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When It Comes To Adopting Blockchain Technology, Education Leads To Utilization

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Blockchain technology -- the distributed ledger database that started with the Bitcoin blockchain in 2009, but nearly 10 years later has spawned innovation through the creation of innumerable blockchains, both private and public around the world -- has captured our collective attention. Blockchain technology has the ability to streamline functions, make processes more efficient, and create peer-to-peer marketplaces.

As enterprise technology projects continue to be announced, many wonder what it will take for blockchain technology to reach its tipping point, the moment when blockchain is embraced across organizations in every sector. I have a clue, and it’s not what you are thinking. It’s not about the technology. It’s about the gatekeepers. In other words, the lawyers.

Once attorneys understand the full potential of blockchain technology we will begin to see greater adoption of the technology. Attorneys are in the unique position to prepare their clients for the inevitable disruptions that will reshape the way they do business. For this reason, I was thrilled to curate a blockchain program along with James Levine, Esq., of Pepper Hamilton LLP, chairman of the E-Discovery and Technology Section of the Delaware State Bar Association, for the State of Delaware’s Annual Bench and Bar Conference.

Lauren Unterberger

The program consisted of short talks by thought leaders from Delaware and the national stage including Valerie Szczepanik, Esq., Associate Director in the SEC’s Division of Corporation Finance and the newly appointed SEC Senior Advisor for Digital Assets and Innovation, who was promptly dubbed by the media, Crypto Czar; and Lewis Cohen, Esq., a lawyer with DLxLaw LLP, one of the first law firms to focus exclusively on matters relating to blockchain technology; and other legal professionals; followed by comments from Vice Chancellor Travis Laster of Delaware’s famed Court of Chancery.  

Delaware was an apt venue for this blockchain program. With the launch of the Delaware Blockchain Initiative in 2016, Delaware was the first jurisdiction anywhere in the world to embrace blockchain technology. I started and directed the Delaware Blockchain Initiative  during my four-year stint as the Director of Corporate and International Development at the Delaware Department of State. In the summer of 2017, Delaware amended its corporate law to enable corporations to maintain their stock ledger, as well as other corporate records, on a blockchain. 

Each of the speakers offered something unique for the lawyers and judges in attendance. Since their wisdom has broad appeal, I encapsulate and share some of their insights below.

Doneene Keemer Damon, Esq., Executive Vice President of the prominent Delaware law firm, Richards Layton and Finger, suggested that blockchain technology could streamline the issuance and management of asset backed securities. Any receivable (such as car or student loans) that generates income can be securitized. Delaware plays an important role in these securitizations because Delaware business entities, such as corporations, limited liability companies, and business trusts often serve as the special purpose vehicles, that is, the business entity that actually holds the the assets, i.e., the receivables, in connection with securitizations.

Lauren Unterberger

Doneene anticipated that parties to a securitization transaction, including the issuers, the banks, the trustees and the loan servicers would all be nodes (participants) on the blockchain. Those parties with permission to view critical performance data about the underlying loans backing the securities would be able to monitor loan performance in real time and would be notified through smart contracts (the code that tracks the loans on a blockchain) in the event of non-performing loans, among other specified criteria.

This type of insight and transparency into the performance of underlying assets of the securitization would allow participants to take more timely corrective action. Creating a blockchain platform that tracks and manages securitizations solves many of the same problems that led to the mortgage crisis in 2008. And, when you also record the corresponding UCC-1 financing statements (which are the documents that that creditors file with the State to secure their loans) to the blockchain, you have a powerful combination that provides greater protections to creditors, and reduces risk all around.

According to Aaron Wright, Esq., a professor at Cardozo Law School and author of the recently published, “Blockchain and the Law," in the future, assets -- everything from shares of stock, to title to real property and title to intellectual property -- will be managed by blockchain technology. The blockchain will become the immutable source of who owns what asset at any point in time. Small computer programs (called smart contracts, which can take the form of digital “tokens”) will transfer and control rights, and/or access to those assets.

Lauren Unterberger

Smart contracts will enable assets to be transferred rapidly (or instantaneously) and, often, for a low cost. Because of this efficiency, there will be heightened efforts to marry traditional contracts with provisions that are written in code that can perform the (digital) asset transfer. In the short term, we will have agreements that are written in natural language (normal English), and some provisions that are written in code, or they will reference a code-based system. The English language and the code will work together to architect more efficient commercial transactions. 

From a contract law perspective, blockchain technology can store the agreement and/or evidence of the fact that the parties have entered into an agreement, as well as the digital signatures corresponding to the relevant documents. Having this type of information recorded to a blockchain enables parties to know which agreement is authoritative, who signed it, and where the various versions of the agreement are located. Blockchains are great at tracking bits of information and automating commercial transactions. But if there is a piece of a contract that a third party can’t objectively verify, that provision probably can’t be reduced to code. Aaron closed with a call to action. Students at universities and law schools are learning about blockchain technology and how to code smart contracts. Attorneys should start engaging with blockchain right now.

Lewis Cohen, Esq., offered a different, Zen-like definition of blockchain, calling it “a toolkit that allows businesses to re-examine their business models.” The blockchain unlocks a different way of thinking about how a business operates, who its customers are, who its stakeholders are and, fundamentally, how it finances itself. He explained that blockchain tokens have become an innovative way for businesses to raise money, noting that because tokens are essentially computer code, they can take whatever form and provide whatever rights the issuer ascribes to them. In the last 18 months, people have demonstrated that they are willing to exchange real world value for tokens. This is due, in large part, to the belief that tokens will appreciate in value. The SEC took notice, and has offered guidance about the circumstances that would give rise to federal regulations in connection with the issuance of tokens.

Lauren Unterberger

Lewis suggested that many business models can fund themselves through the sale of products that take the form of digital assets and digital tokens. He anticipates that, increasingly, businesses will use digital tokens in the delivery of products and services where securities laws are not implicated because, for example, the token has a fixed price and, thus, will not appreciate in value. Attorneys need to be prepared to answer their clients’ questions about how blockchain technology can be used to create new business models, raise capital, and deliver new types of product and service offerings, effectively and compliantly.

Earlier this year, Lewis authored a thoughtful article reflecting on the transformative impact of digital tokens in 2017, which I highly recommend.

Valerie Szczepanik, the senior policy advisor for digital assets and innovation, was positive about the promise of blockchain technology, remarking that this is probably the best time to be a regulator at the SEC or one of the other federal agencies that regulate digital assets. Proposed innovations in digital assets has caused the Commission staff to step back and reconsider foundational aspects of our economy, including money, finance mechanisms and how enterprises can be funded. The SEC looks at digital innovation and changes to the markets through the lens of its three-part mission: to facilitate capital formation, to protect investors and to maintain fair, orderly and efficient markets.

Lauren Unterberger

The SEC recognizes that blockchain technology is disruptive, but it can disrupt in a good way.  It may transform the way businesses can be funded, financed and capitalized.  Blockchain technology can change the way businesses interact with the capital markets, including the way shares are issued, transferred and recorded. The SEC staff has stepped up their engagement within the blockchain community, as well as with law enforcement and regulators in the US and globally. They have set up a blockchain portal, a mailbox at the SEC web site (SEC.gov) that receives comments and encourages dialogue with innovators in the blockchain community. They receive hundreds of inquiries at the mailbox, each one beginning a dialogue. The goal is to find the right balance between encouraging technological innovations and protecting investors against those who would do harm.

In his 2016 keynote speech to the Council of Institutional Investors entitled, "The Blockchain Plunger: Using Technology to Clean Up Proxy Plumbing and Take Back the Vote," Vice Chancellor Laster advanced the position that blockchain technology should be deployed to remove the financial intermediaries clogging the U.S. securities markets.

Vice Chancellor Travis Laster’s remarks at the Conference demonstrated his continued enthusiasm for blockchain technology and his firm belief that blockchain technology will transform the way business is conducted. In a distributed world, business relationships and organizations will be decentralized, managed by smart contracts on blockchains, obviating the need for traditional structures such as corporations and limited liability companies. First movers who provide the legal knowhow to facilitate distributed systems on a blockchain will be well positioned to develop the jurisprudence associated with a token economy.

Lauren Unterberger

Vice Chancellor Laster exhorted Delaware lawyers to become receptive to blockchain technology. He suggested that they explore the novel legal questions that blockchain technology will present in their own practices. For example, he wondered aloud what the default rule might be in the event of a contractual dispute involving a natural language legal agreement that incorporates smart contracts where the code doesn’t match up with the language in the agreement.

Vice Chancellor Laster proposed changes to Delaware law to smooth the way for innovation in blockchain and smart contracts. He suggested amending that provision of the Delaware General Corporation law which governs the issuance of rights and options pertaining to stock to clarify whether the creation, issuance and approvals under that provision can be done by operation of computer code in a smart contract on a blockchain. He suggested extending the Court of Chancery’s subject matter jurisdiction to cover disputes involving blockchain tokens issued by Delaware corporations. He also called upon Delaware attorneys to develop and publish a road map for publicly-traded companies that wish to put their stock ledgers on a blockchain.

In closing, Vice Chancellor Laster commented that most of the analysis related to token offerings has centered on whether a token is a security under federal law. He remarked that issuers should also perform a Delaware-centric analysis to consider whether tokens provide the holders with rights related to the corporation’s internal affairs, such as voting rights or the ability to take over the board. In that event, where the tokens possess equity-like features, the Court of Chancery might find that they have crossed the line, and the tokens now should be treated as if they were shares of equity, conferring on the token issuers the same very same fiduciary obligations that are owed to shareholders of Delaware corporations, including the right to redress in the Delaware Court of Chancery.