block”), and this block is then “attached” to the previous block through cryptography (which creates a “chain”). And because each user maintains an automatically-updating copy of the ledger, it is extremely difficult for hackers to falsify a transaction, as they would have to alter the majority of the copies maintained by all users.
The question is, how will government regulate this technology?
While federal regulators have issued guidelines and statements on cryptocurrency regulation and considered legislation, their approach to federal blockchain regulation has been to wait and see. Certain states, however, are starting to regulate the blockchain space. Arizona passed a law in March 2017 recognizing signatures and electronic records secured though blockchain technology as valid, Delaware established an initiative to maintain corporate records by distributed ledger in May 2016, and Vermont’s legislature passed a bill in June 2016 on authentication and evidentiary value of blockchain. By passing blockchain-enabling statutes, states are signaling their confidence in the technology.
As blockchain increasingly is adopted by different industries, the technology will be subject to governance from various regulators – including regulations that are not specific to blockchain. Innovators developing blockchain-based health records will have to abide by HIPAA (health care privacy rules) and other privacy regulations, for instance. Supply chain providers exploring blockchain will have to consider U.S. and foreign customs regulations. Financial entities using blockchain will need to consider regulations ruling trading assets, the technology’s impact on regulatory capital and other compliance requirements, and mandated reporting and recordkeeping requirements.
So, what should companies do to prepare for and capitalize on the proliferation of this technology? Regardless of industry, companies should conduct a blockchain “audit” to determine the opportunities and see what their competitors are doing, and consider joining one of the many industry groups formed to explore blockchain use cases. Because blockchain technologies are best implemented across many parties sharing governance of the network, companies will have to give up some control over exactly how their data is stored. However, participating with consortia and standards bodies will provide a seat at the table to ensure both influence and understanding of how solutions will be implemented.
Companies considering blockchain technology should also implement a legal and regulatory strategy, looking for opportunities to engage with regulators and monitoring blockchain developments as part of their usual regulatory monitoring. Although blockchain and distributed ledgers will bring significant changes to many industries, staying engaged and informed will help prepare companies across sectors to take their first steps into this new world.
Alan Howard is a partner in Crowell & Moring’s New York office. He has extensive experience representing financial institutions.
Jenny Cieplak is counsel in Crowell & Moring’s Washington office. She focuses on technology transactions and financial services.