DIGITAL CURRENCIES AND THE SO-CALLED “blockchain,” are probably starting to show up on your “new business tech developments” radar screen. Maybe what did it for you was the recent announcement by the Bank of Canada that it’s testing some blockchain technology for its interbank payment space. You know you need to take something seriously when the Bank of Canada starts experimenting with it.
There is a lot of interest around digital currencies and the blockchain. (By some estimates, around US$1 billion has been invested in blockchain-related start-up companies in the past few years.) Some are calling the development of blockchain as significant as the invention of printing — or even the internet itself.
Regardless of the hype, digital currencies like bitcoin and the blockchain technology that underpins them should indeed be garnering serious consideration by Canada’s business community, as well as by governments and range of other entities and organizations that will be able to put these new functionalities to good use. And so, this month, a primer on what these new business models and technologies are; and next month, the legal issues they implicate.
OFFICIAL VS. DIGITAL CURRENCIES
One way to understand digital currencies is to contrast them with traditional currency and payment systems. When we think of “money,” we usually have in mind the legal tender of a country; in Canada’s case, the Canadian dollar. Our nation’s official currency is a medium of exchange, since it’s accepted by merchants, other businesses and individuals. Indeed, the Canada Revenue Agency takes the view that tax obligations can only be satisfied by “legal money,” namely the Canadian dollar.
Our official currency is also a “unit of account,” in that the prices of the multitude of goods and services in the economy are denominated in Canadian dollars, so that the marketplace can compare relative prices and value quickly and efficiently. It would be difficult to operate a market-based economy without an effective currency serving as a broadly accepted unit of account.
Another role of an official currency is as a “store of value.” This requires, ideally, that the currency have a stable value over time. Hyperinflation, as experienced by certain countries in Europe after the Second World War, can negate this role of a currency, which then drives people to store gold, jewellery and other physical assets.
It’s useful to compare a digital currency on these three fronts (as a medium of exchange; as a unit of account; and as a store of value), but before doing that, let’s also consider the various traditional payment systems that have evolved around official currency, including the Canadian dollar.
FROM CASH TO PAYPAL
In a modern economy like Canada’s, there are a number of payment options. Of course, there’s cash — payment by official government bank notes and coins. And cash has a lot going for it. It is easy to use, it’s quite secure, and it gives you anonymity when you use it. When you buy that “delicate” or “sensitive” item from the pharmacy (or from the back rack of the magazine stand) paying by cash means you don’t leave a trace of your purchase. And in 2013, cash still represented about 44 per cent of the volume, and 23 per cent of the value, of all point-of-sale transactions in Canada.
Over the past 25 years, we have seen the steady growth of other payment systems, including debit cards and credit cards. More recently, certain financial institutions have backed gift cards for making mobile payments. You can also now make email transfers of payment. You can even deposit a cheque by photographing it.
Then there are the payment intermediaries like PayPal, which stand between consumers and merchants. Growth in this business is staggering, as online shopping becomes an increasingly common experience. In terms of worldwide e-commerce, some 15 per cent of all purchases are now processed through PayPal.
In the developing world, some digital micro-payment systems have come to market, such as M‑PESA in Kenya (and a number of other countries) and Fundamo in South Africa (and 33 other countries). With these systems, money can be transferred using mobile phones and text messages.
With all these forms of payment, there is a central authority that manages the payment system. In the case of cash, that would be the federal government, which sets the parameters of the money supply — the actual production of the bank notes and coins — and sets interest rates through the Bank of Canada, and the like.
As for the other forms of payment noted above, credit card systems typically have a credit card company (think Visa or MasterCard), the card issuing bank and a payment processor. The credit card company usually has a proprietary clearing system. In the case of debit cards, the credit card issuer is replaced by the Interac Association, whose members settle their payment flows via the Canadian Payments Association.
The point is, the credit and debit card systems have large institutions to manage and record transactions, which are subject to regulatory oversight by government departments and agencies.
P2P CURRENCIES
Digital currencies like bitcoin, which are based on the blockchain P2P IT system, are structured quite differently than the traditional payment systems. There is no central authority, or even a managing intermediary. Rather, digital information (reflecting various transactions), fully encrypted, is recorded and stored on a distributed electronic ledger.
So, rather than your bank or payment processor keeping track of all transactions, a multitude of participants in the digital currency P2P network all have transparent access to all transactions executed over the system. In the case of bitcoin, for example, transactions that are in flight are, roughly every 10 minutes, permanently settled by being encased in the blockchain ledger, after which they are not alterable.
Put another way, with the traditional payment methodology, trust is generated by the fact that the system is overseen by large, (typically) solvent and highly regulated banks and other intermediaries that are keeping detailed records of all transactions. With blockchain, the distributed ledger system generates the trust, because all information is transparent and replicated for all participants to see.
BEYOND PAYMENTS
While payments (foreign remittances, e-fund transfers, e‑commerce, etc.) is the first widespread application for which blockchain is being pressed into service, astute commentators are predicting that literally hundreds of other business processes will come to take advantage of blockchain systems over the coming years.
Essentially, any activity today where an entity records information about transactions, these pundits say, can be done more efficiently with blockchain. For instance, press reports have the Bank of England considering a cryptography-oriented payments network, structured along the lines of bitcoin. The bank’s chief economist is quoted as saying that digital currencies truly raise some fundamental questions about the very future of money.
In terms of the public sector, activities such as recording and storing information about births, deaths, marriages, divorces and other key stages/events in life are also good candidates for blockchain treatment — not to mention, in the educational sector, information about diplomas actually awarded. By keeping track of them on the blockchain, there is less opportunity for fraud, forgery or misrepresentation. Driving records also raise possibilities — for sure, storing your licence, but also your actual driving behaviour, so that you (or your insurance company) can more readily translate your safety record into reduced auto insurance premiums.
Another potential application may exist for land titles, which also raises the prospect of “public-private hybrid” models of blockchain deployment. With respect to land titles, you may be able to still have a central registry, but perhaps it’s one that uses an approved registry system. And once you have land titles done this way, can the jurisdiction’s personal property security registration system be far behind? And so on, including building a new type of stock exchange on the foundation of a blockchain distributed ledger system.
In the private sector, a range of blockchain applications are also being contemplated. The “smart contract” for intellectual property is one type of use, where the encoding of the blockchain releases specific payments whenever certain use is made of a particular software, song or other property. Another likely candidate is in the insurance space, where policies, premium payments and payouts can all be stored and managed through the blockchain.
THE INEVITABLE BLOCKCHAIN
There have been a number of incidents over the past few years that have tarnished the reputation of bitcoin. There have been irregularities with some of the players in the bitcoin space, and the value of a bitcoin relative to official currencies has sometimes gyrated. It’s worth keeping in mind, however, that there are a number of other digital currencies being pressed into service that have adopted changes to their business models to address some of the perceived deficiencies of the bitcoin system.
Moreover, a number of commentators who remain skeptics about bitcoin and other digital currencies nevertheless feel quite bullish about the prospects for blockchain technology. You have to remember, it’s very early days, both for digital currencies and blockchain. I also predict we will see a plethora of variations on the blockchain come to market, again with each successive one correcting a flaw in the earlier system. Accordingly, given their inevitable future growth and usage, it is important to understand the legal implications of both, to which we turn next month.
George Takach is a senior partner at McCarthy Tétrault LLP and the author of Computer Law.
