The rise of the blockchain and smart contracts has been nothing short of a revolution in the world of technology and business. However, with this great innovation comes a slew of legal challenges that must be addressed in order to ensure a safe and efficient transition to this new system. My litigation team did some research, incorporated AI to help put some finishing touches on their efforts, and came up with the following. I think this is a good list and approve the following:
#1: Jurisdictional Issues
One of the biggest legal challenges facing the blockchain and smart contract technology is the issue of jurisdiction. Since these technologies are global, it is difficult to determine which jurisdiction is applicable when it comes to resolving disputes or enforcing contracts.
For example, let’s say that a smart contract is executed between two parties from different countries, and a dispute arises. In this case, it is unclear which court has jurisdiction over the matter. In SEC v. Telegram Group Inc., the Securities and Exchange Commission (SEC) argued that Telegram’s initial coin offering (ICO) violated securities laws, which prompted the court to determine whether U.S. securities laws could apply to a company based in the British Virgin Islands. See https://www.sec.gov/news/press-release/2020-146
#2: Regulatory Compliance
Regulatory compliance is another major challenge for the blockchain and smart contract technology. Since these technologies are often used in the financial sector, there are a number of regulations that must be followed in order to ensure compliance with anti-money laundering (AML) and know-your-customer (KYC) rules.
As one example, a company using a smart contract to issue digital securities must ensure compliance with SEC regulations and other financial laws. See U.S. v. Harmon, where the defendant was charged with operating an unlicensed money transmitting business after allegedly using a peer-to-peer (P2P) Bitcoin exchange to transfer funds without complying with AML/KYC regulations. See https://casetext.com/case/united-states-v-harmon-98
#3: Data Privacy
Data privacy is another major issue that needs to be addressed. Since the blockchain is an immutable and transparent ledger, it is difficult to ensure that personal data is protected in a way that complies with privacy laws.
If a smart contract is used to store personal information, there is a risk that this information could be accessed by unauthorized parties. See United States v. Gratkowski, where the defendant was charged with attempting to distribute child pornography using the Bitcoin blockchain. The case raised issues of whether blockchain technology could allow for the anonymous distribution of illegal content. See https://law.justia.com/cases/federal/appellate-courts/ca5/19-50492/19-50492-2020-06-30.html
#4: Intellectual Property
Intellectual property is another legal issue that arises with the blockchain and smart contract technology. Since these technologies allow for the creation of digital assets, it is important to ensure that intellectual property rights are protected.
For example, if someone creates a smart contract that uses patented technology, they may be infringing on someone else’s patent. In R3 v. Ripple, the companies sued each other over a dispute involving the ownership of intellectual property for blockchain technology. The case focused on whether a verbal agreement between the companies gave Ripple access to R3’s blockchain technology. See https://www.ledgerinsights.com/ripple-r3-settle-blockchain-billion-dollar-dispute/
Another challenge with the blockchain and smart contracts is determining liability in case of a breach. Since smart contracts are executed automatically and without the need for a central authority, it is difficult to determine who is responsible in the event of a breach.
For example, if a smart contract is hacked and funds are stolen, it is unclear who is liable for the loss. In DAO Report, the SEC released a report concluding that The DAO, a decentralized autonomous organization, violated securities laws. The report raised questions about who would be held liable for any losses incurred by investors in the case of a hack or other security breach. See https://www.sec.gov/litigation/investreport/34-81207.pdf
#6: Smart Contract Governance
Smart contract governance is another issue that needs to be addressed. Since smart contracts are self-executing and do not require human intervention, it is difficult to make changes to the code once it has been deployed.
So let’s say a bug is discovered in a smart contract, who can you fix it without disrupting the entire system? In Parity Multisig Wallet Hack, a vulnerability in a smart contract led to the loss of millions of dollars’ worth of cryptocurrency. The case raised questions about how to govern and manage smart contract code to prevent such losses from happening. See https://cointelegraph.com/news/parity-multisig-wallet-hacked-or-how-come
Interoperability is another legal challenge that needs to be addressed. Since there are many different blockchain platforms and protocols, it is difficult to ensure that they can all work together seamlessly.
If a company wants to use a smart contract on multiple platforms, it may need to ensure that the code is compatible with each platform. See SEC v. Kik Interactive Inc., where the SEC alleged that Kik’s ICO violated securities laws. The case raised questions about the interoperability of blockchain technology with existing securities laws and regulations. https://law.justia.com/cases/federal/district-courts/new-york/nysdce/1:2019cv05244/516941/88/
#8: International Trade
International trade is another challenge that needs to be addressed. Since smart contracts can be used to facilitate cross-border transactions, it is important to ensure that they comply with international trade laws and regulations.
As an example, a company using a smart contract to import goods may need to ensure compliance with customs regulations in the importing country. See International Trade: In U.S. v. Griffith, where the defendant was charged with violating U.S. economic sanctions by giving a presentation on blockchain technology to a North Korean audience. The case raised questions about how to apply U.S. sanctions to the rapidly evolving blockchain industry. https://casetext.com/case/united-states-v-griffith-52
Insurance is another issue that needs to be addressed with the blockchain and smart contract technology. Since smart contracts are often used to automate insurance policies, it is important to ensure that these policies are valid and enforceable.
As an example, if a smart contract is used to insure a shipment of goods, it is important to ensure that the policy complies with all relevant insurance laws. See the Leibowitz v. iFinex Inc., which involved allegations of market manipulation by the cryptocurrency exchange Bitfinex and its affiliated stablecoin issuer, Tether. The plaintiffs in the case claimed that the defendants had engaged in fraudulent conduct to manipulate the price of Bitcoin and other cryptocurrencies, causing them to suffer financial losses. The case raised questions about the use of stablecoins in the cryptocurrency market and the role of insurance policies implemented through smart contracts to protect investors in the event of market manipulation. See https://www.classaction.org/media/leibowitz-et-al-v-ifinex-inc-et-al.pdf
#10: Dispute Resolution
Finally, dispute resolution is another major challenge with the blockchain and smart contract technology. The challenge of dispute resolution in the context of blockchain and smart contracts arises because traditional mechanisms may not be effective in resolving disputes in a self-executing and decentralized system. New approaches, such as decentralized arbitration services or dispute resolution mechanisms embedded in the smart contract itself, may be necessary to address these challenges.
In ConsenSys v. Harrison Hines, a former employee of the blockchain company ConsenSys was sued for allegedly violating a non-compete agreement. The case raised questions about how to enforce contracts written in code and how to resolve disputes in a decentralized, trustless system. See https://news.bitcoin.com/consensys-inner-conflicts-spark-legal-action-against-founder/
I hope the above 10 issues planted a few seeds.
Please stay in touch and make today your masterpiece!
Mitch Jackson, Esq.
2013 California Litigation Lawyer of the Year
2009 Orange County Trial Lawyer of the Year
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