MyFondia VirtualLawyer
November 9, 2016

Blockchain unchained

Have you ever wondered how a complex chain of contracts is behind a seemingly simple online purchase? Your money does not go directly to the seller after pressing the ‘pay’ button; there are a number of entities in between, usually banks, credit card companies or other intermediaries. Both you and the seller must have a contract with the bank or credit card company in order for the transaction to be successful. These middlemen are known as ‘trusted third parties’. They are used because the transaction partners do not trust each other.

I would argue that the whole Western economic system is based on the use of such trusted third parties. Our currency system would not be possible without reliable central banks; securities trading always takes place through a broker; the property ownership system is based on a reliable land register; the electricity market is based on third party use etc. Whenever we transfer something of economic value we use some kind of a third party that we trust in the process.

Imagine a situation in which these third parties could be totally bypassed and the transaction or agreement would happen directly between the buyer and the seller. Such an opportunity would revolutionise the fabric of society. The business of banks, credit card companies, utility companies and many other institutions would change drastically or even collapse entirely. Such a change may result from the spread of blockchain applications.

The blockchain itself is not anything more special than a database, which has been a basic application in computing ever since computers became more common. The blockchain differs from your standard database in the fact that it is distributed to thousands of servers around the world, and in particular in that the contents of the data (block) cannot be changed retrospectively without this being recorded into subsequent blocks. It could be compared to accounting records and the financial statement for the fiscal year. When the fiscal year ends, the books will be closed, and the profit calculations and balance sheet are verified on the basis of supporting documents, and the figures can no longer be altered later. The balance sheet for the new fiscal year is opened on the basis of the locked data from the previous year. In a similar way, each block in the blockchain contains a mathematically calculated record of the previous block’s data. If you try to change the details of previous blocks, the hash function will show the change.

The business concept of banks and other trusted third parties has been based on the fact that they have acted as bookkeepers of transactions between parties. A bank has kept track of how much money has come into your account and how much money has gone out from your account. Now such a record can be transferred to a decentralised, transparent database. For this reason, the blockchain is often referred to as a distributed ledger. And here lies the revolutionary nature of the blockchain: by utilising block chain technology, all third parties can be bypassed from various transactions since a record of transactions can be kept using the blockchain. Rather than trusting a bank and its ability to record our bank transactions accurately, we rely on the fact that in a distributed database no single party can take possession of the database and make fraudulent entries without getting caught.

The best-known application of the blockchain is virtual money. There are several types of virtual currency, the most widely used being Bitcoin. Using virtual currency allows the complete bypass of banks; money is transferred directly from the payer to the payee without the involvement of a third party. Payment is unlikely to become wholly based on virtual currency any time soon; instead I believe (and hope) that different micro-payment systems become more common with blockchain technology.

Currently, internet content providers do not have a sensible way to charge users of this content. Individual payment costs are so high that it does not make sense to charge for transactions that are worth less than one euro. On the other hand, consumers are not willing to pay a euro for watching a single YouTube video or reading a magazine article. If, instead, the price was let’s say half a cent, the threshold for paying for content would drop and, on the other hand, it would be possible to charge for content that is currently offered for free. Blockchain technology enables this kind of direct billing between the producer and the user without the incurrence of significant transaction costs.

Blockchain technology has numerous applications, although most of them are still in the experimental stage. An application called Blockcharge is being tested in Germany, which allows anyone to set up an electric car charging point (e.g., in their garden) and sell electricity to electric car users. The application manages the transaction between the seller and the user without middlemen by utilising blockchain technology. The Storj.io application rivals Amazon and other companies that sell server space by offering a solution in which disk space is distributed to thousands of computers belonging to private individuals and companies around the world. Through the service, you can either buy disk space or sell your own additional disk space. The distribution and encryption of files is carried out using blockchain technology.

In the long-term, blockchain technology may also change the work of lawyers. The technology allows for so-called smart contracts, which are software programs that automatically monitor the creation and implementation of contracts. For example, the Swiss bank USB has experimented with intelligent derivatives in which blockchain technology was used to carry out a financial instrument, which took care of charges and payments by itself without the involvement of the bank’s clearing department.

Blockchain technology is not without its problems and it is not certain that it will breakthrough like many are hoping. At present, major problems include system security, and performance and development management of the technology. But, as with so many new things, we probably overestimate the short-term and underestimate the long-term effects of blockchain technology.

Arto Lindfors is Fondia’s IT lawyer and chairman of the steering group for Tekes’ ReCon research project. The project is exploring possible commercial opportunities for blockchain technology.