Blockchain Griffith University

Bitcoin & Blockchain Some Legal Points Dr. Adrian McCullagh Ph.D. (IT Sec), LL.B. (Hons), B. App. Sc. (Computing), GAICD ODMOB Lawyers Brisbane Australia [email protected] Mob: +61401646486

Disclaimer

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PLEASE NOTE: the information disclosed in the presentation is NOT the provision of Legal advice or Professional Services advice. If a reader/attendee has an issue then they should seek appropriate legal/technical advice. The author/presenter makes no warranty as to correctness of anything contained in this presentation. The topic of this presentation is ever changing at a rapid rate and as such this presentation is the sole opinion of the author/presenter and must not be relied upon as either legal or technical advice. Every situation is different and as such proper analysis must be undertaken when seeking professional advice.

Consequently, the takestakes no responsibility for any errors that may exist in thisauthor/presenter paper and certainly no responsibility if any reader/attendee takes any actions based on what is (expressly or by implication) contained in this paper/presentation. All readers/attendees take full responsibility for anything they may do in reliance of anything contained in this paper/presentation. Griffith University Blockchain Presentation

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Agenda     

The srcins of the blockchain What is a blockchain What are the benefits of the blockchain Proposed Blockchain uses Why is blockchain a hot topic

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Smart Contracts and Legal Implications Road Blocks in the development of Blockchains as a disruptive Technology Conclusion Griffith University Blockchain Presentation

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The srcins of the blockchain

Griffith University Blockchain Presentation

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The srcins of the blockchain 

In 2008, an unknown mathematician/cryptographer going by the name of Satoshi Nakamoto (pseudonym) published an obscure paper which described a new form of cryptocurrency, which Nakamoto called bitcoin.

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Nowhere in the Nakamoto paper is there mentioned the term “Blockchain”;


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BUT

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Nakamoto defined his vitual currency as a chain of digitial signatures; that is each owner transfers each coin to another person by digitally signing the hash of the previous transaction and the public key of the next owner.


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He further states “'Nodes always consider the

longest “chain” to be the correct one and will keep working on extending it. If two nodes broadcast different versions for the next 

“block”….

The effect of this is that a cryptographic chain of information (Blocks) is created.


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Hence, blockchain has its srcins with the bitcoin paper written by

Nakamoto, though the actual srcins of the concatenated word “block chain” like Nakamoto him/herself remain a mystery. 

There are 3 underlying technologies and one specific protocol that is encapsulated in bitcoin: 

Hash Algorithms;

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Digital Signatures;

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Merkle Trees; and

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The Proof of Work Protocol or consensus protocol.


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Nakamoto devised a fiendishly cleaver use of these technologies to create what is now known as bitcoin and a new consensus protocol.

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The ultimate aspect of bitcoin is that bitcoin is the first technology in the digital environment that eliminates the double spend problem without the need of a trusted third party.


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The blockchain has been described as being the ultimate disruptive technology in modern society and business.

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As disruptive as the internet was in 1992 when the National Science Foundation allowed non defence commercial entities to take advantage of the World Wide Web.

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OR as the Govenor of the Bank of England has noted: “blockchain is the start of the fourth information revolution”.


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What is a blockchain


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What is a blockchain 12

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A blockchain is basically a distributed ledger (multiple copies of the same thing) that has the following characteristics: Once a transaction is recorded in the blockchain it cannot be deleted or edited without leaving some trace of such deletion or alteration. It becomes a permanent record for all eternity. Any attempted changes to the record will automatically be identified which will cause all parties to investigate what has gone wrong. In essence, the blockchain becomes a tamper evident record of transactions (Immutable).

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What is a blockchain No Central party will control the blockchain; BUT some private blockchains that are being developed will be controlled by a central authority. In general, being a distributed leger a number of copies will be established which makes it difficult for unauthorised third parties to successfully hack every copy of the ledger. Therefore there is no single point of failure. It would require a hacker to simultaneously attack at least 51% of all copies which is just not feasible.

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What is a blockchain 14

The bitcoin blockchain is completely transparent with every participant having read access to the entire blockchain and being able to add to the blockchain when they wish to effect an authorised transaction. The bitcoin blockchain is known as a permissionless blockchain or open blockchain.

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There are being developed permissioned blockchains which will only allow authorised persons having the right to read and add to the blockchain. R3CEV is an example of this.

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The technical aspects of the BitCoin blockchain  

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Each block will contain multiple transactions. In BITCOIN a block is set at 1 megabyte. There is currently a dispute among core administrators of the bitcoin code on how to improve the scalability of bitcoin. In private blockchains the size of the blocks will be set by the administrator/creator of the blockchain. The data structure of a block will be set by the administrator. Griffith University Blockchain Presentation

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What is a Block: data structure Size

Field

Description

4 bytes

Block Size

The size of the block, in bytes, following this field

80 bytes

Block Header

Several fields form the block header

1-9 bytes (Variable Transaction Counter Integer) Variable (alpha numeric)

Transactions

How many follow transactions The transactions recorded in this block 25 May 2016


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Single Block data structure

Block size – 1 Mega byte Blockheader* TX number =4

TX1

TX2

TX3

TX4

* The Blockcheader field is expanded in next slide


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Block header 18

Size

Field

Description

4 bytes

Version

A version number to track software/protocol upgrades

32 bytes

Previous Block Hash

A reference to the hash of the previous (parent) block in the chain

32 bytes

Merkle Root

A hash of the root of the merkle tree of this block’s transactions

4 bytes

Timestamp

The approximate creation time of this block (seconds from Unix Epoch)

4 bytes

Difficulty Target

The proof-of-work algorithm difficulty target for this block

4 bytes

Nonce

A counter used for the proofof-work algorithm


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Block-header data structure * This field is more fully explained in next slide Version Previous block hash Merkle root* Time stamp Target difficulty** Nonce ** Target difficulty deals with the proof of work protocol


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Blockchain: Merkle root


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Block-header data structure

Version Previous block hash Merkle root

Time stamp Target difficulty Nonce


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Target Difficulty – Proof of work 

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Proof of work involves the use of Cryptographic hash functions. A cryptographic hash function is a mathematical algorithm that maps data of any arbitrary size to a fixed length bit string (the resultant is know as the hash or message digest of the srcinal document).

That is, a function is infeasible to invert, and thus us one way. 

The characteristics of a good hash functions are: 

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Very quick if calculate; One way: meaning it should be infeasible to guess the srcinal document by simply knowing its hash result; Collision free: it should be infeasible to find two documents that result in the same hash result; Every document should have its own unique hash result which means that any change to the srcinal document should result in an entirely different hash


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From a technical perspective a good hash function must have the following properties: 

Pre-image resistance 

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Given a hash value h it should be difficult to find any message m such that h = hash(m). This concept is related to that of one-way function. Functions that lack this property are vulnerable to preimage attacks.

Second pre-image resistance 

Given an input m1 it should be difficult to find different input m2 such that hash(m1) = hash(m2). Functions that lack this property are vulnerable to second-preimage attacks.


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Collision Free 

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It should be difficult to find two different messages m1 and m2 such that hash(m1) = hash(m2). Such a pair is called a cryptographic hash collision.This property is sometimes referred to as strong collision resistance.

Proof of work is a brute force procedure to change the nonce so that the resultant hash will have at least 64 leading 0’s. It is energy intensive but once solved is easy to prove.

Version Previous block hash Merkle root Time stamp


Target difficulty Nonce

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Target Difficulty: Proof of Work 

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Because it is not possible to identify from a document what its hash result will be then to get a resultant hash with 64 leading 0’s requires the energy of going through nonce after nonce until the desired hash is created. It has been calculated that currently the energy required to run bitcoin is actually greater than what google expends to run its business operations. In the bitcoin environment, Proof of Work is undertaken by miners who specially designed chips (ASICs) to calculated theuse desired hashes.


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What is a blockchain: a cryptographically connected series of blocks of transaction data Transaction A

Transaction B

Transaction C


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What is the blockchain: P2P distributed / decentralised database of transactions


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Benefits of the blockchain


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Advantages of the blockchain 

The blockchain has the following advantages: 

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It is reliable and available due to its extensive participant involvement; It is transparent as all participants have access to the recorded information; It is immutable in that once the information is recorded on the blockchain it cannot be changed without leaving some trace (its integrity is guaranteed); It is irrevocable in that the information recorded cannot be deleted or reversed (this has significant advantages from an auditing perspective); Griffith University Blockchain Presentation

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Advantages of the blockchain 

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It is digital and thus can be deployed in non-face to face transactions and thus can be automated. It can substantially reduce the time between the instigation of a transaction and its settlement. It can be used for any type of transfer of value: not just bitcoin; It can eliminate the involvement of a trusted third party and thus reduce friction costs or as Coates identified transactions costs.


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Disadvantages of blockchain


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Blockchain disadvantages 

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Blockchains by themselves do not provide any advantage. It is only when other applications are layered on top of them that there is a benefit. As Sir Mark Walport UK Chief Scientist noted : “the implementation of distributive ledgers with embedded smart contracts should lead to substantial improvements in compliance, cost efficiency and accountability.” BUT are some real outstanding legal issues involved in sothere called smart contracts. Migration of data will be an issue if another system is later developed which is more commercially appealing. Griffith University Blockchain Presentation

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Blockchain disadvantages 

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Blockchains standards have not been finalised as this is an evolving technology. Work need to be done of settling the data structure for all transactions whether it is bitcoin or some other transaction that involves blockchains. There are currently billions of dollars invested in legacy systems. The simplest transition is for the currently deployed data repository infrastructure to remain in tact and for blockchain applications to be developed which can interrogate the blockchain and transfer the collected data to the current legacy systems on a temporary basis for reporting purposes onlu. Once the reports are completed the temporary repository can be wiped. Griffith University Blockchain Presentation

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Proposed Blockchain uses 

blockchain deployment can be useful in the following: 

Supply chain management.

Specific product insurance including motor vehicle insurance;

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Lending funds to consumers to purchase goods; Product recall arrangements;

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Repair of products. Griffith University Blockchain Presentation

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Supply chain management 

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Manufacturers could embed through RFID Technology or other IoT technology a blockchain reference which the manufacturer will set up. The blockchain in being an integral part of the supply chain / ownership of goods structure can substantially reduce the risk ofand counterfeit products entering the market being traded.


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The blockchain will not prevent counterfeit goods from entering the market but it will allow the end user/consumer to validate the authenticity of all products and thus it should substantially reduce the size of the end user market and thus reduce the fraud committed on end users. This will particularly important in the pharmaceutical industry with counterfeit drugs. Health professionals will be able to ensure that authentic drugs are at all time administered to patients.


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All new / potential owners will be able to interrogate the blockchain to make sure that the relevant goods are not counterfeit. Luxury goods could be embedded with a QR code by the manufacturer which can be scanned by any mobile devise so as to interrogate the blockchain to check its validity / authenticity.


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Supply chain management  

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Write Once Read Many-times (WORM) technology. It is possible for a manufacturer to embed in some polymer film a key that can be read using a hand-held device like a mobile phone that has embodied in it an app that has been developed by the manufacturer. The App can be authenticated when downloaded from an authorised website that has extended validation certificates allocated to it. Further the app could be digitally signed by the manufacturer so as to reduce the risk of false apps be deployed. It is expected the Pharmaceutical industry to take advantage of this technology. Griffith University Blockchain Presentation

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Counterfeit drugs adversely impacted the US economy by $72 billion in 2015. Basically a clear sheath of a special polymer film could be applied to the encapsulate packaging that is used in keeping the drugs sterilsed A smart phone with light emanation will be able to read the crypto and interrogate the blockchain for authenticity and use by date. Last year it has been estimated that nearly a billion dollars of out of date drug were administered in third world locations. Griffith University Blockchain Presentation

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Insurance Fraud 

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How does the insurance company determine that the person claiming ownership actually is the owner or has an insurable interest? The insurance company can interrogate the blockchain using the serial number/VIN as the reference point to determine ownership. This aspect alone should substantially reduce insurance fraud.


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Lending and blockchain interrogation 

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The lender wants to make sure that the goods are not already encumbered and so it also interrogates the blockchain using the serial number of the product as a reference point. The blockchain is used to record all transactions that involve the relevant product including all borrowings and insurance policies issued.


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Product recall by a Manufacturer/Repairs 

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The manufacturer needs to undertake a product recall due to some safety fault identified post sale. The manufacturer can register on the blockchain the safety recall notice. Now in some jurisdictions it is illegal to transfer a product whilst a product recall notice has been issued. Once the defect, the subject of the recall notice, has been corrected then the manufacturer will update the blockchain to identify that the product has been corrected.


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Why blockchain is a hot topic


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Why is Blockchain a hot topic 

There are a number of major industries that are expending substantial funds on blockchain research, development and deployment. These industries include: Finance sector (FIN TECH); Luxury Goods (Diamond Trades);      

Insurance; Stock Exchanges; Movie Studios; Software development. Griffith University Blockchain Presentation

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Why is Blockchain a hot topic 

Each of the above industries are looking at the use of blockchain from a different angle: The finance/share market sectors is wanting to reduce the time between the signing of a transaction and the time of settlement. In land contracts the delayed time can be as high as 60 days or longer and in the share market it is T+2 days. The longer the period the greater the risk of an issue arising.

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Luxury goods and Pharmaceutical sectors want to counteract counterfeit goods.

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Why is Blockchain a hot topic The insurance sector wants to reduce/eliminate the risk of fraud.

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The IP sectors including movies and software want to eliminate piracy.

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The blockchain can in each case be used to assist in solving these issues.


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Smart Contracts : Legal aspects


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SMART CONTRACTS & Legal Issues  

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A so called smart contract is neither smart or a contract. Lawyers would call it a humpty-dumptyism. (See Lord Glanville Williams series of papers on plain English for lawyers and the discussion between Alice and HumptyDumpty from “Alice through the Looking Glass”) What is a so called smart-contract? : it is computer code that will be connected to a blockchain. The smart code will monitor the internal performance of a contract and any deviation will cause the software to activate certain responses. The Ethereum project has a number of so called smart contracts in development. Griffith University Blockchain Presentation

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SMART CONTRACTS & Legal Issues 

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The R3CEV group is also investigating smart contract uses in a number financial transactions. The difficulties of smart contracts are: 

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How are equitable principle accommodated such as innocent misrepresentation or discretionary aspects of voiding a contract proper; How can force majeure events be accommodated as these are usually external events that impact performance. This may be an opportunity for news gathering organisations that are trusted to provide information dealing with externalities. Griffith University Blockchain Presentation

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What happens if a contract is frustrated due to some external situation that the parties did not contemplate at the time of contracting. Again news providers may be able to establish themselves as a trusted source of such information. What is too occur if performance of the contract is later determined to be illegal; What if the some of the terms are determined by a court to be harsh or unconscionable? How will aspects of the UCC be accommodated such as limitation of liability provisions and font size and capitalization of language. (this is a minor issue but is mentioned for completeness only). Griffith University Blockchain Presentation

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SMART CONTRACTS & Legal Issues 

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Assuming that the above can be accommodated are there certain contracts that should not be monitored by a smart contract? Further investigation / research is required for this area.


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Road Blocks for Blockchain


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Road Blocks for Blockchain 

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On 20 April Morgan Stanley issued its report on the development and deployment of Blockchain solutions. This report identified 10 road-blocks that need to be addressed before blockchains become a reality in banking: 1.

is there a compelling business case to support the expenditure?,

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cost mutualisation/who funds the overhaul of legacy systems?,

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Are there misaligned incentives,

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How do the lack of standards currently impact the development and ultimate deployment especially for inter-operability,

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Is the technology scalable without performance degradation, Griffith University Blockchain Presentation

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Road Blocks for Blockchain 6.

What governance needs to be developed;

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How will regulators deal with the advancement of this new technology,

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What are the legal risks not only with regulators but also with clients,

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Are there any cryptology/security issues presently existing or down the track like the development of Quantum cryptography, and

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Can a blockchain system be developed that is simplistic and interoperable with both other blockchain deployments and legacy systems.


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Road Blocks for Blockchain It is interesting that Morgan Stanley noted that no single policymaker they met concerning the research for their report would allow an "unpermissioned" distributed ledger.  In general a blockchain is meant to be a transparent recording of transactions but it is unlikely that this will be the case for all transactions as the finance sector and its customers will not want their business transaction to be disclosed across the blockchain.  One issue that still needs to be resolved will be partial permissioned blockchain where parts will only be visible to those with the correct credentials. 


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Conclusion


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Conclusion 

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Blockchain is clearly at this point in time an immature technology but is advancing at a rapid rate. Morgan Stanley estimate that commercial systems with Regulatory approval will not occur until 2017/2018. There is great promise and investment occurring in this area. The financial sector is leading the way but other sectors like pharmaceuticals are rapidly looking at this technology.


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Conclusion 

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Regulators across the world are interested in this technology and are greatly assisting in the development and sandbox deployment of blockchain solutions. Risk is still an issue and regulatory compliance remains an outstanding issue as does system liability issues fro clients. Smart contracts are code applications that are built on top of a blockchain and this still needs further investigation


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?? Questions ??


5 May 2016

Blockchain Griffith University

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