Ledger for the digital age

Having an interest in technology and working in the Royal Bank of Scotland Legal team is a perfect combination at the moment. Fintech (financial services-specific technology) is exploding and RBS is at the centre, undertaking a huge amount of work in areas such as mobile banking, AI, open banking and APIs (application programming interfaces), and constantly horizon scanning for the best technological solutions to meet the needs of an increasingly sophisticated customer base.

The focus of this article is “distributed ledger technology”, or DLT, more popularly known as blockchain (although blockchain is just one of a family of DLTs). This has been a buzzword in tech circles since its development around 2009, and over the last couple of years has been a particularly hot topic in the fintech world. Some view it as potentially as influential as the internet itself; some think it is a case of the Emperor’s new clothes. The truth is probably somewhere in between and it is timely to take a look at the basics, as the next 18 months or so are likely to see tangible blockchain projects emerge.

Blockchain basics

But to take a step back – what is blockchain? The term is easily used; more difficult to explain succinctly. Without going into technical detail, the technology is essentially:

• an encrypted digital database;
• based on a distributed rather than centralised model; and
• specifically designed to allow secure digital transactions and to avoid the double spending problem.

As you can already see, that description invites further explanation.

The key element is “double spending”. In a digital transaction in particular, this has always been an issue. How do you prevent someone copying the digital “bits” that represent the value transferred and spending that value twice or even more? The obvious answer in a payment network is a ledger that records the balances and ensures that double spending doesn’t take place. Traditionally, this was a central ledger run by a trusted third party such as a bank. In the blockchain model, this is replaced by a decentralised, or distributed ledger. The distributed ledger works by having a network of “nodes” – simpler to think of as computers in a network, each of which checks the transaction, and overall reaching a consensus as to whether the transaction is valid. Each node has a complete record of the transactions that have taken place in relation to particular “bits”. That record is built into the digital representation of the value transferred. Each transaction is recorded as a block – a file protected by cryptography, which is attached to the last transaction or block, together forming a chain, stretching back into the history of the transactions – hence the name, blockchain.

The information on the blockchain is immutable; it can’t be amended without the nodes spotting the discrepancy as soon as another transaction takes place, as each node will have its own record of what the blockchain should state. If such an attempt took place, consensus would be impossible and the attempted fraudulent transaction would not be verified.

For our purposes, that is a very high-level description, and there is a wealth of detail that I haven’t even begun to set out, relating to the cryptography and the mathematical algorithms involved in verifying transactions (sometimes known as “proof of work”). There are different types of blockchain, such as permissioned (participation by invitation) and unpermissioned (open to anyone), each with advantages and disadvantages, and uses are limited only by imagination.

Blockchain in banking

The bitcoin cryptocurrency is the best known example of blockchain technology. However blockchain has been used in areas such as smart contracts (where predefined criteria, once met, are acted on automatically – perfect for relatively simple insurance arrangements, or ordering extra detergent when your smart washing machine is empty), identity, digital assets, or verifiable data (for example, in keeping track of conflict diamonds).

Given its potential, it is unsurprising that banks are keen to understand and develop their technology in this area. Blockchain could be seen as circumventing the traditional banking model where a bank acts as the trusted third party in charge of a central ledger.

However RBS spotted very early on that blockchain technology is something that needs to be understood by the banking industry, and something that can be utilised to improve customer services, offering secure and speedy transactional operations combined with the expertise, trust and regulatory oversight built up over many years.

As a lawyer it has been a privilege to be a part of the RBS legal team that has been shaping the way we work with the technology. This cutting-edge technology brings its challenges, however, and interestingly the largest challenge is not really technological or legal, but simply one of collaboration.

Can’t do it on your own

For a blockchain product to be a success, it needs to be shared among a community. A bank could develop blockchain technology that works perfectly internally, but it would be of no use to customers if it didn’t interact with other banks.

This has led to some interesting conversations around development of the technology and the use, ownership and licensing of intellectual property. Traditionally, most companies would hold on tight to the ownership of any IP, but it is arguable that in order to encourage wide collaboration and adoption, an open source approach (at least at the underlying platform level) is preferable.

Making the platform open source allows for a swifter uptake and for the development community to work on improving and updating the code. It allows companies to collaborate on projects without the initiator ending up gaining the benefit from the hard work of all. At this stage of a developing technology, the risk of working in isolation to develop a proprietary IP could result in potential collaborators looking elsewhere for a better or easier deal. Of course, there is a balance to be struck between, on the one hand, protecting valuable IP and the investment that went into its creation, and on the other being able to work freely with third parties. Striking this balance is part of the in-house lawyer’s work, and it is a key area where we can help add value to the process, with a pragmatic, commercially focused attitude.

There are many possible options and nuances to licensing models and approaches to IP, and finding the right approach for any given project is a matter of close understanding of the business needs. In these circumstances an in-house lawyer is ideally placed to provide advice and insight.

Collaboration is therefore key to developing usable blockchain solutions, and RBS is involved in projects with other banks and financial institutions, both on an independent project level and within consortia that span the industry, such as R3.

However, with around 25 blockchain consortia in existence, inevitably there is a degree of fragmentation, meaning that there will almost certainly be different blockchain platforms emerging with individual strengths for different uses. At present, the participants are developing many potential applications on various platforms, and there is perhaps a requirement (within the financial services industry) to agree on common standards and regulation to ensure that developed applications can work together across the board.

Legal and regulatory challenges

The technology is very much in its infancy. Most projects are at the proof of concept stage. From a regulatory point of view, the FCA has recently published a discussion paper on DLT which states that they “do not see a ­clear need to consider regulatory changes to our regulatory framework for [DLT] solutions to be implemented”. The regulators are watching carefully, and exploring the potential risks and opportunities, but there is not yet any blockchain-specific regulation – it is simply another tool which can be used within the existing framework.

Having said that, there are legal issues to think about (which the FCA considers outside their remit) as regards using blockchain, including:

• Which jurisdiction would control any legal issues arising from an international blockchain platform? If a transaction is confirmed in multiple locations, which will take precedence for legal governance purposes?
• In a blockchain solution, which immutably records transaction details, how will any privacy concerns be dealt with? How will the “right to be forgotten” apply?
• For smart contracts based on automated responses to set criteria, if the criteria have been incorrectly triggered, there may be no human intervention to prevent the contract being performed, and unwinding the results may be complex.
• Unpermissioned blockchain often works on a totally anonymous basis, opening the door for potential fraud issues.

Blockchain is undoubtedly exciting and potentially gamechanging for many areas; however, fundamentally it’s worth remembering that it is just a technological tool. Existing technologies can provide similar results in many areas, and one of the key things RBS does before investing time and effort into a blockchain project is consider whether the same result could be achieved just as well through existing methods.

Only where blockchain can provide something that the existing tech can’t will RBS move ahead. Where it does, it’s genuinely exciting to be providing legal advice as a part of a technological paradigm shift – a great time to be a lawyer.