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Legal Challenges Of Blockchain Technology

Feb 23, 2021

There are many powerful and exciting use cases for blockchain technology and cryptocurrency, from online transactions to decentralized apps and simpler supply chain processes. However, there are also challenges — and this includes legal challenges.

In this article, we’ll take a look at some of the legal hurdles blockchain and crypto projects have to overcome. Mike Croghan, a cybersecurity data protection and privacy attorney at Clark Hill, joined us on the podcast to cover some of these issues and how they might affect the future of this technology.

How blockchain works

Blockchain technology is a decentralized ledger of information. It’s publicly owned and can be accessed and viewed by anyone. The information in it cannot be altered once it has been created.

This immutability and transparency makes blockchain incredibly useful for decentralization, security, privacy, and the elimination of ledgers. Cryptocurrency, the digital currency underpinned by blockchain, offers a level of privacy and anonymity that ordinary currency just can’t compete with.

While this has many wonderful advantages, it also poses legal challenges.

The legal challenges facing blockchain

Regulators want to make sure criminals can’t exploit blockchain and cryptocurrency. The inherent privacy of blockchain-based transactions means it’s possible to exchange money anonymously, and this feature can be (and has been) abused by criminals who want to obscure their shady activity.

As a result, lawmakers may soon start pushing to make cryptocurrency and blockchain transactions less private. Blockchain companies may be pressured to find a balance between the privacy and anonymity of crypto today, and a more legally compliant model that reduces the risk of crime.

Privacy issues

The debate around blockchain privacy and the legality of this doesn’t look set to slow down anytime soon.

While lawmakers are primarily concerned with preventing crime and removing the tools for nefarious players to do their business, the crypto community is quick to point out that individuals have a right to privacy. And trying to make crypto and blockchain less private and anonymous does seem like an attack on our privacy as citizens.

Regulatory issues

According to Croghan, one of the biggest regulatory issues around blockchain is that if cryptocurrencies are considered securities, they will be bound by SEC regulations.

What that means for blockchain and cryptocurrency companies is that they will need to abide by a whole range of legal obligations and requirements to avoid being punished.

Take Telegram, for example. They launched an ICO — a common way for blockchain companies to raise funds — in 2019 that the SEC shut down because they deemed the tokens to have been unlawfully sold. In June 2020, Telegram settled with the SEC and agreed to return more than $1.2 billion to investors. They also had to pay $18.5 million in civil penalties.

Federal laws

What’s the difference between federal and state laws for cryptocurrency and blockchain?

When it comes to federal laws, there are a number of organizations that govern how cryptocurrency is regulated. These include:

  • The Securities and Exchange Commission (SEC)
  • The Commodities and Futures Trading Commission (CFTC)
  • The Federal Trade Commission (FTC)
  • The Department of Treasury
  • The Internal Revenue Service (IRS)
  • The Financial Crimes Enforcement Network (FinCEN)

However, despite this daunting army of potential enforcers, there is still very little federal lawmaking on this issue. When it comes to state laws, however, it’s a different story.

State laws

Lots of states have passed laws relating to cryptocurrencies and blockchain. There’s a big difference in how the technology has been treated on a state level, with some states taking a favorable stance and others being much tougher.

Wyoming is an example of a more crypto-friendly state. Croghan explains how Wyoming recently passed a bill exempting cryptocurrencies from property taxation. Another example is Colorado, which passed a bipartisan bill promoting the use of blockchain for government record-keeping.

Arizona and Georgia have also taken steps to legalize Bitcoin as a form of payment for taxes.

However, there are almost a dozen other states, including California and New Mexico, where warnings have been issued for investors regarding cryptocurrency. New York is another example of a state that has been considered restrictive with its crypto laws.

Anti-Money Laundering (AML) and Know Your Customer (KYC)

One potential legal challenge for crypto and blockchain projects involves anti-money laundering laws.

For example, the Bank Secrecy Act regulates money service businesses, which includes virtual currency exchanges. This means that cryptocurrency exchanges are required to conduct risk assessments on their exposure to money laundering and implement anti-money laundering programs based on the findings of those risk assessments.

There are other things to be aware of, too. Under these regulations, Americans are prohibited from doing business with foreign nationals who are on a specially designated nationals and blocked entities list.

Failing to keep up with these requirements can be fatal. Croghan brings up the example of BitMEX — a cryptocurrency exchange nominally headquartered in the Seychelles and nominally not accepting U.S. customers.

When they were found to be serving U.S. customers, five entities and three individuals who owned and operated the company were charged by the U.S. authorities for operating an unregistered trading platform and violating CFTC regulations and the Bank Secrecy Act.

Potential solutions to legal challenges

Solving the legal challenges around blockchain and crypto won’t be easy. There’s still a lot of uncertainty around what the regulatory and legal space around crypto will look like. What we do know is that as soon as new laws and regulations are passed, companies in this space will need to ensure that they fully comply with these laws and provide the necessary reassurances to their customers and investors.

Smart contracts and the law

Smart contracts are often touted as a possible replacement for traditional legal processes and lawyers. Croghan doesn’t think this will become a reality any time soon.

He notes that smart contracts may end up forming small parts of wider transactions — similar to real estate escrow agreements — but the overall transactions are too complex to be performed by smart contracts alone.

There are many benefits to smart contracts in the legal space, like self-executing contracts and the removal of middlemen. But there are also some problems that will need to be overcome. They include the possibility of errors with coding and bugs that could derail entire agreements.

There are also questions around jurisdiction — which laws will apply to the contract? How do you enter a blockchain into evidence? These issues and more will need to be dealt with before smart contracts become a regular feature in the legal process.

Summary

As blockchain, crypto, and decentralization become more widely used and acknowledged, they’re going to come under increasing legal scrutiny.

For anyone entering this space or looking to start their own blockchain project, it’s crucial to work with a lawyer who understands the issues and can help you chart a safe course.

To learn more about decentralization and listen to conversations with experts about blockchain and its many uses, tune into The Unstoppable Podcast.

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