15 legal issues a blockchain startup should watch out for.
Blockchain companies can also choose insurance to manage these regulatory risks. Since cryptocurrencies are considered the equivalent of traditional assets like "stocks and "money", traditional insurance can cover some of these risks. Many leading insurers have also launched insurance policies. specialized insurance products to cater to the crypto and blockchain markets outweigh the potential risks associated with it, and businesses that take advantage of this technology right now can reap the benefits. future benefits.
INTRODUCTION
The introduction of any new technology entails ambiguity about how the legal and regulatory systems of different jurisdictions will deal with the new technology.
Until a few years ago, the legal validity and enforceability of electronic contracts was still debated. However, now electronic contracts and electronic signatures have a place in the laws of almost every state and are recognized by the government of that country.
The legislative process to regulate blockchain technology has begun. US states like Arizona and Tennessee have enacted laws stating that records stored on the blockchain and signatures made on the ledger must be treated as electronic records and electronic signatures, respectively. However, India is in the process of introducing a bill to formalize and shape the way digital assets and digital currencies are handled via blockchain.
While blockchain has the potential to revolutionize business transactions and operations, it is important to be aware of the challenges of blockchain technology before getting involved with both feet. So, if you are considering starting your own blockchain startup, read this article carefully to understand the legal issues surrounding the regulation of blockchain technology.
What is Blockchain?
Blockchain refers to a decentralized public ledger on which data can be stored and distributed digitally across different networks of computers linked in a peer-to-peer network. What sets it apart from conventional methods of electronic storage is immutability (the inability to change or delete data), transparency, high security, faster settlement, and decentralized nature. These characteristics are why companies want to jump on this new technology and use its advantages.
Legal issues for blockchain businesses
1. Legal issues
As a decentralized ledger, blockchain nodes can span a large number of locations around the world. This means that every transaction stored on the blockchain is likely to be in any jurisdiction where the network node is located, resulting in a large number of potentially applicable rules and laws for the blockchain network.
The system must comply with all applicable legal and regulatory regimes. It also makes it difficult to track a transaction if that particular transaction turns out to be fraudulent or erroneous in nature.
2. Applicable Law
The laws and regulations of different jurisdictions vary, including the fundamentals of contract and legal title. What makes a contract valid in one state may be a void agreement in another. To avoid this confusion, the laws governing transactions must be predetermined by an internal governance system.
This will allow the user to determine the validity of the contract and their rights and obligations under the contract. It would also be helpful to specify a dispute resolution method that is acceptable to all parties involved.
3. Cybersecurity
While blockchain itself is considered a “counterfeit” and highly secure technology; this benefit will be nullified if the information stored on the blockchain is compromised. Instead of targeting the ledger itself, cybercriminals may attack data entry points, resulting in the storage of false or misleading information.
A 15-year-old man from the UK proved that these types of attacks are possible when he developed proof-of-concept code that allows backdoor access to hardware wallets. This method will allow the attackers to change the payment amount and destination of the wallet, even redirect the payment to their own account in an undetectable way, causing the funds to reach the destination wallet. .
Besides the above technique, brute force attacks are also a potential threat. In most blockchain systems, most of the processing is done by a large number of nodes. If an attacker could identify these nodes and target them, the registry would be compromised. Cryptocurrency exchanges are also vulnerable to Eclipse or Sybil attacks and denial-of-service attacks.
4. Force Majeure
This clause of a contract usually covers events such as war, pandemic, natural disaster, fire or anything beyond human control and the like. . However, in the case of a blockchain-based system, there may be other legal issues to consider, such as smart contract issues, issues of cryptocurrency transfers, one-party access rights, etc. specifying whether such events fall within the scope of force majeure events and whether the parties may rely on them to evade or delay the performance of their contractual obligations. An exception may also be made to this provision stating that "the parties may not claim the Force Majeure clause for matters arising from the party's default or inability to maintain appropriate safeguards for the industry".
5. Intellectual Property
The ledger will certainly contain the value and ownership of such intellectual property is an important factor to consider.
Customers can claim ownership of this intellectual property, or they can choose to license it for the term of the agreement, or agree to a perpetual license if it is not specific to this particular blockchain network, or they may restrict the IP provider's usability based on time, recipient or method of use.
The majority of blockchain and virtual currency projects are developed under open source licenses. These licenses are generally non-commercial, royalty-free, and impose certain restrictions on users. It is therefore important that companies understand the limitations of the open source licenses granted to them and to protect themselves from any potential liability that may arise as a result of a breach of the terms of the license. license.
In addition, any new software development (such as mining, encryption methods, payment methods, etc.) must be patented in order for the company to own the intellectual property of the new technology. . Blockchain-based startups must actively file patent applications to protect critical components of the blockchain.
6. Accountability and Decentralized Autonomous Organizations
An important question for regulators when dealing with decentralized systems is who is responsible for breaking the law? Decentralized Autonomous Organizations (“DAOs”) are entities that are autonomous in nature and are governed through the implementation of pre-coded rules. As such, they require little or no human intervention and are used to execute smart contracts that are then recorded on the blockchain. This gives rise to many legal problems for blockchain companies. First, what is the legal status granted to such subjects? Is it just automated legal contracts, software, or a legal entity like a company? Do they have powers given to “traditional businesses,” such as the right to sue and be sued? Who will be held responsible if one or more laws are violated? This dilemma is similar to the days when it was difficult to determine who was responsible for a company's violations. The problem was solved by bringing the doctrine through the corporate veil. Do we need to develop similar legal principles to determine the liability of DAOs or their creators? Only time will answer. Regulators and courts will find it difficult to arbitrate such disputes and may even impede the mass adoption of these technologies where no rules apply.
7. Database is Proprietary
Although companies generally do not have intellectual property rights to the particular portions of information provided to them, the aggregation of data, i.e. databases , covered by intellectual property rights in different jurisdictions. In India, databases are protected as literary works under India's Copyright Act 1957.
Companies often transfer this data to other bodies, such as their data processors. themselves, marketing agents and other service providers, to store data or to provide better services. If the person or organization to which the database is transferred wishes to use the information for another purpose, they will need the consent of the relevant persons to comply with the data protection regulations in force. in most jurisdictions.
8. Data Privacy
While immutability is one of the key features that make blockchain useful, it acts as a double-edged sword. Since the data once stored on the ledger cannot be deleted or changed (at least, not easily), the blockchain is automatically displayed as non-compliant with data protection laws. The European Union's General Data Protection Regulation provides for a "right to be forgotten" while the California Consumer Privacy Act also gives consumers the right to request changes or deletion of their data. surname.
In addition, cryptocurrency transactions are said to be of a "pseudonymous" nature, meaning that although the data points are not directly related to a particular person, many distinct occurrences and that person's data may be relevant. Once the data is delivered to a person, fake transactions over their lifetime are at risk of being exposed. This risk will inevitably increase over time due to the constant history of transactions on the blockchain.
9. Smart Contracts
Smart contracts are pre-written computer codes. The terms of the contract are determined on an “if” and “if not” basis. Once the specified criteria are met, these blockchain-based contracts are automatically executed without any intermediary to confirm the transaction. This raises questions about the enforceability of these contracts. Since everything is automated, there is little room for negotiation. Elements of offer, valid acceptance, agreement, consideration, etc. may also be considered.
Software developers can also be held liable for poorly written code that results in loss to customers. This could be the result of code malfunctioning or not working as intended by the parties to the transaction. Additionally, public DAO blockchains can be hacked. In 2016, there was one such attack in which hackers targeted smart contracts running on the blockchain and transferred nearly $50 million in funds into a hacker-controlled subcontract. Code developers or DAOs may be responsible for such attacks.
10. Product acceptance
In most smart contracts, the buyer makes a prepayment, which is held in a secure location until the merchant releases the goods/cryptocurrency. . Once the goods or virtual assets are released, payment is automatically made to the merchant. This raises questions about product acceptance. Traditional contracts often contain provisions concerning the standard and quality of the goods, and the buyer is not deemed to have accepted the goods until he has had a reasonable opportunity to check that they conform contract or not.
Most traditional contracts for the international sale of goods are governed by laws such as the United Nations Convention on Contracts for the International Sale of Goods 1980 which contain provisions relating to the Buyer's accept goods. The smart contract must clearly state which laws apply, whether the goods can be rejected, and at what stage the product acceptance takes place.
11. Compliance with financial and tax laws and regulations
This is a complex and ambiguous area as different jurisdictions have different financial laws and regulations. Most financial laws apply to representatives or custodians of financial products. However, decentralized finance systems have a non-custodial structure, which creates ambiguity as to whether these laws apply to these systems.
Applying existing tax frameworks to the digital economy has also proven to be a challenge. There may be separate rules for taxing cryptocurrencies, utility tokens, supply chain management platforms, and more. In many states, cryptocurrency exchanges are required to perform regular risk assessments and implement anti-money laundering programs.
12. Due diligence requirements
Traditional appraisal methods must be adapted. Transaction attorneys performing due diligence on investments in blockchain-based startups must be knowledgeable about the new technology and the unique issues associated with it, such as ownership. data, intellectual property, open source blockchain platform limitations, etc. These factors must be assessed in light of competitive barriers to entry and the business value proposition.
13. Antitrust Considerations
In the case of a partnership or joint venture between competitors on a blockchain platform, there is a risk of the exchange of sensitive information between competitors, which could lead to activities anti-competitive business.
Organizations should implement safeguards to prevent the exchange of confidential data, such as establishing permissions that allow only intended recipients to access the information contained in a data block. Aggregate or anonymize sensitive data stored on the blockchain can also be useful to prevent competitors from taking advantage of it.
14. Confidentiality
In the case of a multi-party blockchain, it should be clearly stated whether the receiving party's addition of confidential information to the blockchain is considered a violation or an authorized disclosure by the disclosing party. or not. Due to the immutability of the blockchain, the terms regarding the return and/or deletion of confidential information upon expiration of the agreement's term must also be reviewed and adjusted.
15. Virtual Assets (Crypto and NFT)
If the blockchain system uses virtual assets in its operation, a new set of complications arise.
The status of cryptocurrencies varies by jurisdiction. Many states have announced a complete ban on cryptocurrencies, while some warn about their volatile and unregulated nature, while some states like El Salvador have adopted virtual currencies and accepted them. legal tender. Taxes on these properties also need to be considered. In India, Union Budget 2022 has introduced a 30% tax on revenue generated from virtual assets.
Conclusion
It is clear from the discussion above that there are a number of risk management challenges involved for any business that intends to adopt blockchain technology. However, we have already seen such challenges, when it comes to Internet adoption, the introduction of e-commerce, and electronic records. It is important to correctly identify risks and legal issues and mitigate them appropriately where possible.
Blockchain companies can also choose insurance to manage these regulatory risks. Since cryptocurrencies are considered the equivalent of traditional assets like "stocks and "money", traditional insurance can cover some of these risks.
Many leading insurers have also launched insurance policies. specialized insurance products to cater to the crypto and blockchain markets outweigh the potential risks associated with it, and businesses that take advantage of this technology right now can reap the benefits. future benefits.
written by:
Manjushree Mitra.