Firms in such diverse industries as finance, energy, healthcare and logistics are testing, and in some cases implementing, blockchain and distributed ledger data structures. At its core, a blockchain is a database that tracks ownership of assets and exchanges of information, and through which assets can be transferred and information made available. Distributed ledger technology (DLT) makes it possible to store this database among a distributed network of computers.
Early applications of blockchain have been focused on financial applications such as digital currencies. Given that the architecture of a blockchain is described as being a distributed ledger, this early set of uses is not all that surprising. Today, however, there are a great many organizations investing heavily in developing blockchain technologies for virtually every industry. Whether a company wants to use blockchains and DLT at the enterprise level, within a trusted group of counterparties, or at a market level, moving from systems-of-record at the company level to an authoritative system-of-record at multiple entities is a very powerful concept. Blockchains and DLT, when combined with more traditional cybersecurity protocols, have the potential to reduce dependence on third party intermediaries, mitigate centralized systemic risk, defend against fraudulent activity and improve data quality and governance.
Technological advances in this new arena will stretch and test the limits of today's laws and societal norms. Because of the game-changing potential that implementation of blockchain and DLT can have on an industry, it is important to proactively assess the risk of running afoul of existing or future expected laws while your technology solution is in development. Partnering with legal counsel who knows both the technology and how to implement it within your regulatory paradigm is critical at the earliest stages of development. Crowell & Moring's deep regulatory and industry experience, combined with our technology knowledge, allows us to provide practical, real-world advice for how these new technologies will impact your industry and how they can be implemented in a compliant manner.
Crowell & Moring attorneys have long been leaders in financial technology, representing regulated entities such as alternative trading systems, swap execution facilities, clearing organizations and broker-dealers, as well as fintech creators and vendors. Our experience in fintech consortiums is unparalleled, and given that any blockchain/DLT solution for fintech will require buy-in from large numbers of market participants, we are well-positioned to assist clients in working toward new solutions in the fintech sector. As counsel to the largest consortium of financial industry players (57 international participants at last count) who are taking a leading role in the development of a DLT platform for financial transactions worldwide, our attorneys are assisting the groundbreaking innovators in blockchain and DLT for fintech. Our experience also includes setting up trading platforms, working with regulated entities to develop compliance programs, and representing regulated entities in investigations and litigation. We have assisted global financial institutions in anti-money laundering compliance related to virtual currencies, and have helped our clients comply with Bank Secrecy Act requirements and develop risk-based compliance programs.
Health care operators, including our clients, are experimenting with the development of a new class of blockchain-based applications that will unlock wasted resources and solve important interoperability problems in healthcare. Any blockchain solution involving health data or records, however, absolutely must be compliant with HIPPA and other regulations regarding patient privacy, and must ensure that patients' data is protected from unauthorized access and misuse. Our attorneys are deeply committed to helping clients understand the practical implications of health information technology. Jodi Daniel, chair of Crowell's Digital Health Practice and formerly the founding director of the Office of Policy in the Office of the National Coordinator for Health Information Technology (ONC), recently spoke about these issues as they relate to DLT at our Digital Health Seminar, co-hosted with Accenture.
International Trade Compliance, Supply Chain Implementation & Finance
Blockchains and distributed ledger technology could provide a significant tool to address import and export supply chain risk and change the way some parts of import/export compliance and finance are done. Finance aspects of international supply chain trade are complex and archaic and are ripe for technological innovation. Careful assessment and implementation, however, are key. DLT is not yet identified by any agency, import or export, as a means to satisfy regulatory obligations, and companies should be prepared to demonstrate what it does and does not do. A factor to consider when contemplating a beta program for DLT is that other third parties may not have the same familiarity, so acceptance may take more time and effort. It is more important to work with counsel who can educate vendors, tollers, service providers, customers, and others on the on the advantages and uses of DLT and on its commercial and regulatory importance.
In a DLT environment, a hacker could change one copy of the blockchain ledger, but would have difficulty changing all the copies because they would have to hack into each decentralized server. If any one server's copy of the blockchain is different from the others', the network would know that server has been compromised. If one server on the network goes down, the other servers still contain all the transaction records. All businesses, however, are susceptible to cyberattacks and to other internal and external threats to their data and systems. Crowell & Moring's integrated approach to risk mitigation enables us to counsel and train companies on strengthening their cyber defenses, developing and implementing global privacy and data protection programs, complying with applicable laws, and incorporating government standards and industry best practices into their risk management programs. We have extensive experience in responding to and managing the crises that can arise when a privacy or data security incident occurs or when a privacy or security vulnerability is made public.
Implementation of any blockchain or DLT solution will require software development and licensing arrangements, as well as securing appropriate protection for innovations whether through patent, copyright, or trade secret. Both blockchain/DLT developers, and companies that use these solutions, will need to consider ownership not only of the technology itself but any data stored on the distributed ledger. Our IP team has the in-depth experience needed to negotiate the development, licensing and implementation of these new technologies.
Commodity Futures and Derivatives Trading
Blockchain technology, DLT and "smart contracts" built on blockchain and DLT layers seem poised to open up a new world of possibilities for futures and derivatives trading. Not only can these technologies help minimize the steps required for post-trade processing, they can make clearing and settlement instantaneous and some even believe they may eliminate third-party intermediaries entirely. Our attorneys understand the excitement behind the use of this new technology, but also understand that regulations may lag behind and that any implementation will need to be in accordance with current regulatory practices. Crowell & Moring's Commodity Futures Trading Commission (CFTC) practice provides representation in a wide variety of regulatory matters relating to the creation and operation of CFTC-regulated entities, dealing with both the CFTC and the National Futures Association. Our attorneys have published CFTC-specific regulatory articles on the benefits and concerns regarding DLT innovations as they relate to post-trade processing of swaps, including reporting, compression and reconciliation. Our team also includes a member of the CFTC's Energy & Environmental Markets Advisory Committee.
One of the most practical applications of DLT will be to the transfer of securities. Through blockchain and DLT, a transfer that currently takes three days to complete can be done instantaneously, although there are questions in the marketplace as to whether simultaneous settlement of all securities trades is really desirable. Of course, any party that chooses to offer its securities to be traded through DLT must consider the risk factors and disclosure requirements involved in such an offering. Crowell & Moring's experienced securities law attorneys can work with offerors in both public and private placements to ensure that DLT offerings are properly documented and the risks are properly disclosed. In addition, our Securities and Exchange Commission (SEC) enforcement practice covers the full range of securities fraud investigations, including federal and state grand juries, and inquiries initiated by the SEC, Financial Industry Regulatory Authority, and other regulatory and investigative bodies. Our experienced team consists of the former head of the SEC Fraud Section, former prosecutors and enforcement attorneys from the Department of Justice, U.S. Attorney's Offices, and the SEC. This combination of talent and government experience means that we are ready to counsel and, if necessary, litigate before any agency or court, and that we will do so in a way that balances regulatory compliance with each client's continuing business needs and concerns.
Anti-Money Laundering & Bank Secrecy Act
The instantaneous acceptance of contract terms through a shared ledger presents anti-money laundering (AML) issues regardless of whether the asset is a virtual currency, high value works of art, property, or any other commodity or service. The risks for international business associated with increased enforcement of AML laws, including trade-based money laundering, are growing daily. We help multinational financial institutions and other companies navigate the legal, business, and regulatory AML requirements that arise under the Bank Secrecy Act (BSA) and other applicable Federal and state laws, as well as the many regulators that have a role in enforcing AML requirements. Our team works with clients in their interactions with the Financial Crimes Enforcement Network (FinCEN), the Financial Industry Regulatory Authority (FINRA), the Department of Justice (DOJ), the Office of the Comptroller of the Currency, the Federal Reserve, and state regulators. Where appropriate, we also partner with our colleagues in London and Brussels to address EU AML rules, and EU data privacy rules.
New Instrument Types
As new blockchain solutions such as appcoins are used by industry participants to raise funds, it is key to understand the legal implications of these instruments. For example, decentralized autonomous organizations (DAOs) have great potential in enabling new sources of capital and empowering investors, but these solutions must also operate within current legal frameworks. We have many years of experience advising clients on what constitutes a “security” or a “securities transaction” under the Howey test and other guidance, and what constitutes a “swap” or a “security-based-swap” under the new Dodd-Frank regulations, and what registration and other obligations arise from the determination. Our attorneys have been involved in the regulation blockchain and distributed ledger technology from its infancy, having participated in early discussions with the SEC Division of Trading and Markets when it was formulating its determination not to regulate Bitcoin as a security.
The regulatory structure for blockchain and DLT is in its infancy. Some policymakers have cautioned regulators to take a "first, do no harm" approach to this innovative technology, but of course different agencies will have varying and sometimes opposing interpretations of its benefits. Bank regulators, while interest in these technologies, remain focused on the safety and soundness of the banking system. The CFTC, for example, has determined that Bitcoin is not a currency and will not be regulated as an FX transaction but rather is a commodity and will be treated for regulatory purposes as gold or oil sales. Likewise, the SEC has determined that it will not view Bitcoin as a currency, a determination in which C&M attorneys participated. However, the U.S. Treasury's Financial Crimes Enforcement Network (FinCEN) has put forth guidance that treats Bitcoin as a "virtual" currency subject to FinCEN's money services business regulations under the Bank Secrecy Act. The U.S. Congress has already held hearings and explored legislative initiatives related to Bitcoin, but most Members are content to monitor its evolution from a niche exchange to a financial tool. Crowell & Moring's Government Affairs Group includes highly experienced professionals who have been at the forefront of the DLT innovations. Many are former congressional staffers and executive branch officials, including a federal Executive Level III confirmee, who bring a unique combination of access, public policy, and legal experience to the table. They have served on Capitol Hill, in executive branch agencies, as the presiding officer of a state legislature, and are bipartisan.