Bitcoin and the age of smart contracts

By Stuart Hoegner March 7, 20147 March 2014

Never mind the headlines. Virtual currencies are here to stay and you can bet they will have an impact on the practice of law.

Bitcoin and the age of smart contracts

Photo licensed by PerfectHue under Creative Commons (CC BY-SA 2.0)

By now it’s trite to say that bitcoin has been much in the news of late. Mt. Gox, one of the largest bitcoin exchanges, is defunct, prompting cross-border investigations and the inevitable lawsuits. Flexcoin, a Canadian business billing itself as a ‘bitcoin bank,’ is shutting down and says it lost the equivalent of $600,000 in bitcoin to hackers. The 2014 Federal Budget set out plans to introduce new anti-money laundering and anti-terrorist financing regulations for virtual currencies. Just this past week, Newsweek published a cover story claiming that it had found Satoshi Nakamoto, the pseudonymous inventor of bitcoin.

But let’s step back from the recent headlines and ask: What’s bitcoin all about? Is it just a currency and a way of holding and transmitting value? Do the recent scandals and scrutiny from governments and law enforcement threaten bitcoin? And, outside of practising in the cryptocurrency space, should lawyers care? How will it affect the legal profession, if at all?

Virtual currencies—a primer

Bitcoin is, among other things, a completely decentralized and virtual currency and payment system that was invented in 2009. Bitcoins are both a currency (like the dollar) and a global payments system (somewhat like PayPal). Bitcoin allows for the private, immediate, and irreversible holding and transmitting of value anywhere, by any one, at any time. Bitcoins (the currency) can be transferred with little or no cost or counterparty risk. They can be acquired in three ways: you can ‘mine’ them by contributing computing power to securing and auditing the bitcoin ledger (called the block chain), you can buy them on an exchange with other currencies, or you can receive them in commerce for goods or services or as gifts.

Back to the “other things” I mentioned above. Bitcoin isn’t just a currency and a payment system; those are just manifestations of distributed ledger technology. The ledger is just a repository of information and transactions, which opens up huge possibilities. One or more block chains (ledgers) could be used to create and administer arbitral proceedings (with multiple verifications to release funds if there is a dispute among parties) and establish intellectual property rights. Coloured coins can be used to denote bitcoins that are marked as tokens for other things that one can trade, including, for example, securities, commodities, and real estate.

Future virtual currencies will allow for smart contracts to be executed through a block chain, i.e., through a protocol agreed to by the contracting parties that is embedded in the decentralized ledger. There is even the possibility of embedding a so-called ‘decentralized autonomous organization’ (DAO) in a block chain, or an entity not incorporated in any jurisdiction but carrying out many—if not all—of the functions of a legal person.

One question I am often asked is: “What’s stopping me from making my own virtual currency, along the lines of bitcoin?” The short answer is: Nothing. Given the above outline, bitcoin is clearly only one possible form of virtual currency. Alternatives to bitcoin (known as ‘altcoins’) are welcome and keep cropping up. Bitcoin may be eclipsed by a cryptocurrency that is better than bitcoin, but virtual currencies in some form—or, more likely, in many forms—are here to stay.

Where are we headed?

Some media and bloggers have trumpeted the end of bitcoin because of the recent scandals and increased calls for oversight. Interestingly, the exchange rate for bitcoins jumped up by $100 since Mt. Gox suspended its operations, although at the time of writing the price has slipped back down somewhat.

Confidence in bitcoin as a virtual currency will likely be shaken by recent events. Public adoption may slow or stall. Consumers must understand that bitcoin vests immense responsibility in them to safeguard their own virtual currency e-wallets. But it doesn’t take a bitcoin apologist to see or show that the integrity of bitcoin as a distributed protocol (and a payment system and currency) is unaffected by scandal or the identity of its creators.

Nor can further government oversight shut it down. While bitcoin, as decentralized technology, may not be regulable, people and entities transacting in bitcoin can be, and already are, regulated. Further AML and CTF regulation of virtual currencies in Canada by the Department of Finance may even be salutary provided the regulations are responsible, they do not unfairly burden businesses or consumers using virtual currencies, and they help clarify the law around bitcoin in Canada.

Why should lawyers care?

The emergence of broad, decentralized virtual currencies is a huge issue for the legal profession. Not only can lawyers take advantage of the same benefits that other service providers enjoy, but more broadly, bitcoin and other cryptocurrencies have the power to profoundly change the practise of law on an international scale. Lawyers ignore these developments at their peril.

Lawyers are merchants selling services like many others. Counsel can be paid in bitcoin (or, at least, they can in Ontario). This allows for instant and secure payments with next to no charges from a financial institution. Imagine rendering a bill, submitting it to your client, and receiving payment within a minute to a wallet that you control with almost no transaction fees. That’s faster than cutting a cheque from trust funds to cover the invoice and is part of the power of bitcoin. Immediacy, irreversibility, low cost, and security: these are the benefits that all merchants are discovering, not just lawyers.

This distributed technology won’t eliminate the need for lawyers any more than it will mean the end of banking, but it could change how we practise law. Payments are one example. In a bitcoin economy, lawyers are unlikely to assume the same role as they have for years as arbitrators or escrow agents.  But they will collaborate on and build the smart contracts fulfilling the arbitral and escrow functions. Consider the possibilities of enforcing trade-mark rights based on rights embedded in the block chain. If escrow is a possibility, then why couldn’t a will on a decentralized ledger with three estate trustees (say) dispose of a testator’s property? Or imagine the jurisdictional issues around a DAO and identifying, contracting with, and suing such an entity. These are all manifestations of bitcoin that are starting to emerge. We don’t know how to address all of these issues, but the challenges are there and may well come to affect most of us, irrespective of our areas of practice.

The prospects for engaging with the legal issues in virtual currency are tremendously exciting. In a sense, these aren’t new issues; over the last 15 years technology has deeply changed how lawyers practise, and the pace of change is accelerating. As with other emerging technologies, lawyers need to be open to change and to finding the possibilities to thrive with new businesses and services.  Then we’ll really be in a position to welcome and help build the bitcoin economy.

Stuart Hoegner is a virtual currency, gaming, and tax attorney and accountant in Toronto. He is called to the bar in Ontario and Nevada and can be reached at stu@gamingcounsel.co.

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