Blockchain technology presents significant opportunities to record financial transactions, identities and various legal operations. However, the technology is new and it therefore must be subjected to various studies, especially in the banking sector, which is highly regulated.

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Javier Sebastian

A recent report from BBVA Research by Javier Sebastian, the Banco Bilbao Vizcaya Argentaria, S.A. digital regulation manager, cites seven such regulatory challenges. The report is titled, “Blockchain in Financial Services: Regulatory Landscape and Future Challenges for its Commercial Application.”

Seven Challenges Ahead

1. Legal framework for blockchain and distributed ledgers. Legal issues include issues of jurisdiction should problems arise. Shared distributed ledgers (DLTs) by definition have no location. Hence, territoriality presents an issue since each network node can be subject to separate legal requirements. There is no central administration for each distributed ledger which could serve as a regulatory “anchor.” For the same reason, liability presents a problem since no party is formally responsible for a DLT’s functioning.

2. Legal framework for recognizing blockchains as tamper-proof and immutable nodes. A legal framework is needed to use blockchains as trusted and unique identity sources. Standard regulation of data protection and identity authentication is needed for this to be possible.

Consensus exists among the IT and cryptographic community on the immutability of well-defined blockchain blocks since it is not technically possible to modify blocks in “work test” systems or controls linked to consensus mechanisms. But no legal recognition of this blockchain aspect exists, hence, it cannot be used as a legal argument.

‘Right To Be Forgotten’

3. Regulation of the “right to be forgotten.” Under European regulation, the “right to be forgotten” allows any citizen the right to have data stored in outside databases, which they can delete at their will. A blockchain’s immutability can present a problem since it conflicts with such rights recognized by governments.

To reconcile such rights with blockhains could require replacing the right to delete information with a right to forbid the use of personal information by third parties. A combination of automatic data encrypting under certain conditions or alternative solutions to disable accessing the information at will could achieve this.

4. Legal framework for the validity of documents stored on blockchains as existence or possession evidence. A second level of recognition is needed to use blockchains for certain businesses.

If the verification of existence prior to the inclusion of the document in a blockchain is sufficiently sound, and there is confidence in the efficacy of cryptographic mechanisms used in the blockchain technology, then blockchains are recognized as immutable sources of trust. Documents in blockchains can then be used as proof of ownership or existence.

Whether the courts of a specific nation accepts this is another issue since there is no jurisprudence to fall back on.

Also read: BBVA economist: Legal framework needed for blockchain technology

‘Native’ Financial Instruments

5. Legal framework for the validity of blockchain issued financial instruments. Used as a platform for defining “native” financial instruments like derivatives or bonds, recognition is needed on the legal validity of such instruments by supervisors and regulators. Money is a key financial instrument that can be issued on a blockchain. Native money on blockchains can present serious issues for macroeconomics and monetary policy warranting a larger analysis.

6. Legal framework for smart contracts. Legal framework for smart contracts, particularly with regard to international trade, requires extra considerations. With regard to jurisdictional issues, one issue is whether the distributed ledger has a location. Another is whether or not the contract signatories are subject to different laws in different jurisdictions.

Various parties are involved in smart contracts beyond the parties to the contracts. These include the contract creator and custodian.

In addition, there is the possibility that one of the contracting parties could breach the contract, as well as the possibility that the contract could be flawed due to coding or design errors, raising the question as to who in such cases is liable.

7. Regulation of the blockchain as a valid regulatory Internet of Things registry. Connected devices have an identity on the Internet of Things. Hence, it would make sense to have a shared registry to store the “identity” and details for each connected thing while permitting them to perform transactions with one another, including machine-to-machine payments.

Having “shared distributed ledgers” for the Internet of Things is gaining support and will require a legal framework to recognize such ledgers as valid regulatory registries.

All challenges concerning liability, territoriality and smart contract applicability are relevant to any blockchain associated with the functioning of the Internet of Things.