“I believe that three major developments are imminent,” stated Sir Geoffrey Vos, Master of the Rolls. “They will mean that every lawyer will require familiarity with the blockchain, smart legal contracts and cryptoassets.”
Last week, The Law Society in collaboration with the Tech London Advocates (TLA) published comprehensive legal and regulatory guidance on Blockchain technology. In a seemingly prophetic manner, Sir Vos predicts the following three significant developments:
1. The launch of Central Bank Digital currencies (CBDCs) that will put cryptoassets into mainstream use.
2. The widespread adoption of digital transferable documentation.
3. The transition from analogue programmes, such as Word, to smart machine readable documents.
An Introduction to Distributed Ledger Technology (DLT)
The term DLT refers to a broad umbrella of technologies that seek to store, synchronise, and maintain digital records across a network of computer centres.
The concept of a ledger is not a new one – the earliest ledgers were kept on clay scripts, or carved into stone, c.4000BC in Mesopotamia. These ledgers were used to record and demonstrate definitive ownership of crops in storage. Purchasing ownership was therefore as easy as handing over the ledger and/or inscribing the new owner onto it.
The Mesopotamian example describes what we would call a centralised ledger – the definitive and only record within an ecosystem. Centralised ledgers continue to be used today, but a significant drawback: they have a single point of failure. If the ledger is lost, stolen, or attacked, the ecosystem and its participants will fail.
The development of civilisation led to the decentralised ledger. We often rely on trusted intermediaries to keep and maintain common digital record repositories. For example, these may come in the form of social networks which keep and maintain records of our photographs, status updates, and music. Similar to centralised ledgers, they suffer from significant drawbacks: they still have points of failure, and rely too heavily on trust (e.g., if the ledger is the target of an attack, participants have limited recourse.)
So… what’s the solution? Distributed ledgers. They seek to avoid the drawbacks of centralised and decentralised ledgers by removing points of failure. The ledger, or parts of the ledger, are replicated and stored across a network of computing centres. This network of computing centres, known as nodes, work together to update the ledger as new updates (i.e., transactions) arise.
They are, theoretically, infinitely scalable, and entirely robust – there is no point of failure, as if one node fails, the others simply continue to work. Think of it as “sharing” the ledger – to shut it down, you would have to shut down every node.
A Cryptoasset may loosely be understood to mean an asset of whatever kind that is represented digitally on a DLT platform. They might exist purely digital, such as the so-called crypto-currency Bitcoin (BTC), or physically, for example a piece of physical art that is represented by way of tokenisation (as an Non-Fungible Token – NFT).
Exclusivity
To enable participants in the network to exclusively control their records or cryptoassets, most DLT implementations utilise “public key cryptography.”
Public Key Cryptography is a system that uses two types of information knowns as keys:
a) Public keys – that may be widely disseminated amongst the network.
b) Private keys – that should be known only to the relevant network participant.
The benefit of this system is that it is asymmetrical. A message (or transaction) which was encrypted using the Sender’s private key, can be decrypted using the sender’s public key, without revealing or compromising the security of the sender’s private key.
DLTs and Cryptoassets in practice: Central Bank Digital Currencies
To understand the use-case of a Central Bank Digital Currency (CBDC), you must first go back to basics.
What is money?
Broadly speaking, money has multiple functions: a store of value, a unit of account, and a medium of exchange.
In most economies, this takes the form of a fiat currency. This is money backed by a government and declared to be “legal tender” (meaning it can be used to settle debts or financial obligations.)
The two forms of money in the UK are central bank money and private money. Central bank money represents liabilities of the central bank. For this public, this takes the form of cash (bank notes and coins).
Private money is commercial bank money, i.e. people’s money deposited at commercial banks and loans created by commercial banks.
What are CBDCs?
A CBDC may simply be understood as the virtual form of fiat money – it has the full faith and backing of the issuing government.
Advantages
Commercial banks act as intermediaries between Central Banks and consumers – they thus act as third-party ledgers within a decentralised system. As distributed systems do not require intermediaries, a CBDC would erode third-party risks – e.g. What if the bank runs out of cash deposits?
It could also improve financial inclusion. Nearly 1.7 billion people are unbanked globally (close to one forth of the global population). Especially in developing and poor countries, the costs associated with developing banking infrastructure are too high – CBDCs can eliminate the need for such expense.
Finally, CBDCs can prevent illicit activity because Cryptography and public ledgers make it easy for a central bank to track money throughout its jurisdiction.
Disadvantages
CBDC does not solve the problem of centralization – a central authority (the central bank) is still responsible for and invested with the authority to conduct transactions.
Moreover, users would have to give up some degree of privacy. If administrators can track illicit transactions, then they can just easily track yours.
Further Reading
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