Blockchain technology is far more than a buzzword. Dubbed “the Internet 3.0”, this distributed ledger technology known best as the data documentation for cryptocurrencies is changing our data management and transactions at breakneck speed. Blockchain technology has inaccurately been held as synonymous with Bitcoin. While Blockchain technology developed to create a foolproof transaction and payments system for Bitcoin, Blockchain goes far beyond crypto, and has now extended reach into countless industries, including government transactional systems. The differentiated structure behind this technology has made it a conundrum to most, and its decentralized base brings many questions to the table regarding regulation. Yet, it is absolutely necessary to understand the workings of this technology and so develop the most optimal regulatory dictates to ensure that the U.S. financial system, business and payment transactions swiftly and safely adapt to digital changes in the global marketplace.
Blockchain technology is revolutionary in its checks and balances for accuracy, transparency and time to completion. While very technical in nature, we explain the basics of Blockchain. The Blockchain distributed ledger has these main attributes:
- Recorded information is stored and time stamped.
- The ledger of transactions is public and transparent.
- The ledger is decentralized. Transactional information inclusive of contracts is sent to separate computers, or nodes in the Blockchain. This is called a peer to peer (P2P) network.
- The ledger transactions have what is called a hash function that cryptographically maps information, or input, to ensure that there is a unique digital signature for each transaction step. Any minute change in transaction creates a separate hash. This function ensures that there is no deliberate fraudulent duplication of any one transaction.
- Transactions and processes within the Blockchain need consensus to be sealed. To prevent malicious blackhat processes or unforeseen crashes, the Blockchain system triggers “Byzantine Faults.” Byzantine Fault Tolerance (BFT) mechanisms require repetition of the same data from each transaction in each node until full consensus is reached. Nodes require a “proof-of-work” consensus to validate transactions in the fastest possible time, which is also part of data mining.
The explanation above is deceptively simple, yet very powerful in terms of speed and transparency. We see that while Bitcoin and other crypto currencies appear to be widely speculative, the actual Blockchain technology is purely methodical, and highly useful in shaping failsafe transaction structure. Naturally, the most concerning feature of Blockchain transaction is its decentralized system. While each Blockchain transaction process may be accurate, the players on a P2P decentralized network can be fraudulent. For example, a private Blockchain set up by a drug cartel can have perfectly accurate transaction processes. Regulation and tracking standards are definitely needed when it comes to the Blockchain.
U.S. BLOCKCHAIN REGULATION
Thus far the U.S. Government has shown support for the development of Blockchain regulation and governance within the context of the technology’s growth and expansion. U.S. Congress has created the Congressional Blockchain Caucus to handle legislation pertaining to Digital Ledger Technology (DLT) and cryptocurrencies. In September 2018 co-chair of the Congressional Blockchain Caucus Tom Emmer (R-MN) introduced the “Resolution Supporting Digital Currencies and Blockchain Technology” bill, the “Blockchain Regulatory Certainty Act” and the “Safe Harbor for Taxpayers with Forked Assets Act.” These bills encourage the federal government to monitor Blockchain entities that may or may not need to register as money transmitters. Moreover, the bills provide suggestions for taxation of digital assets via crypto taxation guidance. Thus far under IRS Notice 2014-21, digital currency is treated as property rather than a foreign currency. According to Emmer, the US private sector needs clarity when it comes to Blockchain technology in order to lawfully expand innovation and growth.
Congressman Emmer’s legislation has since been complemented by U.S. Representatives Darren Soto and Ted Budd through the introduction of “The Virtual Currency Consumer Protection Act of 2018” and the “U.S. Virtual Currency Market and Regulatory Competitiveness Act of 2018.” These bills provide recommendations to the U.S. Commodity Futures Trading Commission (CFTC). Both bills focus on cryptocurrencies with regards to price manipulation, and examine U.S. Blockchain technology regulation in the global cryptocurrency universe. It is noteworthy that the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) delineates virtual currency as “a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.” In addition, Representative Warren Davidson (R-OH) has announced his plan to introduce legislation for the development of a new token asset class to facilitate regulation of initial coin offerings (ICOs). Representative Davidson has also offered suggestions for using Blockchain technology for the creation of ‘wall coins’ to fund the border wall between the U.S. and Mexico.
U.S. PUBLIC SECTOR BLOCKCHAIN IMPLEMENTATION
While U.S. Blockchain regulation is still in the infancy stages, Blockchain technology implementation within various public sector departments shows steady growth.
In 2018 the U.S. Food and Drug Administration (FDA) took steps to implement a Blockchain tracking system along the supply chain to increase food safety, especially in light of the nationwide E.coli scare that occurred with Californian romaine lettuce. The U.S. Department of Homeland Security (DHS) has currently employed Blockchain technology in its forensic analysis of criminal activity regarding both public and private cryptocurrencies. The U.S. Customs and Border Protection (CBP) and Transportation Security Administration (TSA) currently have request for proposals regarding Blockchain documentation solutions for accurate identification and fraud prevention. The U.S. Air Force is implementing Blockchain solutions in personnel training to build systems for proper security and logistics. And at the state level, Washington’s Douglas County Department of Commerce is set to pour funds into an entire Blockchain innovation campus.
BLOCKCHAIN OPERATIONAL RISKS
Hossein Kakavand, Bart Chilton and Nicolette Kost de Sevres’ “The Blockchain Revolution: An Analysis of Regulation and Technology Related to Distributed Ledger Technologies” examine the operational risks associated with developing the technology. We highlight the following risks which should be addressed by U.S. regulatory institutions as the Blockchain governance framework takes shape.
Blockchain software operates in a decentralized fashion. Thus, each owner would have individual transactional access, unlike central clearing software. If a new release of Blockchain software is not evenly installed, the likelihood of immediate consensus transactions may be diminished in reliability as a viable Financial Market Infrastructure (FMI). Bandwidth also may pose a problem when it comes to decentralized Blockchain capacity. With growing number of permissioned and permissionless Blockchains, and heavier transactions both in complexity and volume, there is a question of how to handle both national and global capacity, and which governing entity may be the backup for such capacity.
On January 5, 2019, crypto exchange Gate.io reported a hack of Ethereum Classic worth more than USD$200,000. Oddly enough, the money was returned to the Gate.io by January 12, leading crypto experts to believe the hack was done by an ethical whitehat hacker to delineate consensus and security faults in the Blockchain. The Blockchain is not fully secure, especially due to its decentralized nature. There needs to be more failsafe measures implemented per transaction, and per financial governing entity to safeguard against cyberattacks.
There is an old saying, ‘who will guard the guards?’ This rings true for players in the Blockchain. One of the strengths of the Blockchain prides upon removing intermediaries, thus creating more transparency. However, the players in each transaction need to be savvy in understanding how peer to peer networks operate. Since only a limited percentage of potential users understand the Blockchain, we have systemic operational risk, which can only be mitigated with structured and practical education. In addition, and even more concerning is how to identify a definite entity responsible for ‘crucial repair’ should the Blockchain suffer collapse, as no governing body is formally responsible for maintaining the Blockchain. To date, technology firm R3CEV has lead a sizable consortium of financial institutions for distributed ledger standards, procedures and safety measures. Regulatory bodies may find it highly beneficial to work with such consortiums to form common Blockchain disaster response standards.
Distributed Ledger Technology (DLT) is here to stay, and it bodes well for U.S. industry to steadily adopt the technology in supply chain logistics, transactions and payments, while considering a combination of more traditional transaction methods to ensure diversity and safety in commerce. We are heartened to see such bipartisan support for the development of Blockchain technology for U.S. innovation, and encourage U.S. regulatory bodies to work with private sector institutions to properly formulate Blockchain standards.
Kakavand et al. “The Blockchain Revolution: An Analysis of Regulation and Technology Related to Distributed Ledger Technologies.” SSRN Online. 2017.
Lanz, Jose Antonio. “U.S. Congressman Tom Emmer to Lead Pro-Blockchain and Crypto Legislation.” Ethereum World News Online. 2018.
Lisk Academy. “Blockchain Basics.” Lisk Academy Online. 2019.
Suberg, William. “Two US Bills Focus on Cryptocurrency Market Manipulation and Improving Regulations.” Cointelegraph Online.