What is Distributed Ledger Technology?
Distributed Ledger Technology (DLT) is a bundle of technologies that are associated with advancing the concept of the distributed ledger into our world. A distributed ledger is a shared ledger that consists of synchronised data spread across multiple computer sites. The ledger works through the interconnectivity of both data and users. The primary issue with DLT is the security risk due to the numerous ways in which digital data can be fraudulently created, manipulated and deleted.
What is Blockchain?
Blockchain is a system that utilises DLT in such a way that mitigates the security issues that DLT creates. A record of a transaction or series of transactions is virtually simultaneously created and stored on all of the computers in the network (the distributed ledger) without the need for an intermediary to verify them and is protected by advanced cryptographic means so that the chance of any one person wrongly changing a particular record is said to be tiny indeed. Blockchain data is verified by the users and is completely immutable through the use of cryptography.
Developments in Australia
The CSIRO’s Specialist Data61 unit has recently released two reports looking at the ways in which blockchain technology (and DLT more broadly) could dominate the commercial world in the coming years.
The first Data61 report focuses on the potential issues with DLT in four different economic scenarios and gives advice about how to practically deal with these issues. The purpose of this report is to ensure that DLT users have in place the correct risk management policies to be able to react to various potential situations.
The second Data61 Report consists of case studies in remittance payments, open data registries and agricultural supply chains. The studies look at the ways in which blockchain could be implemented in these scenarios to reduce costs, increase efficiency and improve data visibility (including when combined with other technologies such as the Internet of Things).
Despite its benefits, Data61 has voiced concerns with the privacy and security aspects of the technology, noting that most studies of blockchain and DLT have been conducted “on a sunny day”. As superior technology is developed (e.g. quantum computing), there is a risk that the cryptographical processes underpinning blockchain could be broken, giving particular blockchain users an unfair advantage (and the potential ability to ‘hack’ the blockchain).
Data61 has urged ASIC to adopt a principle of “technological neutrality” when considering the regulation of blockchain and DLT, and to provide guidance on how it will evaluate blockchain or DLT proposals as they arise.
In March 2017, Standards Australia released its Roadmap for Blockchain Standards (Roadmap). This follows a proposal by Standards Australia in April 2016 to create a new international technical committee of the International Organization for Standardization (ISO) to create standards for blockchain and DLT.
The Roadmap creates the ISO/TC 307 committee and considers a range of issues including:
- the need to develop blockchain terminology standards as a means to clarify definitions in the sector;
- the development of standards for terminology, privacy, security, identity, risk, governance factors associated with blockchain and DLT;
- the role of any standard in supporting the regulation of blockchain or DLT in the future, and the potential relationship between the law and standards.
The ISO/TC 307 committee met for the first time in Sydney between 3 – 5 April 2017 to begin the development of the new blockchain standards. There have been no further developments since.
Initial Coin Offerings
The exponential development of blockchain and DLT has caused a new type of fundraising to emerge: Initial Coin Offerings (ICO). ICOs are inspired by IPOs, and involve a crowdsale of blockchain tokens (i.e. intangible assets stored on a blockchain which entitles token holders to a bundle of rights) by a blockchain platform to fund the development and operation of future blockchain projects on that platform. The blockchain projects are generally directed by the curators of the blockchain platform. The most high-profile example of an ICO in practice is the formation of the Decentralized Anonomous Organization (DAO), but other companies such as Bancor and Tezos have raised money for blockchain projects using ICOs.
After an ICO, blockchain tokens held by investors may be freely bought or sold, which could cause fluctuations in the value of the tokens. Blockchain tokens may also entitle investors to profits derived from any blockchain project implemented as a result of ICO funding. In this respect, ICOs have become quite popular in the U.S. amongst venture capitalists seeking to earn huge returns on investments but do not want to tackle the administrative burdens of an IPO.
The regulation of ICOs is not settled in Australia, but has been subject to debate. For instance:
- Greg Medcraft, chairman of ASIC, recently considered that ‘typically structured’ blockchain tokens do not possess the characteristics of traditional securities and would fall outside the purview of securities regulators. This follows previous ASIC guidance outlining that digital currencies derived from a blockchain are not considered ‘financial products’. However, he conceded that there may be instances where a blockchain token could be structured so that it was considered a ‘security’ under the Corporations Act 2001 (Cth) (thus requiring an IPO to be issued). There may also be AFSL implications if a blockchain token is considered an interest in a managed investment scheme.
- The U.S. Securities and Exchange Commission (SEC) recently issued a report confirming that ICO tokens issued in the DAO were ‘securities’ and that DAO’s offering of ICOs did not comply with U.S. securities laws regarding the public offering of securities. The SEC considered that:
- DAO token holders provided funds to The DAO with the expectation of earning returns on their investment;
- The funds were provided under the impression that the curators of The DAO would direct the activities of the DAO; and
- The curators of the DAO had sole managerial power in relation to The DAO, and directed the activities of The DAO.
In the Australian context, the structure of the DAO token could be considered analogous to an interest in a managed investment scheme.
The SEC did not conclude that all blockchain tokens would be considered a ‘security’ (as this analysis hinges on the precise structure of the blockchain token), but it will be interesting to see if other global regulators follow the direction of the SEC in this regard. In our view, it is only a matter of time before ASIC comes to regard Australian ICOs that have features similar to those in the DAO offering to be the offering of ‘securities’ that fall with the Australian regulatory regime and for cryptocurrencies to be regarded as ‘financial products’.
In January 2016, ASX partnered with Digital Asset Holdings to develop blockchain processes that would allow near-real time settlement of equities (thus replacing the existing CHESS platform that currently provides ASX’s clearing and settlement systems). In September 2016, ASX commenced public consultation on the replacement of CHESS. Further ASX comments were released in March 2017 outlining the ASX’s ‘plan-of-attack’, and other key comments from public consultation. No further developments have occurred in this space.
In late 2016, Australia Post developed a digital identity solution that a person could use to verify their identity (e.g. when applying for a passport or mortgage). The solution uses a blockchain platform to store the person’s identity data. In addition, Australia Post is currently working with Alibaba and Blackmores to develop blockchain solutions to improve the traceability of food products in markets where counterfeit products are common.
Two of Australia’s big 4 banks, ANZ and Westpac have also begun to implement blockchain processes to monitor bank guarantees in a single digital ledger (thereby replacing existing paper-based processes), and the University of Melbourne has trialled the use of blockchain technology to record student credentials (thus allowing people to share verified copies of their qualifications with employers and other third parties in a tamper-proof system).
We are excited at Cowell Clarke about the future that blockchain holds and are committed to assisting businesses in all industries that wish to utilise blockchain technology. We will continue to assess the developments in this space. For more information, please contact Nicholas Cardone or someone from our team.