“Every lawyer will require familiarity with the blockchain, smart legal contracts and cryptoassets – both conceptually and functionally,” were the words of Sir Geoffrey Vos, Master of the Rolls, in a speech marking the second edition of the Law Society’s blockchain report.
The past two years have seen a rapid acceleration in the adoption of these new technologies across a number of platforms, particularly the financial and industrial sectors. All professionals (and those who insure them) will need to understand at least the rudiments of these new technologies and where and how risks may arise.
A blockchain is a digital ledger consisting of records (or “blocks”) used to record transactions across multiple computers. “Blocks” are connected using cryptography – each block contains a cryptographic “hash” of the previous block, a time stamp and exchange information, meaning “blocks” cannot be altered without the alteration of all subsequent blocks in the chain.
Every time a new transaction occurs on the blockchain, a record of that transaction is added to every participant’s ledger. Transactions are confirmed or verified by “miners”, who solve cryptographic problems and add the transaction or “block” to the blockchain, updating the ledger. This theoretically removes the risk of fraud or error, allowing participants to verify and audit transactions independently.
Blockchain is the best-known example of a distributed ledger technology (DLT), an umbrella term for technologies that store, synchronise and maintain digital records across a network of computing centres.
Blockchain and other DLTs record transactions that take place using digital currency or cryptocurrency, the most well known of which is bitcoin. Other types of cryptoassets include non-fungible tokens (NFTs), a unique, non-divisible token, often linked to an object such as digital art, which uses blockchain technology to record ownership and validate authenticity, and central bank digital currencies (CBDCs).
Cryptoassets are increasingly in mainstream use: the Bank of England and HM Treasury have set up a taskforce to explore the creation of a UK CBDC (or “digital money”), which would sit alongside cash and bank deposits.
We have already seen the first court proceedings in England and Wales in relation to NFTs: art collector Amir Soleymani has made a claim against digital platform Nifty Gateway over the sale of the NFT Abundance and the validity of the ranked auction model. There will undoubtedly be future litigation as the technology is more widely adopted.
Vos’s words make it clear lawyers must get up to speed with the new technology. A key development discussed in the new edition of the Law Society’s guidance is the increased use of smart legal contracts – digital and automated contracts often used for blockchain transactions, where obligations may be represented or written in code.
Once used only for basic transactions, smart contracts are being adopted for more complex functions. As with any new technology, this gives rise to novel issues and lawyers dealing with the digitisation of contracts and transactions will need to consider the risks presented by this evolving technology.
While smart legal contracts offer clear advantages in terms of accuracy, transparency and efficiency, what happens when things go wrong? If poor planning or over automation leads to a party being exposed to an unintended risk or results in a breach, who is responsible? Will it be the lawyer or the developer who wrote that section of the code? And what happens if the smart contract code is hacked, causing loss to a party to the contract – as happened in 2016 in the high-profile decentralised autonomous organisation hack, where $60m of investors’ money was drained by fraudsters exploiting a bug in a smart contract?
There should be a clear delineation of the duties and obligations of the developers and programmers creating code for smart contracts – which could in turn lead to the concept of a “reasonable coder” if coders face claims when things go wrong.
The implications of blockchain could be game-changing for the accountancy profession, leading to operational simplification, reductions in fraud and greater transparency. The Institute of Chartered Accountants in England and Wales has hailed blockchain as likely to “dramatically improve efficiency”. Blockchain could reduce the costs of maintaining and reconciling ledgers, providing certainty as to the ownership and history of assets.
Records will no longer need to be duplicated and verified across organisations and regulators can be provided with more timely and transparent access. In theory, this could remove the need for traditional accounting methods, as there will be one common and indisputable ledger. With increased automation and efficiency, though, come new risks and accountants will quickly need to develop a working knowledge of the new technologies.
For auditors conducting external audits, some transactions may be more easily visible and verifiable and the focus may shift from confirming the accuracy of transactions to considering how those transactions have been recorded or scrutinising valuations.
Audit teams will need to ensure their methods for obtaining audit evidence consider blockchain as well as traditional ledgers. Sophisticated clients are already dealing in bitcoin and digital wallets and accountants and auditors will need to be able to work with clients who invest in or trade cryptocurrency.
The implications of blockchain could be game-changing for the accountancy profession, leading to operational simplification, reductions in fraud and greater transparency.
For insolvency practitioners, blockchain could vastly simplify the exercise of gathering information on assets and liabilities – but could lead to new challenges in securing, valuing and disposing of cryptoassets appropriately.
Blockchain could in the long-term lead to fundamental changes in how transactions are taxed and reported. For now, tax practitioners need to be aware of the correct tax treatment of all aspects of blockchain transactions and to understand how the existing tax framework applies to cryptoassets.
For financial advisers, while at present the UK’s Financial Conduct Authority has a very limited remit for what it supervises, that may change as the market for cryptocurrency investment grows. There is also a clear risk of financial crime and financial advisers are already being targeted by fraudsters operating cryptocurrency scams.
As with any emerging technology, the ultimate applications of blockchain – and the impact of those applications – are not yet clear. The evolution and proliferation of blockchain may lead to new targets for claims, such as blockchain oracles or administrators. For established professions, the range of applications already in place will clearly have implications across a wide range of sectors. In the face of a rapidly evolving technology, it is vital for professionals and their insurers to stay abreast of those risks.
*This article was first published in the 4.05.22 edition of Insurance Day