Catarina Ferreira (Master’s student in European Union Law at the School of Law of the University of Minho)

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1. The blockchain technology

Blockchain is commonly known as the underlying technology used in Bitcoin. This “new” and revolutionary technology, whose roots are ancient, has been introduced (as we know it) in 2008 when Satoshi Nakamoto released the Bitcoins’ white paper. In the white paper, Nakamoto presented a decentralized payment model based on cryptography and using blockchain technology. This idea would allow a move forward from the traditional model, based on trust and relying on an impartial third, and achieving currency decentralization (being possible to perform direct transactions between two parts).

It cannot be denied that blockchain is a new paradigm, a new information technology with tiered technical levels and multiple applications for any form of asset^[1], going beyond the financial sector. Nowadays, blockchain’s impacts are being compared to the ones that followed the development of the Internet. So, understanding what is blockchain and the ideology behind it, is a requirement for those who want to apply the law without damaging the technology.

Before clarifying what blockchain is, it should be noticed that since Bitcoin’s blockchain many others have arisen. Nonetheless, there are commonalities between all blockchains, and in this work, we’ll be discussing all those commonalities and not a specific blockchain. 

Technically, blockchain can be defined as a distributed and decentralized database where all transactions are verified by a distributed system based on a P2P network architecture^[2]. This distributed system operates and regulates itself through cryptographic algorithms. At its simplest, blockchain can be understood as a chain of blocks of information^[3] that relies on encryption and immutability (those two images play a central role when talking about blockchain and explaining how it works). 

We can understand blockchain’s immutability when analysing its process. First of all, it should be said that blockchain is immutable because it presents itself as a decentralized and distributed ledger: (1) decentralized, as no single user can control, alone, the data contained on the blockchain; and (2) distributed since it’s mechanisms and data are located across many computers on the network (nodes), creating equal access to the data on the blockchain^[4].

Keeping these traits in mind we can conceive how a transaction is performed by using a blockchain. Initially, the transaction data is sent to the network and disseminated by all its nodes, to be approved by the other participants. Once the transaction is validated by the network nodes, it will be added to a new block together with other transactions that have gone through the same process. After the transactions are validated and added to the new block that is being generated, this block will be added to the blockchain, and the network nodes will have to agree on its addition. Usually, the addition of a new block happens when solving a “cryptographic puzzle” that all nodes in the network work on (this happens in Proof-of-Work networks). However, in certain blockchains, only one of the network nodes will be designated to generate the next block, through a process that does not involve as much computation as in the previous scenario, these networks are called Proof of Stake.

Figure 1: Anderberg, A., Andonova, E., Bellia, M., Calès, L., Inamorato Dos Santos, A., Kounelis, I., Nai Fovino, I., Petracco Giudici, M., Papanagiotou, E., Sobolewski, M., Rossetti, F. and Spirito, L., Blockchain Now And Tomorrow, Figueiredo Do Nascimento, S. and Roque Mendes Polvora, A. editor(s), EUR 29813 EN, Publications Office of the European Union, Luxembourg, 2019, ISBN 978-92-76-08977-3, doi:10.2760/901029, JRC117255. P.14.

To summarize, we have a transaction that, along with the others, will integrate the new block that will be added to the blockchain. Thus, regarding the block, it will be possible to consult its header, which contains information such as the time of its creation, the date, and the hash of the previous block. Additionally, each transaction contained in the same block will also have a header containing information such as the time the transaction was carried out, the date, destination, and origin address, as well as the actual content of the transaction (the payload). All this information is immutable.

When talking about the other key feature of blockchain, encryption, multiple benefits can be pointed. Encryption is described as “a cardinal point in blockchain ecosystem” as it empowers trust, provides the certification of authenticity without traditional intermediaries, and enables users to interact without revealing their identity^[5].

One example of encryption on the blockchain is the use of public and private keys, as it has been used the public key cryptography method.  So, it consists of using a “two cryptographic keys’ system” (one public and one private) to be able to validate the transactions. When an individual wants to carry out a transaction, it is signed with their private key. The remaining nodes of the network, using the public key, are able to verify that, with no doubt, the signature is valid. Each user has an address to which public and private key corresponds. By analogy, we can understand the address as our account number and the private key as the password corresponding to that same account, which is always necessary when we want to make any interaction with the account. On the other hand, our public key, associated with the address, is known to everyone on the network.

At this point, we are able to understand the main features of blockchain, how transactions work and how security, authenticity, and trust are established on blockchain technology.

2. Legal issues

Before we move forward to a more legal perspective, it is important to identify 3 groups within the blockchain, based on the utility given to it: (1) blockchain 1.0 refers to the idea of cryptocurrencies, their development, and the transactions associated with them; (2) blockchain 2.0 has been related to smart contracts, where the technology is used to implement automatic transactions between users, so is a broader category and not limited to simple monetary transactions; and (3) blockchain 3.0 relates to the application of technology to other areas such as social media, online research, health, literature, etc.^[6].

The legal manifestations and issues that can ascend from the use of this technology are multiple and no one is unconcerned about them.

The European Commission, when designing the “Shaping Europe’s digital future” project, started a Blockchain strategy announcing that the European Union intends to be a leader at blockchain technology while highlighting that European values and ideals should be guaranteed when talking about a legal and regulatory framework for this technology. In fact, the European Union is already working on a legal framework for crypto-assets, trying to mitigate the legal problems that can arise from the use of blockchain 1.0.

When it comes to blockchain 2.0 and 3.0 no steps are being taken by the European Commission. However, blockchain participants must be conscious of the legal implications when using blockchain technology. When operating the technology numerous problems can arise, both under private or public law.

There are many examples of problems that can/should be discussed, although only a few problems will be mentioned in order to start thinking about blockchain and future steps that should be taken.

When talking about private law, smart (legal) contracts^[7]  are an “issue” to discuss. Smart contracts are defined, by Nick Szabo, as “a computerized transaction protocol that executes the terms of a contract”^[8]. With the blockchain technology, smart contracts have become a new hot topic to discuss, since smart contracts running on blockchain present unique qualities such as: (i) purely electronic nature; (ii) implementation through software; (iii) high degree of certainty; (iv) conditional nature; (v) self-execution; and (vi) self-sufficiency^[9].

The use of smart contracts in legal fields is increasing, but there are a few basic legal questions that remain uncertain. How do we know which is the applicable law and jurisdiction? Should we recognize code as a natural language when it is a legal requirement? Who is responsible when the contract has been miscoded? What is the procedure when an external event occurs and the smart contract cannot be undone? Do smart contracts protect consumers and provide legal certainty? These are only a few examples of problems that need to be discussed and solved.

At least, there is a major problem (under public law enforcement) when working on blockchain technology: compliance with the GDPR. The European Commission stated that “Blockchain technology should be compatible with, and where possible support, Europe’s strong data protection and privacy regulations”^[10], but it can be difficult when looking at the main features of blockchain technology, such as immutability.

Once more, there are a few legal problems that can arise when using blockchain technology. How to guarantee the Right to be Forgotten if blockchain is immutable?  Who is the data controller when it comes to blockchain technology? Is there a GDPR compliant blockchain? How should personal data be anonymized?

Blockchain technology is a new world full of potential that is yet to discover. However, law and innovation are not at the same pace and it is necessary to start discussing some issues that arise from the use of blockchain. If it is good news that European Union is already looking at some points, it’s mandatory to start discussing the big picture, starting to include other situations where the technology is being used.

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[1] Melanie Swan. Blockchain – blueprint for a new economy. Sebastopol: O’Reilly Media, Inc.. 2015. p. vii.

[2] A system based on a P2P network architecture is a system in which communications take place without the existence of a central server, which means that any node on the network can send and receive data without the need for permission from a central element and without having to use it to get the data. For more developments on the definition of P2P see https://techterms.com/definition/p2p?fbclid=IwAR0ear7XD3czrkgYGsnZtajhOFkuohwnArguZecrsTNpIH8_M_zftmO10xs.

[3] Lorne Lantz e Daniel Cawrey. Mastering Blockchain – Unlocking the Power of Cryptocurrencies, Smart Contracts, and Decentralized Applications. Sebastopol: O’Reilly Media, Inc.. 2021. p. 34.

[4] Thibault Schrepel. Blockchain + Antitrust – The Decentralization Formula. Cheltenham:Edward Elgar Publishing. 2021. p.24.

[5] Thibault Schrepel. Blockchain …cit.. p.18.

[6] Thibault Schrepel.  “Collusion by Blockchain and Smart Contracts”. Harvard Journal of Law & Technology, vol. 33, n.º1. 2019. p. 122.

[7] About the difference between smart contracts and smart legal contracts: Andre Janssen. “The Formation of Smart Contracts and Beyond: Shaking the Fundamentals of Contract Law?”. 2018. Available on: https://cutt.ly/9nJRUfB [09.06.2021].

[8] Nick Szabo. Smart Contracts. Available on: https://perma.cc/5NF3-R6N3 [19.11.2021].

[9] Alexander Savelyev. “Contract law 2.0: ‘Smart’ contracts as the beginning of the end of classic contract law”. Information & Communications Technology Law. vol. 26, n.º 2.  pp. 124 – 127.

[10] European Commission. Shaping Europe’s digital future: Blockchain Strategy. Available on:https://digital-strategy.ec.europa.eu/en/policies/blockchain-strategy .

Picture credits: Geralt.