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Bitcoin & Blockchain

Some Legal Points


Dr. Adrian McCullagh

Ph.D. (IT Sec), LL.B. (Hons), B. App. Sc. (Computing), GAICD


ODMOB Lawyers
Brisbane Australia
ajmccullagh57@gmail.com

Mob: +61401646486

Disclaimer
PLEASE NOTE: the information disclosed in the presentation is NOT the
provision of Legal advice or Professional Services advice. If a
reader/attendee has an issue then they should seek appropriate
legal/technical advice. The author/presenter makes no warranty as to
correctness of anything contained in this presentation. The topic of this
presentation is ever changing at a rapid rate and as such this
presentation is the sole opinion of the author/presenter and must not be
relied upon as either legal or technical advice. Every situation is different
and as such proper analysis must be undertaken when seeking
professional advice.
Consequently, the author/presenter takes no responsibility for any errors
that may exist in this paper and certainly takes no responsibility if any
reader/attendee takes any actions based on what is (expressly or by
implication) contained in this paper/presentation.
All readers/attendees take full responsibility for anything they
may do in reliance of anything contained in this
paper/presentation.
Griffith University Blockchain Presentation

25 May 2016

Agenda
The origins of the blockchain
What is a blockchain
What are the benefits of the blockchain
Proposed Blockchain uses
Why is blockchain a hot topic
Smart Contracts and Legal Implications
Road Blocks in the development of Blockchains
as a disruptive Technology
Conclusion
Griffith University Blockchain Presentation

25 May 2016

The origins of the blockchain

Griffith University Blockchain Presentation

25 May 2016

The origins of the blockchain


In 2008, an unknown mathematician/cryptographer going
by the name of Satoshi Nakamoto (pseudonym) published
an obscure paper which described a new form of

cryptocurrency, which Nakamoto called bitcoin.


Nowhere in the Nakamoto paper is there mentioned the
term Blockchain;

Griffith University Blockchain Presentation

25 May 2016

The origins of the blockchain


BUT
Nakamoto defined his vitual currency as a chain
of digitial signatures; that is each owner transfers
each coin to another person by digitally signing
the hash of the previous transaction and the
public key of the next owner.

Griffith University Blockchain Presentation

25 May 2016

The origins of the blockchain


He further states 'Nodes always consider the
longest chain to be the correct one and will
keep working on extending it. If two nodes
broadcast different versions for the next block.
The effect of this is that a cryptographic chain of
information (Blocks) is created.

Griffith University Blockchain Presentation

25 May 2016

The origins of the blockchain


Hence, blockchain has its origins with the bitcoin paper written by

Nakamoto, though the actual origins of the concatenated word


block chain like Nakamoto him/herself remain a mystery.
There are 3 underlying technologies and one specific protocol that
is encapsulated in bitcoin:
Hash Algorithms;
Digital Signatures;

Merkle Trees; and


The Proof of Work Protocol or consensus protocol.
Griffith University Blockchain Presentation

25 May 2016

The origins of the blockchain


Nakamoto devised a fiendishly cleaver use of these
technologies to create what is now known as bitcoin
and a new consensus protocol.

The ultimate aspect of bitcoin is that bitcoin is the first


technology in the digital environment that eliminates the
double spend problem without the need of a trusted
third party.

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The origins of the blockchain


The blockchain has been described as being the ultimate
disruptive technology in modern society and business.
As disruptive as the internet was in 1992 when the National
Science Foundation allowed non defence commercial
entities to take advantage of the World Wide Web.
OR as the Govenor of the Bank of England has noted:

blockchain is the start of the fourth information revolution.

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What is a blockchain

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What is a blockchain
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A blockchain is basically a distributed ledger


(multiple copies of the same thing) that has the
following characteristics:
Once a transaction is recorded in the blockchain
it cannot be deleted or edited without leaving
some trace of such deletion or alteration. It
becomes a permanent record for all eternity. Any
attempted changes to the record will
automatically be identified which will cause all
parties to investigate what has gone wrong. In
essence, the blockchain becomes a tamper
evident record of transactions (Immutable).
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What is a blockchain
No Central party will control the blockchain;
BUT some private blockchains that are being
developed will be controlled by a central
authority. In general, being a distributed leger
a number of copies will be established which
makes it difficult for unauthorised third parties
to successfully hack every copy of the ledger.
Therefore there is no single point of failure. It
would require a hacker to simultaneously
attack at least 51% of all copies which is just
not feasible.
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What is a blockchain
The bitcoin blockchain is completely
transparent with every participant having
read access to the entire blockchain and
being able to add to the blockchain when
they wish to effect an authorised transaction.
The bitcoin blockchain is known as a
permissionless blockchain or open
blockchain.
There are being developed permissioned
blockchains which will only allow authorised
persons having the right to read and add to
the blockchain. R3CEV is an example of this.
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The technical aspects of the BitCoin


blockchain
Each block will contain multiple transactions.
In BITCOIN a block is set at 1 megabyte. There is
currently a dispute among core administrators of the
bitcoin code on how to improve the scalability of
bitcoin.
In private blockchains the size of the blocks will be set by
the administrator/creator of the blockchain.
The data structure of a block will be set by the
administrator.
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What is a Block: data structure


Size

Field

4 bytes

Block Size
Block Header

80 bytes

1-9 bytes (Variable Transaction


Counter
Integer)
Variable (alpha
numeric)

Transactions

Description
The size of the
block, in bytes,
following this field
Several fields form
the block header
How many
transactions follow
The transactions
recorded in this
block
25 May 2016

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Single Block data structure

Block size 1 Mega byte Blockheader* TX number =4

TX1

TX2

TX3

TX4

* The Blockcheader field is expanded in next slide

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Block header
Size

Field

Description

4 bytes

Version

A version number to track


software/protocol upgrades

Previous Block Hash

A reference to the hash of


the previous (parent) block in
the chain

Merkle Root

A hash of the root of the


merkle tree of this blocks
transactions

4 bytes

Timestamp

The approximate creation


time of this block (seconds
from Unix Epoch)

4 bytes

Difficulty Target

The proof-of-work algorithm


difficulty target for this block

4 bytes

Nonce

A counter used for the proofof-work algorithm

32 bytes

32 bytes

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Block-header data structure


* This field is more fully
explained in next slide
Version Previous block hash Merkle root* Time stamp Target difficulty** Nonce
** Target difficulty deals with
the proof of work protocol

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Blockchain: Merkle root

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Block-header data structure

Version Previous block hash Merkle root Time stamp Target difficulty Nonce

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Target Difficulty Proof of work


Proof of work involves the use of Cryptographic hash functions.
A cryptographic hash function is a mathematical algorithm that maps data
of any arbitrary size to a fixed length bit string (the resultant is know as the
hash or message digest of the original document).
That is, a function is infeasible to invert, and thus us one way.
The characteristics of a good hash functions are:
Very quick if calculate;
One way: meaning it should be infeasible to guess the original document by
simply knowing its hash result;
Collision free: it should be infeasible to find two documents that result in the same
hash result;
Every document should have its own unique hash result which means that any
change to the original document should result in an entirely different hash

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Target Difficulty Proof of work


From a technical perspective a good hash function must
have the following properties:
Pre-image resistance
Given a hash value h it should be difficult to find any
message m such that h = hash(m). This concept is related to
that of one-way function. Functions that lack this property are
vulnerable to preimage attacks.

Second pre-image resistance


Given an input m1 it should be difficult to find different input
m2 such that hash(m1) = hash(m2). Functions that lack this
property are vulnerable to second-preimage attacks.

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Target Difficulty Proof of work


Collision Free
It should be difficult to find two different messages m1 and m2
such that hash(m1) = hash(m2). Such a pair is called a
cryptographic hash collision. This property is sometimes
referred to as strong collision resistance.

Proof of work is a brute force procedure to change the


nonce so that the resultant hash will have at least 64 leading
0s.
It is energy intensive but once solved is easy to prove.
Version Previous block hash Merkle root Time stamp Target difficulty Nonce

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Target Difficulty: Proof of Work


Because it is not possible to identify from a document
what its hash result will be then to get a resultant hash
with 64 leading 0s requires the energy of going through
nonce after nonce until the desired hash is created.
It has been calculated that currently the energy
required to run bitcoin is actually greater than what
google expends to run its business operations.
In the bitcoin environment, Proof of Work is undertaken
by miners who use specially designed chips (ASICs) to
calculated the desired hashes.

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What is a blockchain: a cryptographically


connected series of blocks of transaction data
Transaction A

Transaction B

Transaction C

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What is the blockchain: P2P distributed /


decentralised database of transactions

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Benefits of the blockchain

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Advantages of the blockchain


The blockchain has the following advantages:
It is reliable and available due to its extensive
participant involvement;
It is transparent as all participants have access to the
recorded information;
It is immutable in that once the information is
recorded on the blockchain it cannot be changed
without leaving some trace (its integrity is
guaranteed);
It is irrevocable in that the information recorded
cannot be deleted or reversed (this has significant
advantages from an auditing perspective);
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Advantages of the blockchain


It is digital and thus can be deployed in non-face to
face transactions and thus can be automated.
It can substantially reduce the time between the
instigation of a transaction and its settlement.
It can be used for any type of transfer of value: not just
bitcoin;
It can eliminate the involvement of a trusted third party
and thus reduce friction costs or as Coates identified
transactions costs.

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Disadvantages of blockchain

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Blockchain disadvantages
Blockchains by themselves do not provide any
advantage. It is only when other applications are
layered on top of them that there is a benefit.
As Sir Mark Walport UK Chief Scientist noted: the
implementation of distributive ledgers with embedded
smart contracts should lead to substantial improvements
in compliance, cost efficiency and accountability.
BUT there are some real outstanding legal issues involved
in so called smart contracts.

Migration of data will be an issue if another system is


later developed which is more commercially appealing.
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Blockchain disadvantages
Blockchains standards have not been finalised as this is
an evolving technology. Work need to be done of
settling the data structure for all transactions whether it is
bitcoin or some other transaction that involves
blockchains.
There are currently billions of dollars invested in legacy
systems. The simplest transition is for the currently
deployed data repository infrastructure to remain in tact
and for blockchain applications to be developed which
can interrogate the blockchain and transfer the
collected data to the current legacy systems on a
temporary basis for reporting purposes onlu. Once the
reports are completed the temporary repository can be
wiped.
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Proposed Blockchain uses


blockchain deployment can be useful in the
following:
Supply chain management.
Specific product insurance including motor
vehicle insurance;
Lending funds to consumers to purchase
goods;
Product recall arrangements;
Repair of products.
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Supply chain management


Manufacturers could embed through RFID
Technology or other IoT technology a
blockchain reference which the manufacturer
will set up.
The blockchain in being an integral part of the
supply chain / ownership of goods structure can
substantially reduce the risk of counterfeit
products entering the market and being traded.

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Supply chain management


The blockchain will not prevent counterfeit goods
from entering the market but it will allow the end
user/consumer to validate the authenticity of all
products and thus it should substantially reduce the
size of the end user market and thus reduce the
fraud committed on end users.
This will particularly important in the pharmaceutical
industry with counterfeit drugs. Health professionals
will be able to ensure that authentic drugs are at all
time administered to patients.
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Supply chain management


All new / potential owners will be able to
interrogate the blockchain to make sure that
the relevant goods are not counterfeit.
Luxury goods could be embedded with a QR
code by the manufacturer which can be
scanned by any mobile devise so as to
interrogate the blockchain to check its validity /
authenticity.

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Supply chain management


Write Once Read Many-times (WORM) technology.
It is possible for a manufacturer to embed in some
polymer film a key that can be read using a hand-held
device like a mobile phone that has embodied in it an
app that has been developed by the manufacturer.
The App can be authenticated when downloaded from
an authorised website that has extended validation
certificates allocated to it. Further the app could be
digitally signed by the manufacturer so as to reduce the
risk of false apps be deployed.
It is expected the Pharmaceutical industry to take
advantage of this technology.
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Supply chain management


Counterfeit drugs adversely impacted the US economy
by $72 billion in 2015.

Basically a clear sheath of a special polymer film could


be applied to the encapsulate packaging that is used in
keeping the drugs sterilsed A smart phone with light
emanation will be able to read the crypto and
interrogate the blockchain for authenticity and use by
date.
Last year it has been estimated that nearly a billion
dollars of out of date drug were administered in third
world locations.
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Insurance Fraud
How does the insurance company determine
that the person claiming ownership actually is
the owner or has an insurable interest?
The insurance company can interrogate the
blockchain using the serial number/VIN as the
reference point to determine ownership.
This aspect alone should substantially reduce
insurance fraud.

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Lending and blockchain interrogation


The lender wants to make sure that the goods
are not already encumbered and so it also
interrogates the blockchain using the serial
number of the product as a reference point.
The blockchain is used to record all transactions
that involve the relevant product including all
borrowings and insurance policies issued.

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Product recall by a Manufacturer/Repairs


The manufacturer needs to undertake a product recall
due to some safety fault identified post sale.
The manufacturer can register on the blockchain the
safety recall notice. Now in some jurisdictions it is illegal
to transfer a product whilst a product recall notice has
been issued.
Once the defect, the subject of the recall notice, has
been corrected then the manufacturer will update the
blockchain to identify that the product has been
corrected.

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Why blockchain is a hot topic

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Why is Blockchain a hot topic


There are a number of major industries that are
expending substantial funds on blockchain
research, development and deployment. These
industries include:
Finance sector (FIN TECH);
Luxury Goods (Diamond Trades);
Insurance;
Stock Exchanges;
Movie Studios;
Software development.
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Why is Blockchain a hot topic


Each of the above industries are looking at the
use of blockchain from a different angle:
The finance/share market sectors is wanting
to reduce the time between the signing of a
transaction and the time of settlement. In
land contracts the delayed time can be as
high as 60 days or longer and in the share
market it is T+2 days. The longer the period
the greater the risk of an issue arising.
Luxury goods and Pharmaceutical sectors
want to counteract counterfeit goods.
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Why is Blockchain a hot topic


The insurance sector wants to
reduce/eliminate the risk of fraud.
The IP sectors including movies and software
want to eliminate piracy.
The blockchain can in each case be used to
assist in solving these issues.

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Smart Contracts : Legal aspects

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SMART CONTRACTS & Legal Issues


A so called smart contract is neither smart or a contract.
Lawyers would call it a humpty-dumptyism. (See Lord
Glanville Williams series of papers on plain English for
lawyers and the discussion between Alice and HumptyDumpty from Alice through the Looking Glass)
What is a so called smart-contract? : it is computer code
that will be connected to a blockchain. The smart code
will monitor the internal performance of a contract and
any deviation will cause the software to activate certain
responses.
The Ethereum project has a number of so called smart
contracts in development.
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SMART CONTRACTS & Legal Issues


The R3CEV group is also investigating smart contract
uses in a number financial transactions.
The difficulties of smart contracts are:

How are equitable principle accommodated such as


innocent misrepresentation or discretionary aspects of
voiding a contract proper;
How can force majeure events be accommodated
as these are usually external events that impact
performance. This may be an opportunity for news
gathering organisations that are trusted to provide
information dealing with externalities.
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SMART CONTRACTS & Legal Issues

What happens if a contract is frustrated due to some


external situation that the parties did not
contemplate at the time of contracting. Again news
providers may be able to establish themselves as a
trusted source of such information.
What is too occur if performance of the contract is
later determined to be illegal;
What if the some of the terms are determined by a
court to be harsh or unconscionable?
How will aspects of the UCC be accommodated
such as limitation of liability provisions and font size
and capitalization of language. (this is a minor issue
but is mentioned for completeness only).
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SMART CONTRACTS & Legal Issues


Assuming that the above can be accommodated
are there certain contracts that should not be
monitored by a smart contract?

Further investigation / research is required for this


area.

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Road Blocks for Blockchain

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Road Blocks for Blockchain

On 20 April Morgan Stanley issued its report on the


development and deployment of Blockchain solutions.
This report identified 10 road-blocks that need to be
addressed before blockchains become a reality in banking:
1.

is there a compelling business case to support the


expenditure?,

2.

cost mutualisation/who funds the overhaul of legacy


systems?,

3.

Are there misaligned incentives,

4.

How do the lack of standards currently impact the


development and ultimate deployment especially for
inter-operability,

5.

Is the technology scalable without performance


degradation,
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Road Blocks for Blockchain


6.

What governance needs to be developed;

7.

How will regulators deal with the advancement of


this new technology,

8.

What are the legal risks not only with regulators but
also with clients,

9.

Are there any cryptology/security issues presently


existing or down the track like the development of
Quantum cryptography, and

10.

Can a blockchain system be developed that is


simplistic and interoperable with both other
blockchain deployments and legacy systems.
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Road Blocks for Blockchain

It is interesting that Morgan Stanley noted that no


single policymaker they met concerning the
research for their report would allow an
"unpermissioned" distributed ledger.
In general a blockchain is meant to be a
transparent recording of transactions but it is unlikely
that this will be the case for all transactions as the
finance sector and its customers will not want their
business transaction to be disclosed across the
blockchain.
One issue that still needs to be resolved will be
partial permissioned blockchain where parts will
only be visible to those with the correct credentials.
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Conclusion

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Conclusion
Blockchain is clearly at this point in time an immature
technology but is advancing at a rapid rate.
Morgan Stanley estimate that commercial systems with
Regulatory approval will not occur until 2017/2018.
There is great promise and investment occurring in this
area.
The financial sector is leading the way but other sectors
like pharmaceuticals are rapidly looking at this
technology.

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Conclusion
Regulators across the world are interested in this
technology and are greatly assisting in the development
and sandbox deployment of blockchain solutions.

Risk is still an issue and regulatory compliance remains an


outstanding issue as does system liability issues fro clients.
Smart contracts are code applications that are built on
top of a blockchain and this still needs further
investigation

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?? Questions ??

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