The Iowa State Bar Association s ecommerce & Intellectual Property Law Sections presents Intellectual Property Law & ecommerce Seminar

Transcription

1 The Iowa State Bar Association s ecommerce & Intellectual Property Law Sections presents 2017 Intellectual Property Law & ecommerce Seminar What s a Blockchain and Why Should I Care? An Introduction to ICOs, Smart Contracts, Bitcoin Splits, and Blockchain Technology 3:30 4:15 pm Presented By Srikant Mikkilineni 6701 Westown Parkway, Suite 100 West Des Moines, IA Phone: Friday, December 1, 2017

2 Brick Gentry P.C. 2017

3 What is a cryptocurrency? A decentralized digital cash system. Bitcoin is the most famous cryptocurrency (or infamous depending on who you ask). Litecoin, Ethereum, Ripple, etc. are just a few other cryptocurrencies. Many attempts prior to Bitcoin to create a digital cash product. Digicash in the 90s However, as the recording and movie industry can tell you, digital products are very easy to copy and distribute widely. So how do you keep people from freely copying a Bitcoin and devaluing it? Blockchain technology 2

4 What is a crypto-split? A change in a blockchain s source code (the code that tells the blockchain how to operate) creates a new blockchain and, thus, a new cryptocurrency. The new cryptocurrency is considered a fork or a split from the original cryptocurrency. Current Bitcoin Splits/Forks: Bitcoin Cash Bitcoin Gold Bitcoin SegWit2x upcoming split? The planned split was called off at the last minute in November. 3

5 Splits usually occur due to disagreements over how to administer the blockchain network. We ll discuss blockchain technology a little later in the presentation, but let s look at how the blockchain is used with cryptocurrencies. 4

6 If you give someone an apple in the real world, they physically take possession of that apple. You no longer have control of the apple. Assuming you don t have any more apples, you no longer have an apple to give to anyone else. However, with a digital apple, things are different Its possible a bad actor can copy the digital apple a hundred times, to make it look like he has a hundred apples instead of only one. Image from: 1/

7 However, everyone knows when you photocopy something, it loses some of it s resolution. Similarly, every time you copy something digitally, the file changes subtly the file hash is modified to account for the additional bits tracking the data changes. Image from: Financial Times, This modification can be, and is, tracked to verify whether the digital apple is authentic. This is done by a decentralized, peer-to-peer network of computers the blockchain. 6

8 No Regulation at the Federal Level, Yet Sens. Grassley, Feinstein (D-Calif.), Cornyn (R-Texas), and Whitehouse (D-R.I.) have introduced the Combating Money Laundering, Terrorist Financing and Counterfeiting Act of See , 115 th Congress (2017). The goal of this bill is to make it easier for the federal government to seize assets transported overseas or into the U.S., such as digital currencies, to aid law enforcement with stopping money laundering, terrorist financing, and counterfeits. However, critics say the bill is too broad, and because technically, Bitcoin is carried with a user just by possession of the wallet encryption string, Bitcoin users would have to declare their Bitcoin assets every time they travel in or out of the country (if they hold $10,000 or more in Bitcoin). 7

9 IRS Notice provides guidance stating that although virtual currency can be used to pay for goods and services, it is not recognized as a currency by the IRS. Instead, the IRS has classified virtual currencies as property. Other IRS guidance takeaways include: Employers paying in Bitcoin must file W-2 and withhold federal taxes; Payments made to contractors must be disclosed and selfemployment taxes shall apply; Transactions with Bitcoins must be reported; and Gains and losses in Bitcoin sales/exchanges is characterized by whether or not it is a capital asset in the hands of the taxpayer. 8

10 FinCEN has additional guidance for virtual currency administrators and exchanges and classifies them as money transmitters which makes these operations subject to the bank secrecy act as well as money services business regulations from FinCEN. Users and payment processors are expressly excluded from the FinCEN guidance from See FinCEN, FIN-2013-G001 9

11 State Regulations: Texas, North Carolina, New York, and other states have blockchain and/or cryptocurrency specific regulations or guidance. New York in particular has taken many steps to regulate the various aspects of Bitcoin, e.g., Bitcoin investors, exchanges, traders, etc. Iowa: Iowa has no blockchain or virtual currency related regulations enacted or pending. 10

12 State Regulations: Texas: Memorandum 1037 states no money transmitter license is required to sell Bitcoin in Texas. Texas is, arguably, the most Bitcoin friendly state. Kansas (which is modeled after Texas), Tennessee, South Carolina, and Montana are all considered Bitcoin friendly. Illinois: Unregulated for the moment, but it is expected to adopt guidance that only requires exchanges and virtual currency ATMs to comply with Illinois Transmitters of Money Act ( TOMA ). Illinois recently passed House Resolution 120 to create an intergovernmental task force that will study public sector applications of Blockchain technology. See Block Chain Taskforce, Illinois House Resolution 120, Illinois State Legislature, 100 th General Assembly (2017). 11

13 State Regulations: New York: Famously considered Bitcoin hostile due to its BitLicense regulation. BitLicense requires licenses for residents and entities within the state undertaking business activities using virtual currencies. Specifically, anyone receiving virtual currencies for transmission; storing, holding, or maintaining custody of virtual currencies for others; buying and selling virtual currencies as a customer business; performing exchange services; and/or controlling, administering, or issuing virtual currency. Developing virtual currency software and merchants and consumers that use virtual currency solely for the purpose of the sale and purchase of goods/services or investment purposes are the only two exceptions listed that are not subject to BitLicense requirements. 12

14 State Regulations: New York (cont d) The BitLicense scheme went into effect on August 8, 2015 and only 3 BitLicenses have been issued as of January September 2015 Circle July 2016 Ripple January 2017 Coinbase All other applicants have been denied. 13

15 State Regulations: California: Although California does not have unfriendly Bitcoin regulations in place (BitLicenses are considered unfriendly), it has attempted to regulate bitcoin in the past. See Digital Currency, AB-1326, California Legislature Regular Session (2015). California has introduced the Virtual Currency: Regulation bill this session that would mirror much of New York s BitLicense regulations. See Virtual Currency: Regulation, AB-1123, California Legislature Regular Session (2017). 14

16 Uniform Law Commission: ULC s model regulation, Uniform Regulation of Virtual Currency Business Act, was approved at this year s National Conference. Accordingly, it is likely we will start seeing states adopt same in the near future. Model Regulation available at: gulation%20of%20virtual%20currencies/2017 AM_URVCBA_AsApproved.pdf 15

17 Uniform Law Commission: The model regulation identifies activities that require protection, namely, the storage, transfer, and exchange of virtual currency on behalf of others. The model regulation does not apply where other regulation is deemed adequate e.g. Electronic Funds Transfer Act. Banks and companies that merely provide software, computing power, or other services that enable virtual currency business are exempt from the model regulation. Individual, academic, and de minimus use are also exempt. 16

18 Uniform Law Commission: The focus of the model regulation requires covered entities: Maintain enough virtual currency to satisfy the entitlements of its users; Ensure that the property interests of customers are pro rata in the event of a shortfall; and Provide that the virtual currency of customers is not the property of the virtual currency business or reachable by its creditors. 17

19 Uniform Law Commission: The model regulation also requires businesses to register with their designated state authority and provide evidence of adequate capital on a regular basis. There is an on-ramp process within the model regulation that successively increases the regulatory compliance required. This is meant to ease the burden on virtual currency business start-ups. 18

20 Other Cryptocurrencies: Ethereum; Litecoin; Ripple; and 1,000s more out there. More coming via ICOs 19

21 Initial Coin Offering ( ICO ) in the U.S.: The SEC s position is that most ICOs are considered securities transactions and, as such, they must comply with existing SEC securities regulations. However, if the ICO can pass the Howey Test they do not need to comply with the aforementioned regulations. The Howey Test, in the context of blockchain tokens, requires three independent elements be met, : 1. An investment of money; 2. In a common enterprise; and 3. With an expectation of profits predominantly from the efforts of others. See Securities and Exchange Commission v. Howey Co., 328 U.S. 293 (1946). 20

22 ICOs Around the World: China and South Korea have banned ICOs. The EU has stated there is no recourse in cases of dispute with ICOs. Canada and Russia are creating regulatory sandboxes to allow ICO firms to experiment for a certain time without being subject to securities laws. Many governments have cautioned against investment in ICOs. U.S. UK Germany 21

23 Celebrity Warnings and Endorsements: Jordan Belfort, a.k.a. the Wolf of Wall Street, called ICOs the biggest scam ever in October. However, other celebrities have endorsed ICOs as a way to garner additional attention for the ICO in an attempt to drive up the price of the ICO. Floyd Mayweather Stox Coin Paris Hilton - LyndianCoin The SEC has recently warned that celebrity endorsements of ICOs may be potentially unlawful. 22

24 As mentioned before, blockchain technology is a peer-to-peer validation technology that came about with the Bitcoin digital currency. Traditional validation methods require banks to send transactions to a central authority or clearinghouse for validation. Blockchain technology utilizes a distributed network of computers to each verify/validate a transaction thereby exponentially increasing the number of computers a criminal must compromise to effectively initiate and validate a fraudulent transaction. 23

25 Blockchain technology is a data structure that allows for the creation of a digital ledger of transactions that is shared among multiple computers on a distributed network, i.e., computers that are not located together. A common mechanism of encrypted communication allows the distributed network of computers to each manipulate the ledger securely. 24

26 When data representing a transaction is recorded to the blockchain ledger it is extremely difficult to change or remove because each of the participants in the network receives a copy of the existing blockchain and they run algorithms to evaluate and verify the proposed transaction. If a majority of the computers agree that the transaction is valid, the new transaction is approved and a new block is added to the blockchain. 25

27 At its core, blockchain technology requires a network of computers, a network protocol that the computers can communicate through, and a consensus mechanism, i.e., the rules used to verify each transaction and agree on the state of the blockchain. Accordingly, blockchain technology can be used in other applications outside of cryptocurrencies. 26

28 Startups and industry associations have come about to apply the Blockchain technology to other markets or more traditional payment methods such as real time payment systems. R3CEV, consortium of financial institutions working to adopt a distributed ledger system. IBM is attempting to adopt Blockchain technology for supply chain validation. Mastercard has applied for at least 4 Blockchain patents. Smart contracts have been a growing implementation of blockchain technology recently. 27

29 Blockchain technology is in the process of or has already been applied to: Food safety networks; Medical and insurance record verification; Identification verification; Inventory tracking and supply chain metrics; Case history processing; and Real estate records (Chicago). 28

30 Smart Contracts Public and Private/Custom Blockchain Implementations Smart Contract name is a bit of a misnomer. More accurate to call them self-executing digital contracts. Already recognized in Arizona and more state recognition likely. 29

31 Smart Contracts Public and Private/Custom Blockchain Implementations These contracts verify the execution of obligations by both parties to a contract before executing an end result very similar to an escrow agent (which is often an attorney). Can also act as identity verification before executing the terms of a contract similar to a notary. 30

32 Smart Contracts Public and Private/Custom Blockchain Implementations For example, you want to rent a house typically, you make a deposit, which the landlord holds in escrow, perhaps with their attorney, and then provides you with the access key on a particular date defined within the contract as the start of the term of the rental. With a self-executing contract, you would provide your payment via the blockchain, the landlord would receive notification of the verified funds and would provide the digital access key on the agreed-upon date. If the landlord does not provide the key by the specified date, your verified funds are returned to you. If the landlord provides the key early, both your funds and the key are held until the start date no escrow or escrow agent required. 31

33 Please feel free to me with any additional questions or comments. Thank you. Srikant Mikkilineni (515)