Blockchain: Adopting legal frameworks to gain competitive advantage

Technology is developing at an ever-increasing pace, particularly in relation to cryptoassets and the blockchain space. With governments still deciding how they will regulate these developments, what can a business wanting to utilise blockchain technology do to protect itself and gain a competitive edge? 

Background

Blockchain technology came to prominence as the means to facilitate  cryptocurrency transactions. As a distributed, public ledger, secured using cryptography, the blockchain provided a secure environment which overcame many of the hurdles faced by previous cryptocurrencies. People quickly realised that the features of the public blockchain, such as transparency and immutability, could be applied beyond cryptocurrency.

A key part of blockchain’s potential comes from the creation of smart contracts, which are self-executing protocols embedded in the blockchain. Smart contracts ensure that transactions which traditionally might have been managed by third parties (such as the purchase of land or other assets, currency transfers or payment of royalties) are automatically executed when certain pre-defined parameters or rules are met. There is considerable excitement around the opportunities this technology provides for reduction in third party fees and transaction times, whilst enhancing customer access and limiting fraud.

It is easy to see why a sector based around this new technology is quickly developing.  However, long term success is likely to depend on creating suitable approaches to best practice.

Protect your investment

Unless you are a skilled developer, you’ll be hiring someone to build your blockchain. You may wish to develop your own proprietary version, or you may intend to create a DApp (Distributed Application) to operate on an existing platform such as Ethereum. Ethereum operates as an open source platform utilising both permissive and restrictive licences, so it is important to understand how the licensing model will fit with your business model. In simple terms, the blockchain is software.  You should therefore have a contract in place with your developer, as you would for any other software-related project.

Contract terms such as payment schedules, acceptance criteria and termination clauses (not to mention a VERY detailed specification) are essential to ensure you get what you expect and are paying for.

A smart contract is still a contract and is therefore subject to established legal principles. You should ensure that there is a clearly documented record of the terms that will be coded into the smart contract, which may need to be negotiated if there is more than one party involved.   Having such contracts in place will also demonstrate the legality and functionality of your business for customers and investors.

Intellectual property

Consider carefully the elements of intellectual property involved. If you are paying for the creation of proprietary software, you will want to become the owner of this wherever possible.

You may be using third party software, engaging web designers, artists or other creatives to create intellectual property for you, or you may be using music, art or designs within your business model. Nothing ruins a good business idea like a claim against you for infringement of intellectual property rights, so ensure everything is covered off in contracts well in advance of it becoming an issue.

Data Protection

Data privacy is a complex issue for all businesses, but the blockchain has additional considerations due to its transparent and unchangeable nature.

Let’s consider the wine industry, because the blockchain provides an excellent system to prove provenance and convince buyers they are getting the genuine article. However, the system may depend on the personal details of the current and previous owners being made publicly available forever. Therefore, to ensure compliance with the GDPR, careful consideration of privacy rights and required privacy information is needed, alongside appropriate risk assessments and data management processes. With the increase in sanctions, this is not one to get wrong!

Initial Coin Offerings and Security Tokens

Although blockchain businesses do not need to create their own cryptocurrency, they may choose to. The main reason for doing so would be to generate income with which to launch or grow the business.

A common misconception is that the Financial Conduct Authority (FCA) does not regulate Initial Coin Offerings (ICOs). If the quality of the token is that of a regulated investment and/or the activities of the company can be classed as regulated activities, the regulations will apply. In particular, companies issuing Security Tokens (which represent fractions of an existing, tradable asset), are likely to attract the FCA’s attention. However, the FCA is open to business innovation, so it would be wise to work with a compliance specialist to ensure you do this effectively.

Engaging with new audiences and customers

Each blockchain project will need to interface with a business’ intended market to generate revenue.

For example, if you were looking to develop a blockchain to drive value and options for consumers in the Telecoms sector, you would need to consider both the laws governing the selling of services over the internet (distance selling) and the restrictions around marketing to individuals.

Clear terms of business would be needed with consumers (subject to consumer rights) and with the Telecoms companies, so all parties know what to expect, and are aware of their liabilities and potential charges/income.  In addition, regulations may mean you are subject to additional requirements.  Prior approval of the smart contract, by Ofgem, may be recommended to avoid wasted costs.

You may look to outsource to cloud or SaaS suppliers in order to establish a customer interface linked to your blockchain, which is less energy intensive and more flexible if your business or customer focus changes.

All businesses face these considerations, so they are not barriers and are included to illustrate that no business operates in isolation.

Investment and Sale

Finally, many businesses require external investment whilst often having one eye on a future sale. Both will be easier by demonstrating you have in place development agreements, IP protection, valuable customer contracts etc. and compliance documentation.

Summary

The blockchain space provides an exciting arena for entrepreneurs to create new and innovative ways of doing business. New technologies do not operate outside the law.  Understanding the legal framework (or working with a legal team or adviser that does) will provide a competitive edge for those willing to plan ahead.