Follow the money

By Leo Singer Fall issue 2014

Bitcoin is more than a virtual currency: it’s powered by a system that could revolutionize everything from contracts and wills to legal work.

Follow the money

Illustrations by Robert Johannsen

At 9 a.m. on Oct. 29, 2013, the world’s first Bitcoin ATM went live in a coffee shop in downtown Vancouver, enabling Canadian dollars to be easily turned into bitcoins, and vice versa — another small step toward global acceptance of the world’s favourite cryptocurrency. Despite its wildly fluctuating value against the dollar over the past 12 months, big online retailers such as Expedia and Overstock have started — or signalled their intention — to accept bitcoins as a means of payment. Bitcoin is making inroads into mainstream financial and economic life faster than any of its proponents dared imagine.

The currency clearly has serious potential despite being a risky, roller coaster of an investment vehicle. It enables virtually free, frictionless transfer of wealth between individuals, eliminating the need for banks or other financial institutions. It avoids the need for currency exchange commissions, credit card fees or other banking costs. It gives people — especially in the developing world — access to a financial system that might otherwise be out of reach. Bitcoin has the potential to create an alternative, parallel financial system — one that could deal traditional banking a heavy blow. And governments are slowly becoming aware of the technicalities and legalities; they’re examining how bitcoin transactions might be taxed, and drawing up legislation to stem the use of bitcoin for money laundering, the drug trade, and other illegal activities (enforcement of these regulations will be another matter entirely).

But the most interesting and revolutionary part of Bitcoin is not bitcoins — it’s the system that underpins it.

Chain reaction

Satoshi Nakamoto, the mysterious person or persons who invented Bitcoin (and, by some estimates, owner of a bitcoin stash worth half-a-billion dollars (U.S.)) has created an innovative means of recording and securing the details of all bitcoin transactions: a public ledger, known as the ‘blockchain’. The block­chain is what makes Bitcoin possible; it prevents fraud and eliminates the need for a trusted third party. Continually updated and audited, exact copies of the blockchain are held on thousands of ‘nodes’ — computers running the bitcoin code — around the world. Those who devote their processing power to auditing the blockchain are rewarded with newly minted bitcoins. This trove of transaction information is entirely public and transparent — and yet individual bitcoin holders use pseudonyms, so the transactions are essentially private.

Stuart Hoegner, a Toronto-based lawyer specializing in international online gaming and the use of cryptocurrency, believes that the blockchain is where the real action will take place. He says that it has the ability to fundamentally change the practice of law. “I don’t think there is any question that it’s potentially very radical,” he says. “The question is whether it will take off.”

"With many creative minds investigating the wilder shores of blockchain technology, Bitcoin the currency might become increasingly irrelevant."

Every entry on the blockchain can be tagged with additional information, beyond the actual bitcoin transaction itself. Once this is added to the blockchain and verified, it’s information that cannot be changed: time-stamped, public, and etched in stone. Hoegner says the blockchain could easily be used as a register of real estate; a global, secure and public database of transactions. The same is true for cars and other property — even stocks and shares. Since the blockchain, in theory at least, is invulnerable to corruption, and co-managed by the entire Bitcoin community, the ledger would provide an inviolable record of ownership, one that does not depend on a trusted third party. This calls into question whether we need any traditional government databases. “Property registration, trademarks, patents, setting up of companies,” says Hoegner, “anything along those lines can be done through the blockchain.”

But the blockchain can do more than simply provide a blank slate that holds information. It can be used to execute transactions — actively, and automatically, transferring ownership. For example, the owner of a car could hold a digital ‘key’, linked to the blockchain title of ownership. That ‘key’ could be stored in a smart phone which disables the immobilizer of the car, allowing the engine to start just like current electronic car keys. But if that vehicle were to be sold, the transfer of the ‘key’ could easily be accomplished securely, executed when the money arrives in the buyer’s account. 

This example illustrates how smart contracts are one of the most anticipated uses of blockchain technology. They’re made up of executable code embedded in the blockchain. When condition X is met (for example, the correct payment for the car is transferred from the seller to buyer), then Y is executed (the digital key is removed from the seller and placed in the hands of the buyer).

Since the blockchain is decentralized and constantly audited, it’s a secure way to execute an agreement without relaying on a trusted third party. Smart contracts could be used to hold funds in escrow. They could be used to execute a will; after a person’s death, payments would be automatically made to the benefactors without the need for a traditional probate process. (In this case there would have to be a mechanism built in to the code to confirm the fact of that person’s death).

If smart contracts take off, what does it all mean for lawyers? Is blockchain automation a threat to their livelihood? Stuart Hoegner isn’t worried.

“My own view is that there won’t be a call for less law­yers,” he says. “They’ll be a call for different kinds of legal work. And I suspect that kind of legal might be more exhilarating and rewarding than a lot of the more mundane work that law­yers do now. It might free lawyers to think more laterally.”

Montreal lawyer Jillian Friedman, who specializes in cryptocurrency and e-commerce, has a more fundamental objection: she’s nervous about the cold, inflexible nature of a contract that’s free from human intervention. “I’m very excited about smart contracts,” says Friedman, “and what they could do for the practice of law and commercial agreements. But always keep in mind there’s a very important role for human judgment, that isn’t based necessarily on math and logic.”


Illustration by Robert Johannsen

Say a loan is issued under a smart contract, and the borrower is bound to provide regular financial documentation to the lender. “Often in commercial agreements the results are not deterministic,” says Friedman. “Just because the borrower didn’t provide the appropriate documentation one month, the lender might decide not to call in the loan, or not seize the collateral.”

Of course some safeguards could be built in. For example, a utilities company might devise a smart contract that would automatically cut off the electric supply if a fixed number of payments are missed — with the proviso that the temperature that day is above freezing. But as Friedman points out, automated code cannot account for every eventuality. “You would have to think of every single variable that would affect the result. There’s no room for either/or.”

A leaderless revolution?

Even Satoshi Nakamoto may not have imagined the more exotic uses of the blockchain. Imagine an autonomous organization with many shareholders, but no one in charge. There is no headquarters, no board of directors, and no management. It provides services and receives recompense without human intervention. This entity can be created purely in software, and once it’s uploaded, it will take on a life of its own.

This is the DAC, or Decentralized Autonomous Corporation, the futuristic vision of Vitalik Buterin, a 20-year-old Canadian hacker and software developer. Buterin is the developer of ‘Etherium’, a blockchain-based service that’s designed to host applications that live in the decentralized, ethereal world of the peer-to-peer blockchain.

A DAC would be distributed and decentralized across every node in the blockchain — just like Bitcoin. It might take the form of a financial services company that allows for currency or stock trading, or trading futures and derivatives. Or a ‘bank’ that provides loans or microloans for entrepreneurs, using funds supplied by a myriad of online investors. Other proposed uses are online gambling, the distribution of domain names, a crowd-owned social networking site, or a secure, decentralized data storage facility. Essentially, any type of web-based service that deals in information or money could find a home in this ethereal online space.

The idea of the DAC has some radical implications. First, any governance of the corporation would be entirely decentralized — and so extremely democratic. Once it is uploaded, the creator essentially loses control. Second, because a DAC would not be tied to any one legal jurisdiction, it could choose to ignore legal niceties such as privacy laws, copyright legislation, patents, and other legal constraints. DACs are similar to Bitcoin in this respect: “Probably not regulable,” says Stuart Hoegner, “short of turning off the internet.”

Peer-to-peer file sharing has, by and large, proved impervious to legal challenges — and so might DACs. For example, block­chains have already been used to develop secure messaging and email systems that so far appear difficult, if not impossible, for governments to monitor. This is a boon for those concerned about civil liberties, and useful for anyone, whatever their legal or illegal intentions, who wants to ensure the authorities cannot eavesdrop.

Though libertarians value their privacy, others value the ability to create an organization that’s community-owned and wholly transparent. Vitalik Buterin gives the example of a social networking site that could be run and owned by its members, without giving a for-profit corporation like Facebook access to massive quantities of personal information.

Still, the bot-like autonomous nature of DACs is unsettling. Primavera De Filippi, a research fellow at the Berkman Center for Internet & Society at Harvard Law School worries about the legal implications.

“The thing about the DAC,” says De Filippi, is that “you can completely lose track of the human being.” If the DAC in question is involved in illegal activity — say money laundering, “you can trace it back to a human being who has deployed this on the blockchain. You can punish the creator, but you cannot still stop the autonomous organization.” She points out that you cannot shut down the server since the code is completely decentralized, “and you cannot assign liability to anyone because there is not a single human being who is responsible for its actions.” The very quality that makes DACs powerful — their autonomy — also makes them a threat.

Law, says De Filippi, is directed at people, and Etherium “presents amazing challenges to the law, because there are no people.” But she believes that DACs, just like Bitcoin itself, will only appeal to the mainstream when they become integrated into the legal process. “As long as those entities are not regulable, people will not trust them.”

With many creative minds investigating the wilder shores of blockchain technology, Bitcoin the currency might become increasingly irrelevant. Stuart Hoegner says the monetary value of bitcoin is unimportant; “In years from now it could be $10,000 per Bitcoin, or zero. It doesn’t really matter. The concept of an accessible, fully decentralized ledger is what’s way more exciting.” But he warns of blindly embracing everything that the blockchain has to offer.

“The law of unintended consequences,” he says, “is a pretty powerful thing.”

Bitcoin 101

Bitcoin is essentially a virtual monetary system — usually described as a cryptocurrency — which possesses a number of key features:

• Decentralized: There is no one central repository or institution that controls Bitcoin, like the Bank of Canada or the Federal Reserve in the United States. It works as an online peer-to-peer payment system.

• Software-based: Bitcoin are created by algorithm, through a decentralized network of millions of computers working to solve increasingly complicated mathematical problems (known as mining). Through mining, the computer’s owner is awarded a fixed number of bitcoins.

• Virtual: Bitcoin is a purely digital form of the currency. You can’t print or mint it, there are notes or coins.

• Value: More conventionally, bitcoins carry value, and therefore can be used to trade for goods or services or as donations. You can send bitcoins to anyone once you know their Bitcoin address. Payments are recorded in a public ledger, know as a blockchain, using the basic "digital currency" unit, also called bitcoin.

• Secure: though not impenetrable, the measures implemented for Bitcoin are considered more secure than those used by any banking system.

• Recorded: Cryptography is at the heart of Bitcoin’s security. All bitcoins are recorded forever, and transactions are accounted for, and stored in multiple places. This prevents double-spending, counterfeiting or stealing bitcoins.

Leo Singer is a regular contributor based in Montreal.

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