Since our last post on cryptocurrency, the price of Bitcoin has risen nearly $1,500. This rapid rise in the value of cryptocurrency is representative of the extreme volatility that has given many investors pause. While cryptocurrency still yearns for acceptance, the backbone of cryptocurrency has already garnered favor with financial intermediaries. The blockchain and distributed ledger technology have indeed vaulted cryptocurrencies to the forefront of the entrepreneurial frontier, but it has greater potential and ramifications for the entire economy.
The blockchain is a record of peer-to-peer transactions categorized into blocks on a distributed ledger. Despite the terms “block” and “distributed ledger,” the blockchain functions similarly to a local bank authorizing and recording a transaction; but instead of only one party holding the entire ledger book, the transactions are recorded communally by member nodes (peer-to-peer network of computers). The blockchain can confirm a transaction almost instantaneously instead of several banks trying to reconcile and audit separate ledgers and transactions. Whenever a transaction takes place on the blockchain, the member nodes of the blockchain develop a new hash and digital signature to update the ledger and create a new “block.” This block, or recorded transaction, is time-stamped and encrypted and will remain with the currency for life. Therefore, cryptocurrencies are made up of a chain of recorded transactions (i.e. blocks) that create the blockchain.
As with other financial technology (“Fintech”), the blockchain is subject to cyber security threats and technical glitches. However, blockchain technology is designed differently than other Fintech. In order for hackers to change the distributed ledger, they would have to infiltrate the specific block they are targeting as well as all preceding blocks in the chain. The individual hash marks in each block ensure that any attempt to change the chain would have to be approved by the other member nodes. Such a change in the historical transaction ledger would be rejected because it would conflict with existing entries. However, the blockchain is still a digital technology and it has not been free of its technical difficulties. For example, Mt. Gox, a former Bitcoin exchange, lost nearly $450 million worth of Bitcoin in 2013 due to a technical glitch. Digital disasters can be avoided or mitigated with proper insurance and cybersecurity policies by the exchanges. Also, cryptocurrencies and the blockchain will likely see an increase in regulation.
U.S. regulators, central banks, and major financial institutions have already seen great potential in the distributed ledger technology. Chairman Chris Giancarlo of the U.S. Commodity Futures Trading Commission stated in the spring of 2016 that blockchain and the distributed ledger technology “has the potential to link networks of legal recordkeeping the same way the Internet connects networks of data and information.” The U.S. Federal Reserve and its Chair Janet Yellen expect the blockchain to significantly affect current payment systems. Meanwhile, the central bank of Singapore has already hired a consulting firm to manage and develop a blockchain-based platform for interbank payments. While major financial players remain hesitant to accept cryptocurrency, they are more willing to accept the possibilities of blockchain. Financial Intermediaries have participated in the R3 consortium, which recently built a distributed ledger platform specifically for financial services, and have explored the possibility of using the blockchain for interbank settlements.
The blockchain’s use extends beyond cryptocurrencies and indeed has already been used in other industries, including agriculture, health care, and even insurance. In health care, for example, the blockchain can be used to track medical supplies and secure patients’ medical records. The blockchain is also the basis for “smart contracts” which are cryptographic contracts that execute as soon as a condition is met. In the case of insurance, for example, rather than requiring a traveler to contact the insurer once travel plans go awry, a smart contract would be triggered as soon as the traveler’s flight is cancelled.
While the blockchain technology can be used in various industries, its use as the basis for cryptocurrency has stirred the greatest controversy. Despite its general acceptance, the blockchain is just one piece to the cryptocurrency puzzle. More controversial than the blockchain technology is the initial coin offering (“ICO”). Many ICOs have already launched during the latest cryptocurrency craze. These offerings of coins and tokens are not only the subject of much debate, but are also the subject of our next post in this series on cryptocurrency.
This article is not legal advice, and was written for general information purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its authors, Andrew Silvia and Arina Shulga of Ross & Shulga PLLC. We are a New York-based law firm specializing in advising individual and corporate clients on various aspects of corporate and securities law, including initial coin offerings.
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