The Building Blocks of a Blockchain Governance Framework
Balancing benefits and risks
Setting the context
Blockchain technology, the underlying technology of the popular cryptocurrency ‘Bitcoin’, has been at the forefront of the new open-source era of the world wide web— Web 3.0. Blockchain has the potential of revolutionising services and businesses. As noted by the Ministry of Electronics and Information Technology (“MeitY”) last year, blockchain will add a value of over $176 billion by 2025 and over $3 trillion by 2030. By 2022, at least one blockchain-based business will reach a valuation of $10 billion.
Recognising the value proposition of this technology, governments across the globe are actively promoting the adoption of blockchain. Along with the release of a national strategy paper on blockchain (“National Strategy Paper”), the Government of India has also been exploring the potential to use blockchain in critical sectors such as e-governance, pharmaceuticals, public distribution system, judicial system ,land records etc. Regulators such as the Securities and Exchange Board of India and Telecom Regulatory Authority of India have already implemented blockchain for efficiently recording the issue and exchange of securities and filtering spam messages.
With blockchain taking the centre-stage in both government and private sector, it becomes imperative to understand if the existing legal framework that has focused on designing centralised trust based systems can accommodate decentralised technologies like blockchain. The National Strategy Paper highlights that the first step towards deploying and scaling blockchain is to assess the legal and policy implications of blockchain and to frame a sustainable regulatory framework for its use, which is what this blog delves into.
Blockchain refers to technologies that rely on a distributed ledger wherein information is stored on blocks across different computer networks (nodes) that are chained together. Traditionally, while carrying out transactions, parties rely on a central entity or trusted intermediaries to validate such transactions and act as a source of trust for the parties. As transactions get more complex, the number of intermediaries required to establish trust at every point increases as well, leading to an increase in the cost and time. Blockchains are revolutionary in this aspect since they eliminate the need to have such intermediaries to validate the authenticity of transactions or validate any data which has been uploaded.
They work on a consensus mechanism which means no one can unilaterally add, modify or alter data on a blockchain but instead, new information can only be added if all parties/nodes therein consent to such addition or modification. Each data is visible to all the nodes and can be therefore verified instantly. Thus, there is no need for trust establishing intermediaries or a central point of trust i.e.the entire process is decentralised. The identity of the nodes are mostly pseudo-anonymous with only the specific internet protocol address being the predominant identity marker.
Blockchain based systems often rely on smart contracts, which are digital agreements that are stored on blockchain platforms. They automate the performance of obligations when certain preconditions (which are coded on the blockchain) are met. For instance, in a smart contract relating to sales, only once the goods are marked as delivered in the blockchain will the automated payment obligation get triggered.
Potential advantages of blockchain technologies over centralised ledgers include disintermediation by greatly reducing the number of intermediaries, greater transparency, auditability, efficiency gains in speed and cost, etc. For instance, in India, for land record registries, blockchain is being used to record details of property and transfer of such property. These records will for perpetuity stay on the blockchain and can be verified and accessed easily without the involvement of any central authority. Any change in hands of the property can be automatically updated and instantaneously reflected on the blockchain making it easier for the government to trace and track property details.
Legal and policy Issues
The unique features of blockchain technologies raise several legal and policy issues for jurisdictions across the globe.
First, compliance with existing laws such as data protection and anti-money laundering laws. For instance, most data protection regimes rely on a central controller who collects personal data to impose data protection obligations. However, the decentralised nature of blockchain makes it difficult to identify the central controller that can be the subject of data protection laws. Additionally, since transactions recorded on blockchain cannot be revered or erased, it complicates the exercise of rights such as the right to be forgotten provided under data protection laws. Similarly, permissionless blockchain systems, wherein no authorisation is required to participate and any user may access and edit the information on the blockchain, may mask the identity of users, thereby posing challenges to the implementation of ‘know your customer’ norms.
Second, in many cases, the nodes of blockchain can be spread across jurisdictions, thereby raising questions on which jurisdictions’ laws will be applicable to blockchain based transactions.
Third, the reliance on smart contracts also raises important issues. While the formation of smart contracts generally complies with the legal requirements under contract law, problems arise during enforcement. Smart contracts can usually execute only straightforward “‘if-then’ promises. For instance, promises like ‘if goods are delivered by 5th May, 2022, then payment shall be disbursed by 7th May, 2022’ can be easily coded. However, they cannot accommodate open-ended and dynamic terms such as ‘best efforts’ or ‘reasonable performance’ which are necessary for most commercial transactions.
Designing standards for governance
While existing blockchain arrangements rely on contractual arrangements to rely on important legal issues, however, with the rise in deployment of blockchain based applications by public and private sector entities in India,, there is a need to conceptualise a robust governance framework to use such technologies in a safe and sustainable manner.
Key Principles for Designing a Governance Framework
- Transparency: Rights, powers and obligations of each participant must be enumerated and the decision-making process must be traceable. Participants should have access to relevant information to understand the blockchain system and the risks and and challenges of using such blockchain-based service.
- Legitimacy: Set up mechanisms which ensure that the information or data available and stored in the blockchain is accurate and verifiable.
- Accountability: Design a mechanism to assess how liability will be ascertained and on whom.
Key features of a Blockchain Governance Framework
1. Identification of participants: Various entities such as network developers, network operators, users and other intermediary platforms, participate in a blockchain system. Examining the role of each participant is important to design rights, liability, accountability and liability provisions.
2. Participation conditions: The eligibility criteria or conditions for participants in a blockchain should be clearly set out. Such conditions can relate to disclosure of identity, location-based criteria etc.
3. Rights of the participants: Once the participants are identified, the framework needs to also stipulate the rights of each participant so that they can interact with the blockchain with legal certainty. Some of the key rights include, for instance network operators may require rights of safe harbour under which they will be protected from any claims relating to hosting of objectionable data if they have no control over the nature of data that is being uploaded on the blockchain. . For users rights such as right to be forgotten, data limitation, audit powers and data accuracy might be more important.
4. Liabilities of the participants: As with rights, the contraventions or the activities which will make each of such participants liable to sanctions also needs to be stipulated. The liability occurrences will vary across participants. For instance, network users’ liability can stem from unauthorised or wrongful use of the blockchain application. Network operators may be liable for mismanagement of the blockchain application or for facilitating unlawful activities through blockchain. Network developers may also be liable for the design and objective of the blockchain application.
5. Exit Mechanisms and rights: Participants should have the right to leave a blockchain network. Participants should have specific exit rights which may include the right to erasure, data minimisation, data limitation, etc. However, the framework must also mention which data will be retained in the blockchain so as to trace participants in case of any wrongdoings on their part.
6. Jurisdiction: The framework must set out the mechanism to ascertain jurisdiction and the applicable law. This is important for enforcement and dispute resolution provisions. Developing a comprehensive jurisdiction provision will not only ensure that participants are not left without any legal recourse but also prevent regulatory arbitrage.
7. Security features: The proposed usage of blockchain is envisaged not only for limited private use but also for public use in critical sectors such as e-governance, healthcare, education etc. which involve handling and storing of personal data or apportioning of public goods. Thus, the framework must prescribe security standards that a blockchain network must comply with to prevent hacks or unauthorised interference. This can include stipulations regarding security certifications and regular audits.
8. Enforcement mechanism: The governance framework also needs to stipulate enforcement mechanisms and processes which will necessitate evaluating different types of mechanisms. This will involve evaluating whether complete off-chain enforcement i.e. through laws and judicial bodies is more feasible than on-chain enforcement through RegTech, wherein regulatory requirements are coded or a combination of both.
Blockchain has huge potential for unlocking efficiency gains. India has been very forthcoming and proactive in adopting blockchain solutions to enhance legacy systems. However, the unique features of blockchain such as decentralisation, pseudo-anonymity, immutability etc. raise unique challenges for traditional legal frameworks which hinge on identifying central points of accountability and responsibility. If such challenges are not addressed, the large-scale deployment and scaling of potential solutions will be frustrated. Therefore, a comprehensive governance framework needs to be developed which will address such concerns. The key features of the governance framework, as outlined herein are instrumental for using blockchain in a legally sustainable manner as well as to create a facilitative environment for blockchain participants to interact with certainty.